securities header


October 2012


From the editors of CCH Federal Securities Law Reporter, CCH Blue Sky Law Reporter and the securities publications of Aspen Publishers, this update describes important developments covered in these publications, as well as timely topics of interest generally to federal and state securities practitioners. This update includes a preview of IPO Vital Signs, an advanced IPO research analysis tool, for IPO professionals and pre-IPO companies. New this month is a preview of RBsource, an all-in-one online securities law resource, powered by the Securities Redbook. Finally, please see the “Hot Topic of the Month,” for research tips and references to CCH and Aspen source material on point.

 To view past issues of the Securities Update, please visit

 If you have questions or comments concerning the information provided below, please contact me at


Financial Reform Resources



CCH Federal Securities Law Reporter

SEC Extends Sunset of Temporary Municipal Advisory Registration Rule. The Securities and Exchange Commission amended interim final temporary Rule 15Ba2-6T, which provides for the temporary registration of municipal advisors under the Securities Exchange Act, as amended by the Dodd-Frank Act, to extend the date on which Rule 15Ba2-6T (and consequently Form MA-T) will sunset to September 30, 2013. Under the amendment, all temporary registrations submitted pursuant to Rule 15Ba2-6T also will expire no later than September 30, 2013. This is the second time the Commission has extended the sunset date for rule 15Ba2-6T. The rule was originally effective through December 31, 2011 and was subsequently amended in a later release to extend the sunset date to September 30, 2012.

The temporary municipal advisor registration scheme remains in place as Congress considers refining the definition of municipal advisor through legislation. The pending legislation (H.R. 2827) would limit the term “municipal advisor” to such advisors formally engaged, in writing and for compensation, by a municipal entity. H.R. 2827 passed by voice vote in the House of Representatives on Thursday, September 20, and was referred to the Senate Committee on Banking, Housing, and Urban Affairs. Release No. 34-67901 is reported at ¶80,148.

2nd Circuit: SEC Showed Sufficient Evidence of Insider Trading. A 2nd Circuit panel vacated and remanded a district court order granting summary judgment in favor of three individuals charged by the SEC with insider trading. According to the Commission, an underwriter at a company providing corporate financing tipped a friend, who was employed as an analyst at a hedge fund, about the potential acquisition of a company. The friend then passed this information on to his superior, who traded on this material, non-public information.

The appellate court held that summary judgment was erroneous because the Commission’s evidence created genuine issues of material fact as to each defendant’s liability under the misappropriation theory. The panel first found that the Commission presented sufficient evidence to survive summary judgment as to the underwriter’s liability. Citing Supreme Court precedent, the panel stated that it was undisputed that the underwriter owed his employer a fiduciary duty since a company’s confidential information “qualified as property.” The Commission also showed that the underwriter knew of his obligation to keep information about the transaction confidential due to his own testimony that he knew it was confidential, a deal book with every page marked “Extremely Confidential,” and his knowledge of the confidentiality provisions in his employers’ code of conduct.

There was some dispute as to whether the Commission presented sufficient evidence to allow a jury to conclude that the alleged tip actually occurred, but the panel found the evidence to be sufficient. While there was no direct evidence of the tip, the panel said, the evidence presented was sufficient for a jury to infer that the underwriter tipped his friend. The evidence was also sufficient for a jury to find that the underwriter knew that the friend would likely use the information to trade in securities. The evidence was also sufficient to show that the underwriter intentionally made the tip and had personally benefitted from it. It was undisputed, the panel stated, that the underwriter was friends with the tippee, and a “personal benefit” includes making a gift of information to a friend. This, the panel concluded, was sufficient for a jury to conclude that the underwriter intentionally or recklessly revealed material non-public information to his friend, and that he knew that he was making a gift of information that the friend was likely to use when trading.

The panel then found sufficient evidence to send the question of the friend’s liability to a jury. According to the panel, the Commission’s evidence of the friend’s sophistication and knowledge of the underwriter’s position at his employer was sufficient for the jury to conclude that the friend knew or had reason to know that the tip would breach the underwriter’s fiduciary duty to his employer. Finally, the evidence was also sufficient for a jury to infer liability on the part of the friend’s superior. The panel determined that the evidence was sufficient to allow a jury to infer that the superior was aware that the underwriter position exposed him to information that he should have kept confidential. A jury could also infer from the evidence of the superior’s actions that he believed that the information was credible and originated from someone entrusted with confidential information, the panel explained. There was also a genuine question of fact as to whether the superior traded while in knowing possession of material non-public information since the Commission showed that the superior told others that he bought the shares on a tip. The district court’s order was accordingly vacated and remanded for further proceedings. SEC v. Obus (2ndCir) is reported at ¶97,014.

SEC Had Duty to Report Scheme to SIPC, Negligence Claim Dismissed. A claim that the SEC breached its duty to timely report the alleged Robert Stanford Ponzi scheme to the Securities Investor Protection Corporation could continue, according to a federal district court (SD Fla). A claim that the Commission negligently approved a Stanford entity’s amended investment adviser registration could not proceed, however.

This case arose from Robert Stanford’s alleged operation of a Ponzi scheme involving the sale of fraudulent offshore certificates of deposit. Stanford Group Company, allegedly created by Mr. Stanford to promote these investments, was registered with the SEC as a broker-dealer and investment adviser. The SEC investigated numerous complaints about Mr. Stanford and the company from 1997 to 2004 and each time found that Stanford was operating a Ponzi scheme. The plaintiffs sued the Commission for negligence under the Federal Tort Claims Act (FTCA). Specifically, the plaintiffs alleged the SEC failed to timely report the Stanford Ponzi scheme to the SIPC under the Securities Investor Protection Act once it determined that the Stanford company was in or approaching financial difficulty. The plaintiffs also claimed the SEC negligently approved annual amendments to the company’s Investment Advisers Act registration after finding that the firm was a Ponzi scheme.

The government moved to dismiss the case for lack of subject matter jurisdiction, arguing that both of plaintiffs’ claims fell within the discretionary function exception to the FTCA, thus depriving the court of subject matter jurisdiction. The court rejected the government’s main argument that the SEC’s decision to report a broker-dealer’s financial troubles to the SIPC is discretionary. The government argued that determining the firm to be a Ponzi scheme was not the same as concluding that the company was in or approaching financial difficulty under the SIPA. The court, however, said that if plaintiffs’ allegation that the Commission had found the company to be a Ponzi scheme was true, then by definition the company was in or approaching financial difficulty. Although the determination that a firm is in or approaching financial difficulty itself involves discretion, the statutory obligation to report to the SIPC upon making this finding is nondiscretionary. Thus, the plaintiffs’ sufficiently alleged that the SEC had a non-discretionary duty to report the Stanford company to the SIPC. The court declined to consider the government’s other arguments that it had not determined that the firm was a Ponzi scheme or that it would have discretion to act even following a report to the SIPC. These arguments were inappropriate for a motion to dismiss where all of plaintiffs’ claims are accepted as true.

By contrast, the court held that plaintiffs may not proceed with their claim that the SEC negligently approved the firm’s annual amended Investment Advisers Act registration. The plaintiffs alleged that the Commission had a non-discretionary duty to substantively review annual amendments to the firm’s registration. The court, however, credited the government’s argument that the SEC owed no duty to grant or deny amendments to adviser registrations because the relevant laws and rules do not mandate SEC action. Even if SEC approval was required, said the court, the act of granting or denying amendments to an Adviser Act registration is discretionary. Zelaya v. U.S. (SD Fla) is reported at ¶97,001.

2nd Circuit: Mortgage-Backed Securities Cases to Proceed. A lead plaintiff seeking to represent investors in 17 securities offerings had standing to sue Goldman Sachs based on several of the offerings backed by residential mortgage pools originated by several banks and mortgage companies. The mortgage-backed certificates in question were issued under one shelf registration statement, but were sold in 17 separate offerings using 17 different prospectus supplements. NECA alleged that contrary to generic representations in the offering documents, neither Goldman Sachs nor the loan originators they used employed standards aimed at determining the borrowers’ ability to repay the underlying loans. According to the complaint, at the time the trusts were created, “there were wide-spread, systematic problems in the residential lending industry” where “loan originators began lending money to nearly anyone, even if they could not afford to repay the loans, ignoring their own stated lending underwriting guidelines.”

The court held that the lead plaintiff, the NECA-IBEW Health and Welfare Fund (NECA) had standing to assert the claims of purchasers of certificates backed by mortgages originated by the same lenders that originated the mortgages backing plaintiff’s certificates, because such claims implicate “the same set of concerns” as the plaintiff’s claims. The court further held that NECA need not plead an out-of-pocket loss in order to allege a cognizable diminution in the value of an illiquid security under Section 11.

Goldman Sachs argued that each offering was issued pursuant to a different “registration statement,” even if every offering’s registration statement included the same shelf registration statement. The defendants also noted that the shelf registration statement common to all the certificates contained no information about the loan originators or the mortgage collateral underlying them. That information was instead contained in the prospectus supplements unique to each offering. The court rejected this argument, concluding that NECA had “class standing” to assert the claims of purchasers of certificates backed by mortgages originated by the same lenders that originated the mortgages backing the certificates that it purchased, even though they were in different offerings. These claims implicated “the same set of concerns” as NECA’s claims, concluded the court. While not all claims were revived, NECA could bring class claims on behalf of those purchasers who met this commonality requirement.

With regard to the cognizable loss question, the court rejected the determination below that NECA suffered no loss because it did not allege any missed payment from the trusts and admitted that no payments had been missed. The 2nd Circuit rejected the idea that “a fixed income investor must miss an interest payment before his securities can be said to have declined in value.” According to the appellate panel, the reasonable inference from NECA’s allegations was that, because the loans backing the certificates were riskier than defendants represented, the future cash flows to which NECA was entitled under the certificates required a higher discount rate once the offering documents’ falsity was revealed, resulting in a lower present value. NECA-IBEW Health & Welfare Fund v. Goldman Sachs & Co. (2ndCir) is reported at ¶97,005.


CCH Blue Sky Law Reporter  

California Adopts New Exemption for Private Fund Advisers. An exemption from investment adviser registration for private fund advisers was adopted by the California Department of Corporations. The exemption replaces a de minimis exemption that corresponded to the now-outdated federal exemption under Section 203(b)(3) of the Investment Advisers Act of 1940. The basic requirements for claiming the exemption are set forth, along with the additional requirements and grandfather provisions for private fund advisers to certain retail buyer funds. The following terms are defined: “advisory affiliate,” “affiliated person,” “control,” derivative investment,” “fund of funds,” management rights,” “operating company,” “qualifying private fund,” “private fund adviser,” “retail buyer fund,” “venture capital company,” “venture capital fund,” venture capital investment” and “venture capital operating company.” ¶12,167D.

Montana Establishes Procedures for Allocating Money from Restitution Fund to Victims of Securities Fraud. Procedures adopted by the Montana Securities Department following creation of a securities restitution fund under the Montana Securities Act set forth how money from the fund will be allocated to victims of securities fraud; how victims will apply for compensation from the fund; and the method for calculating the percentage of money a victim will be eligible for when the fund approaches zero. ¶36,471 - ¶36,477.

Fund Adviser’s Failure to Register Did Not Entitle Investors to Rescission. In Shailja Gandhi Revocable Trust v. Sitara Capital Management, LLC, a federal district court (N.D. Ill.) held that investors in a private investment fund were not entitled to rescind their purchases on the grounds that the defendants had failed to register as investment advisers under the Illinois Securities Law. Courts interpreting the federal securities laws on which the Illinois Securities Law is based have held that individual investors in a fund are not clients of the fund’s investment adviser and, therefore, cannot sue the adviser for a failure to register under the statute. Even though the defendant who sold the securities to the investors was the same person who acted as the fund’s investment adviser representative, the defendants were not acting as investment advisers at the time of sale. Thus, the sale was not “made in violation” of the registration requirement, the court reasoned. As the investors admitted that the defendants never provided investment advisory services directly to them, the court granted summary judgment to the defendants. Shailja Gandhi Revocable Trust v. Sitara Capital Management, LLC will be reported at ¶74,992.


Aspen Federal Securities Publications  

Fundamentals of Securities Regulation, by The Late Louis Loss, Joel Seligman, and Troy Paredes. The 2013 Supplement to the Sixth Edition will soon be available online. This compendium reviews the most significant aspects of securities regulation and provides essential information covering a wide array of topics concerning securities law. In addition to expanded coverage of securities regulation overall, the Sixth Edition also has been expanded to incorporate extensive discussion and analysis of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The 2013 Supplement includes extensive discussion and analysis of Congressional enactment of the JOBS Act of 2012.  The JOBS Act notably: creates broad new exemptions for emerging growth companies from specified executive compensation and financial data requirements, the internal accounting control provisions, reduces to two years the requirement of audited financial statements, streamlines applicable research report requirements, and permits emerging growth companies to confidentially submit draft registration statements; amends Regulation D’s Rule 502(c) prohibition on general solicitation and advertising so that it no longer applies to Rule 506 offerings solely to accredited investors; amends Rule 144A(d)(1) to now permit general solicitation and advertising in Rule 144A offerings; crowdfunding is now permitted for sales up to $1 million in a 12-month period under a new heavily regulated provision; the Commission is directed to add a new $50 million small issue exemption for securities that may be offered and sold publicly; and sections 12(g)(1)(A) and (B) were amended to raise the 1934 Act registration thresholds to 2,000 holders of record.

The 2013 Supplement also analyzes the Congressional enactment of The STOCK Act, which amends § 21A to prohibit insider trading by members of Congress, employees of Congress, executive branch employees, Federal judges, and judicial employees on the basis of material nonpublic information derived from the performance of these persons’ official responsibilities. This supplement also includes discussion of rule adoptions or amendments required by the Dodd-Frank Act, including: amendments to Securities Act Rules 134, 138, 139, 168, Forms S-3, S-4, F-3, and F-4, as well as Schedule A to remove references to reliance on security ratings; amendments to Rules 501(a)(5) and 215 to revise the accredited investor standards; adoption of Rule 13h-1 to assist the Commission in obtaining trading information on large traders; adoption of Rule 204(b)-1 to require investment advisers registered with the SEC that advise one or more private funds and have at least $150 million in private funds assets under management to file Form PF with the Commission; and adoption of Rule 202(a)(11)(G)-1 to define family offices that will be excluded from the definition of investment adviser under the Investment Advisers Act. Important cases addressed in this supplement include, among others: U.S. Supreme Court decision in Credit Suisse Sec. (USA) LLC v. Simmonds, in which the Court held that the §16(b) limitations period is not tolled until the filing of a §16(a) statement; Second Circuit decision in Fiero v. FINRA, which held that FINRA does not have authority to bring court actions to collect disciplinary fines; Brown v. Calamos, in which Judge Posner distinguished three different approaches in analyzing SLUSA motions to dismiss; Second Circuit decision in Lehman Bros. Mortgage-Backed Sec., which held that a credit rating agency that provided advice and strategic direction to an issuer did not control the issuer under §15; and SEC v. Citigroup Global Markets, Inc., in which the Second Circuit stayed an earlier order by Judge Rakoff that had concluded that a proposed consent judgment was “neither fair, nor reasonable, nor adequate, nor in the public interest.” The Second Circuit sharply disagreed with virtually all aspects of Judge Rakoff’s analysis.

Representing Corporate Officers, Directors, Managers, and Trustees, Second Edition, by Marc J. Lane.  The most recent supplement is now available online. This publication is a guide to the practical aspects of corporate governance for attorneys, officers, directors, managers, and trustees. The introduction of new legislation, rules, and standards by governmental bodies and society in the wake of recent corporate and accounting scandals has led to a focus upon the responsibilities and liabilities of directors, officers, managers, and trustees. A host of new hurdles have arisen. Increased SEC oversight, new NYSE and NASDAQ listing standards, new fiduciary and other duties, and new criminal penalties have changed the landscape for those who control corporations and have cast new meaning unto preexisting law. The author’s careful examination of the terrain of the current business world with an experienced legal eye identifies these and other new landmarks of law for the busy director or officer. By logically laying out the new steps to safe corporate governance, the cases, tables, and checklists will comfort the veteran and neophyte alike. The most recent supplement reflects the changing needs of directors, officers, managers, and trustees and requirements of the laws, rules, and standards that affect them, including: a new section, Crowdfunding under the Jumpstart Our Business Startups (JOBS) Act; a new section concerning the duty of care, where directors in Pennsylvania have additional protections compared to those in other states—especially Delaware; new sections on: attempts to require public companies to allow shareholders to nominate directors, prosecution of officers of FDA-regulated corporations, and “Say on Pay” shareholder votes and the Business Judgment Rule; new sections concerning poison pill plans: defense against hostile takeovers, and protecting a net-operating-loss carryover; expanded discussion of the SEC’s new regulatory powers under Dodd-Frank; and an updated discussion of nonprofit and hybrid corporations, such as L3Cs and benefit corporations.

Investment Adviser’s Legal and Compliance Guide, by Terrance J. O’Malley. The 2012-2 Supplement is now available online. This title reflects the most current discussion of legal and compliance topics for investment advisers, including fundamental issues arising under the Adviser Act, and incorporates the latest SEC guidance provided in rule releases, policy statements, no-action letters, and SEC staff speeches. This 2012-2 update includes information about the SEC’s new “Aberrational Performance” initiative that focuses on advisers with outsized performance; additional information about updated requirements for charging performance fees to “qualified clients”; clarification of the SEC’s new ability under the Dodd-Frank Act to examine records of persons with custody of client assets; updated information about the status of potential anti-money laundering program requirements; additional information about the SEC’s expectations for internal application of an adviser’s code of ethics; additional guidance for registration by hedge fund advisers and their related entities; information about new requirements for the SEC regarding the time allotted for completing examinations; updates to the compliance requirements summary chart, the record retention chart, and the compliance calendar, and to the SEC guidance and the rules; and a new appendix with SEC guidance relating to use of Form PF.

Sarbanes-Oxley Act: Planning and Compliance. The 2013 supplement is now available online. This comprehensive resource provides practical guidance to help ensure compliance with all Sarbanes-Oxley rules and regulations. The 2013 Supplement includes a detailed explanation of the Jumpstart Our Business Startups Act or “JOBS Act,” which exempts “emerging growth companies” from the Section 404(b) auditor attestation requirements of the Sarbanes-Oxley Act, but not from the Section 404(a) management report requirements; a discussion of a case from the U.S. District Court for the Middle District of Florida holding that a Section 302 certification may, in some circumstances, preclude a corporate CEO or CFO from denying his or her liability for “making” an allegedly fraudulent statement as an agent of the corporation; an overview of the Committee of Sponsoring Organizations of the Treadway Commission’s (COSO) draft of a revised version of Internal Control—Integrated Framework; an analysis of an SEC enforcement action in the U.S. District Court for the District of Kansas in which the court rejected the SEC’s position that a company’s proxy statements were misleading because they referred to the company’s code of ethics without also disclosing violations of that code; a discussion of a First Circuit Court of Appeals opinion holding that only the employees of the defined public companies are protected by the whistleblower provisions of 18 U.S.C. § 1514A; a discussion of a Fifth Circuit Court of Appeals case holding that even if an employee established a prima facie case of retaliation under Section 806, an employer may still avoid liability by proving by clear and convincing evidence that it would have taken the same disputed unfavorable personnel action even in the absence of the employee’s protected activity; an analysis of a Seventh Circuit Court of Appeals opinion discussing the relationship between the retaliatory actions and the underlying wrongdoing for purposes of RICO; an examination of a case in the U.S. District Court for the District of Columbia declining to apply retroactively the Dodd Frank Act’s ban on the enforceability of a pre-dispute arbitration agreement in 15 U.S.C. § 1514A(e); a discussion of the JOBS Act’s exemption of emerging growth companies from the “say-on-pay” vote requirement of Exchange Act Rule 14a-21; an explanation of the JOBS Act’s exemption of emerging growth companies from the separate shareholder advisory vote on golden parachute compensation; an analysis of a technical change in the requirements of Nasdaq Marketplace Rule 5605(b)(1) concerning how to disclose those directors that the board has determined to be independent; a discussion of the JOBS Act’s exemption of emerging growth from any rules of the PCAOB requiring mandatory audit rotation; an examination of the SEC’s Jumpstart Our Business Startups Act Frequently Asked Questions—Generally Applicable Questions on Title I of the JOBS Act (“JOBS Act FAQ”); and Section 6.07 has been added to discuss pending PCAOB proposed auditing and attestation standards that would affect audits of corporations subject to the disclosure and reporting requirements of the SEC.

Financial Reporting Handbook, by Michael Young. The latest release, Release 36, is now available online. This reference provides quick access to critical aspects of financial reporting. In addition to covering the Sarbanes-Oxley Act, SEC rules and regulations, standards of the Independence Standards Board and the AICPA and requirements of the New York Stock Exchange, NASDAQ, and the American Stock Exchange, the Financial Reporting Handbook tackles important underlying themes such as the centrality of the audit committee, the individual responsibility of executives, and the integrity of the outside auditor.


IPO Vital Signs

IPO Vital Signs, an advanced IPO research analysis tool, assists IPO professionals and pre-IPO companies satisfy their most challenging research needs and answers hundreds of mission critical questions for all the players in the IPO process. IPO Vital Signs’ tabular data analyses focus on issues surrounding client advisement, deal negotiation, and prospectus disclosure.

IPO Week in Review, a weekly e-newsletter to keep professionals up to date with recent filing and going public activity, is an important element of the IPO Vital Signs system or is available by separate subscription. Coverage includes a monthly feature article on recent trends in going public in the U.S.

To see how an IPO Vital Sign works click on the Vital Sign title below:

Free Preview!>>


#298 IPO Aftermarket Performance 
by SIC Code (Aggregated)

 How are IPO industry groups performing under current market conditions? 

  • Compare the performance of recent IPOs by SIC Code
  • Rank the industries by the aggregate change in value of their IPOs
  • Review the single largest percentage gain, and percentage loss for each SIC Code


Tip! Click on blue numbers to drill down for more information.
Click on IPOs with a Trade Date Between to change the date range for IPOs and select an aftermarket price as of date. Use the drop down boxes to:
1) select the date range for a set of IPOs by first trade dates; and
2) select the date as of which you want to review aftermarket prices.
Click the [Refresh] button to view the new information.



A new research tool powered by the Securities Redbook (Securities Act Handbook), RBsource offers you securities laws, rules, regulations and forms together with related SEC guidance and interpretations. With RBsource, you will have SEC guidance related to a specific law, regulation or rule at your fingertips without the need of further searching or browsing. RBsource uniquely associates related content, going beyond the limits of standard searching making research more streamlined and productive. This intuitive research tool will drastically reduce your research time and provide the unparalleled confidence expected from the trusted Securities Act Handbook.

SEC Rulemaking Activity

  • 34-67901—Extension of Temporary Registration of Municipal Advisors (September 21, 2012).

The Commission has amended Exchange Act Rule 15Ba2-6T to extend the expiration date of this rule and Form MA-T from September 30, 2012 until September 30, 2013. The extension permits municipal advisers to continue to register with the SEC under Exchange Act Section 15B on a temporary basis until the Commission adopts final rules to establish a permanent regime for municipal adviser registration.

Legislative Update

The Dodd-Frank Act significantly reformed municipal securities. However, Congress may not be finished with its reform of these laws. H.R. 2827 recently passed the House by voice vote. The bill, sponsored by Rep. Robert Dold (R-Ill), clarifies the meaning of “municipal adviser” and thus who must register with the SEC. Another section clarifies the fiduciary duties of municipal advisors. The bill also defines “investment strategies,” “solicitation of a municipal entity or obligated person,” and “municipal derivative.” The Senate has referred the bill to the Banking Committee.

The Road Ahead

Upcoming rulemaking activity will continue to reshape the securities regulation landscape. The items below are a selection of expected near-term regulatory actions. The SEC’s schedule is subject to change at any time. RBsource includes daily updates to securities regulations affected by final Commission action.

The SEC has adopted many required Dodd-Frank rules since the law’s enactment in 2010. But some Dodd-Frank rules still must be adopted. The SEC also must implement the more recent JOBS Act. To date, the Commission has proposed rules to implement JOBS Act Title II, but has yet to adopt rules for crowdfunding and other activities.

Topics beyond Dodd-Frank and the JOBS Act also may occupy the SEC’s time. Commissioner Daniel M. Gallagher recently spoke about the SEC’s “relative” priorities. According to Commissioner Gallagher, money market fund reform is chief among these goals. Money market funds, said Commissioner Gallagher, contributed to the financial crisis but were not included in the Dodd-Frank reforms. The Commission recently failed to garner enough support to even vote on whether to propose money fund reforms under Investment Company Act Rule 2a-7. Other key topics include rules for transfer agents, broker-dealer risk assessments, and net capital and customer protection.


Hot Topic of the Month

his month’s Hot Topic is Exchange Act Rule 10b-5 Trading Plans. Rule 10b5-1 provides that, for purposes of insider trading liability, a person trades on the basis of material nonpublic information if a trader is aware of the material nonpublic information when making the purchase or sale. As in all Rule 10b-5 fraud cases, insider trading liability under Rule 10b-5 requires a showing of scienter. Rule 10b5-1 was adopted to clarify the “use requirement” employed by some courts before the adoption of the rule.

Prior to the rule’s passage, the 11th Circuit held that an insider could rebut charges of insider trading by introducing evidence that inside information was not actually utilized when making the trades at issue. This standard was referred to as the “use” test. The 9th Circuit endorsed this approach in a criminal case, holding that  a use requirement is consistent with the language of Rule 10b-5, which emphasizes manipulation, deception and fraud, and disagreed with the SEC’s contention that the requisite intent to defraud is inherent in the act of trading while in possession of insider information. Noting that scienter is a necessary element of an insider trading violation, the court reasoned that the knowing possession standard advocated at the time by the SEC could not be strictly limited to those situations actually involving intentional fraud. In the release adopting Rule 10b5-1 concerning the use of inside information, the SEC confirmed that the rule did not alter the scienter requirement.

The rule also sets forth several affirmative defenses or exceptions to liability. These exceptions permit persons to trade in certain specified circumstances where it is clear that the information they are aware of is not a factor in the decision to trade, such as pursuant to a pre-existing plan, contract, or instruction that was made in good faith. Rule 10b5-1(c)(1), for example, allows persons to plan securities transactions in advance, at a time when they are not aware of material, nonpublic information, and then complete those pre-planned transactions at a later time, even if they subsequently learn of material, nonpublic information.

To raise the Rule 10b5-1(c) defense successfully, a person must establish three elements. First, he or she must demonstrate the existence of a prior contract, instruction, or plan concerning the securities in question. Second, the person must show that the preexisting contract, instruction, or plan meets certain conditions. Finally, the person must show that the trade occurred “pursuant to” the preexisting contract, instruction, or plan. The person raising an affirmative defense must also satisfy a separate good faith requirement.

We publish related information in a wide range of resources (e.g., Federal Securities Law Reporter, SEC Today, Insights – Amy L. Goodman, Securities Regulation – Loss, Seligman & Paredes, etc.), and document types (laws, regulations, releases, newsletter articles, treatise discussion). For example:

  • Federal Securities Law Reporter
    • Exchange Act Rule 10b5-1, at ¶22,775D
    • CCH Explanations (e.g., ¶22,778.020)
    • U.S. v. Smith (9th Cir 1998), at 1998 CCH Dec. ¶90,274
    • SEC v. Adler (11th Cir 1998), 1998 CCH Dec. ¶90,177
  • Insights – Amy L. Goodman (e.g., “Building a Better Insider Trading Compliance Program” (March 31, 2011))
  • Securities Regulation – Loss, Seligman & Paredes (e.g., Chapter 9.B.4)
  • Regulation of Securities: SEC Answer Book – Levy (e.g., Q18:8)
  • SEC Compliance and Disclosure Interpretations, at ¶8660, et seq.
  • Jim Hamilton’s World of Securities Regulation