Among all the calls for reform of Rule 10b5-1, a Section 16 issue may be lurking. In the letter Elizabeth Warren and two other senators sent to then Acting SEC Chair Allison Lee in February, the senators expressed concern that insiders are using Rule 10b5-1 plans inappropriately to sell stock immediately after the release of good news, allowing them to reap “huge windfalls at the expense of ordinary investors.” In addition to suggesting changes to Rule 10b5-1, the senators noted that Section 16(b) permits issuers to recover short-swing profits and asked the Commission to “consider working with Congress to modify the rule to cover profits obtained through 10b5-1 sales that follow disclosure of material information that causes share prices to fall in the period immediately following the disclosure.”
It isn’t clear (to me) whether the senators want to add a profit recovery provision to Rule 10b5-1 or instead want to amend Section 16(b). The senators cited an academic study, though, which seems to suggest that Section 16(b) would be the appropriate vehicle. The study concludes that insiders’ Rule 10b5-1 sales tend to occur on days when companies disclose positive news that causes the company’s stock price to rise briefly and then decline over the next ten days, and recommends that Section 16(b)’s disgorgement remedy be extended to the profit the insider gained by selling at the peak, without regard for whether the insider also purchased issuer securities within six months of the sale. The study also proposes a formula for calculating the profit.
In her response to the senators, Ms. Lee said that she had instructed the staff to review Rule 10b5-1 and, as part of the review, to consider the senators’ point regarding short-swing profits.
-Alan Dye, Section16.net August 1, 2021
