Rule 10b5-1 of the Securities Exchange Act of 1934 (the “Exchange Act”) addresses the issue of insider trading liability.
Specifically, 10b5-1 discusses when liability stems from a trader’s “use” or “knowing possession” of “material nonpublic information.”
10b5-1 states that a trade is made “on the basis of” material nonpublic information if the trader buys or sells securities while aware of the information.
Affirmative Defenses to Insider Trading
With this in mind, Rule 10b5-1 provides some affirmative defenses to insider trading that allow traders to buy and sell securities in specific circumstances when it is clear that the material nonpublic information was not a factor in the decision to trade.
What are the 10b5-1 Affirmative Defenses?
Under Rule 10b5-1(c)(1)(i)(A), the SEC does not consider the purchase or sale to be “on the basis of” material nonpublic information if, before becoming “aware” of material nonpublic information, the trader
- Already entered into a binding contract to buy or sell the security; or
- Already instructed another person to buy or sell the security; or
- Previously adopted a written plan for trading securities.
What is a 10b5-1 Trading Plan?
A 10b5-1 trading plan is a structured securities trading plan or strategy that a trader can set up when he or she is not aware of material nonpublic information. In theory, if documented properly, this trading plan can then be followed even if the trader later becomes aware of material nonpublic information.