US authorities are investigating whether executives have been gaming prearranged stock-sale programs designed to thwart the possibility of insider trading.
(Bloomberg) — US authorities are investigating whether executives have been gaming prearranged stock-sale programs designed to thwart the possibility of insider trading.
The Justice Department and Securities and Exchange Commission are using computer algorithms in a sweeping examination of preplanned equity sales by C-suite officials, according to people familiar with the matter. Investigators are concerned that some people are manipulating the stock-sale programs, which are intended to shield executives from misconduct allegations by letting them schedule transactions in advance and on preset dates.
Critics say the plans have many possible loopholes. There’s no cooling-off period, so executives may adopt one and then use it to trade just days later. Insiders can nix scheduled trades that would cause them to miss out on a stock-price bump tied to good corporate news. What’s more, executives can also have multiple, overlapping plans, increasing opportunities for such abuses.
Corporate America has widely adopted the so-called 10b5-1 plans since the SEC created rules for them two decades ago, and they’re now responsible for thousands of transactions collectively worth billions of dollars annually. Yet the agency hasn’t updated the regulations for years, the program’s recordkeeping has been antiquated and recent academic research has pointed to significant gaps in surveillance.
The share-sale plan investigations, which are being led by the Justice Department’s fraud section in Washington and SEC enforcement attorneys, are the latest examples of authorities taking a tougher line on long-standing Wall Street trading practices during the Biden era.
Federal officials requested information from executives early this year, said one person. They’re now preparing to bring multiple cases, said two other people. They all asked not to be identified discussing the confidential investigations.
Representatives for the SEC and Justice Department declined to comment.
Signs of Investigations
The SEC has proposed overhauling the rules, and several Democratic senators including Elizabeth Warren and Chris Van Hollen have demanded changes. New York City’s comptroller has gone as far as calling some of the plans a form of insider trading.
Meanwhile, signs of the investigations have begun to emerge.
In October, Sientra Inc., a breast-implant maker, disclosed that it had received subpoenas from both the Justice Department and the SEC, including one from a grand jury, seeking materials concerning the trading activities of a former chief executive officer in 2019 and 2020.
Mike Piazza, a lawyer for Jeffrey Nugent, the former CEO, said his client’s “stock sales were executed pursuant to a valid Rule 10b5-1 trading plan. He looks forward to a prompt resolution of the investigation.”
A lawyer for Sientra said the company was cooperating with the investigations.
Just a few weeks earlier, the SEC penalized China-based Cheetah Mobile Inc.’s Chief Executive Officer Sheng Fu and its former president, Ming Xu, over the sale of American Depositary Shares of the company. The agency didn’t accuse the company of breaking securities rules.
The SEC alleged that in 2016, the two planned to sell shares after learning that revenue from a key advertiser was in decline. The well-timed sales allowed them to avoid about $300,000 in losses, according to the SEC. The two agreed to settle with the regulator by paying a combined $756,000, without admitting or denying wrongdoing.
Cheetah Mobile’s investor relations’ representatives didn’t respond to multiple email messages seeking comment. Lawyers that served as defense counsel for the individuals in the case didn’t respond to voice and email messages.
Surveillance gaps
Prearranged plans are appealing to corporations and executives because, if properly used, they can give a solid defense against insider-trading allegations.
But executives often adopt short-term trading plans and sometimes only for a single transaction, according to a recent academic review of 20,000 plans. The study by business professors from Stanford University, the University of Pennsylvania and the University of Washington, found a wide disparity in the amount of time between the adoption of a plan and the first trade. About 82% had so-called cooling-off periods shorter than six months.
US officials including SEC Chair Gary Gensler — and his Trump-era predecessor Jay Clayton — have said the agency’s rules for the plans have led to gaps in its surveillance of potential insider trading. Among the changes that the agency proposed last December is a four-month waiting period for executives between a plan adoption and the sale of shares. No such waiting period is currently required.
For years, records of the prearranged trades were submitted to the SEC on paper, stored in filing cabinets and destroyed after a period of time. The agency has started making the filings available online.
–With assistance from David Scheer and Gao Yuan.
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