What it means for a corporate insider or company to act in “good faith” is about to dramatically change when it comes to insider trading.
Under U.S. contract law, acting in good faith usually centers around the honesty of a person’s conduct, honest intent, or a sincere attempt to deal fairly. For compliance departments, the practical application of this standard has been woven through policies and procedures. But when it comes to insider trading, those policies and procedures will face a significant change-up.
In a continued effort to protect investors, the SEC recently released updates to insider trading rules, in part related to the provisions around acting in good faith. The SEC decided that the requirement to act in good faith with respect to insider trading needed an upgrade.
Around 20 years ago, the SEC adopted rule 10b5-1. This rule aimed to provide affirmative defenses to corporate insiders and companies who buy and sell company stock – so long as the trading plans got developed before the transactions and in good faith. The previous iteration of the rule required the plans be entered into in good faith. However, over the last 20 years, courts, legislators, and other commentators have argued that this provides a loophole for insiders to benefit from this rule’s liability protections while opportunistically trading on insider information.
This SEC new rule amendment seeks to close those loopholes. The newly updated rule requires that to satisfy the new requirements, the new 10b5-1 plan must attest: 1) No awareness of any material nonpublic information about the issuer or its securities; and (2) The plan is being adopted in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b5-1. This essentially extends the good faith requirement through the life of the plan, not just when the plan gets established.
The SEC has explained these changes as aimed at strengthening investor protections concerning insider trading. The changes have been designed to help shareholders understand when and how insiders trade in securities about which they may have material nonpublic information. Ultimately, compliance departments will be called upon to determine what exactly “good faith” means while incorporating these new requirements.
I’ll keep you posted as the SEC rules roll out, and about the changes we at IMP recommend and implement for our clients.