Scienter and Rule 10b5-1 Trading Plans

Whether trading under a Rule 10b5-1 trading plan can help shield corporate executives from securities fraud liability is a topic that courts continue to explore.

Rule 10b5-1, put into place in 2000, establishes that a person’s purchase or sale of securities is not “on the basis of” material nonpublic information if, before becoming aware of the information, the person enters into a binding contract, instruction, or trading plan (as defined in the rule) covering the securities transaction at issue. To take advantage of this potential affirmative defense, many executives have implemented trading plans for their sales of company stock.

Insider trading, of course, is often used by plaintiffs in securities class actions to create an inference of scienter (i.e., fraudulent intent). The plaintiffs allege that the individual corporate defendants profited from the alleged fraud by selling their company stock at an artificially inflated price. In the latest decision to consider the impact of Rule 10b5-1 trading plans on insider trading scienter allegations, the court in In re Netflix, Inc. Sec. Litig., 2005 WL 1562858 (N.D. Cal. June 28, 2005) found that the fact that the trading in question took place pursuant to a trading plan mitigated against a finding of an inference of scienter.

The author of The 10b-5 Daily has written an article (with one of his colleagues) on this topic.

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