SEC 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. Even as the SEC is considering amendments to Rule 10b5-1, courts continue to grapple with when and how a stock trading plan can help shield corporate executives from securities fraud liability.
In KBC Asset Management NV v. DXC Technology Co., 19 F.4th 601 (4th Cir. 2021), the Fourth Circuit examined the various categories of scienter allegations made by the plaintiffs, including allegations that the company’s CEO and CFO sold shares during the nine-month class period. The CEO sold 17% of his holdings, for proceeds of over $10 million, and the CFO sold 77% of his holdings, for proceeds of over $9.5 million. The sales were concentrated in the time period shortly before the company revised its revenue projections downward (i.e., the alleged “corrective disclosure” at the end of the putative class period).
The Fourth Circuit held that despite the large amounts involved and the arguably suspicious timing, the sales could not support a strong inference of scienter. First, the court found that the CEO’s sale of 17% of his holdings was similar to percentages that the court previously had held to be “nearly de minimus.” Second, while the CFO’s sales were far more significant on a percentage basis, during the nine-month period prior to the class period the CFO had sold nearly $15 million worth of shares. The court declined to “draw a strong inference of scienter from the fact that [the CFO] sold much less stock during the period in which he was allegedly defrauding investors than during the period in which he is not alleged to have done so.”
The defendants also argued that any inference of scienter should be negated by the fact that all of the trades were done pursuant to Rule 10b5-1 trading plans. The Fourth Circuit concluded that it could not consider the impact of the trading plans because the record was “silent as to when [the CEO and CFO] entered their plans.” If the plans had been entered into during the class period, they would not “mitigate a suggestion of motive for suspicious trading.” Interestingly, the court also noted in a footnote that it was not clear whether it could consider the trading plans “as an affirmative defense at the motion-to-dismiss stage.” Rule 10b5-1 trading plans, however, are an affirmative defense to a claim of insider trading, which is different than a claim of securities fraud based on material misrepresentations. There does not appear to be any reason why a court could not consider the existence of trading plans in assessing whether trading by corporate insiders has raised an inference of scienter.
The SEC’s proposed amendments to Rule 10b5-1 place additional restrictions on how trading plans are structured and create extensive corporate disclosure requirements around the creation and use of trading plans. If adopted, these amendments are likely to have a significant impact on the defense of securities class actions. Stay tuned.
Holding: Dismissal affirmed.
The 10b-5 Daily 