The SEC has proposed significant changes to Rule 10b5-1 that may make complying with its requirements much more challenging. But despite a lot of commentary to the contrary from the chattering classes, the existing rule is far from a “get out of jail free” card. In that regard, the Fourth Circuit’s decision in KBC Asset Management NV v. DXC Technology Co., 19 F.4th 601 (4th Cir. 2021), highlights some potentially significant limitations on the protection provided under Rule 10b5-1. This excerpt from “The 10b-5 Daily’s” recent blog on the decision indicates that one of those limitations may arise from the rule’s status as an affirmative defense:
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.”
The first statement by the Court isn’t surprising, given the fact that Rule 10b5-1 requires plans to entered into at a time when the insider does not have MNPI. However, the suggestion that Rule10b5-1’s status as an affirmative defense might preclude a court from considering it at the motion to dismiss stage is likely to raise a few eyebrows. Here’s the language of the footnote to which the 10b-5 Daily referred:
Although we have previously considered trading plans as an affirmative defense when reviewing an appeal from a dismissal for failure to state a claim under Rule 12(b)(6), see Yates, 744 F.3d at 891, Plaintiffs contend it would be inappropriate for us to do so here. See Opening Br. at 49 (citing Lefkoe v. Jos. A. Bank Clothiers, No. WMN-06-1892, 2007 WL 6890353, at *6 n.11 (D. Md. Sept. 10, 2007) (noting that “[r]aising the affirmative defense of trading under a 10b5—1 trading [plan] . . . is typically premature . . . in a motion to dismiss” (internal quotation marks omitted))).
They may have a point. It is well established that we only consider affirmative defenses at this stage when facts sufficient to rule on the defense are apparent “on the face of the complaint.” Goodman v. Praxair, Inc., 494 F.3d 458, 464 (emphasis omitted) (quoting Richmond, Fredericksburg & Potomac R.R. v. Forst, 4 F.3d 244, 250 (4th Cir. 1993)).
As courts often do, the Fourth Circuit punted on the issue — but the precedent it cited suggests that it (and other courts) might be amenable to prohibiting the assertion of the affirmative defense in a motion to dismiss. For many users of Rule 10b5-1 plans, that kind of prohibition might be a very big deal. That’s because plaintiffs will have the opportunity to conduct potentially extensive and costly discovery before defendants will be able to raise a Rule 10b5-1 defense in their summary judgment motions.
-John Jenkins, TheCorporateCounsel.net February 16, 2022