TAKEAWAYS
- The
SEC settled insider trading charges in relation to misuse of a Rule 10b5-1 plan established in the name of aBritish Virgin Islands entity owned by officers of the issuer. -
The remedies in the Cease and Desist Order suggest that the
SEC might utilize an issuer's internal compliance processes to regulate trading by insiders, particularly with respect to foreign issuers that might otherwise be outside theSEC's reach. -
The
SEC adopted final amendments to Rule 10b5-1, adding conditions to successfully invoke the Rule's affirmative defense to insider trading.
Rule 10b5-1 plans have gained wide acceptance and compliance. On
According to the Commission's press release, the CEO and CTO entered into a purported Rule 10b5-1 plan with respect to Cheetah securities while they were in possession of MNPI, and sold Cheetah shares pursuant to the plan while in possession of MNPI. The CEO and CTO agreed in the Cease and Desist Order (the Order) to pay civil penalties and agreed to undertakings related to future securities transactions.
The Commission does not frequently bring enforcement actions involving Rule 10b5-1 plans. This action, followed closely by the adoption of final rules heightening the requirements to invoke the Rule's affirmative defense to insider trading, reflects the Commission's current focus on trades made by company insiders pursuant to plans that purport to comply with Rule 10b5-1. We discuss the final amendments to Rule 10b5-1 in detail here.
The Facts:
Cheetah develops content-driven products, such as mobile phone and computer applications. Like many web-based companies, Cheetah earns a large part (up to one-third) of its revenues from fees generated by the placement of third-party advertisements within its products. In the summer of 2015, Cheetah's primary advertising partner (Advertising Partner) informed Cheetah that a change the algorithm used to determine these fees might halve the amounts paid over to Cheetah. Cheetah's efforts to mitigate the effect of the new algorithm failed. As a result, Cheetah experienced significant declines in revenue from the Advertising Partner in the fourth quarter of 2015 and the first quarter of 2016—representing roughly 3% and 8% of its total quarterly revenue, respectively.
Cheetah did not tie the negative trend to the change in Advertising Partner's algorithm in its
On
The CEO and CTO intended for the March Trading Plan to be a Rule 10b5-1 plan. A Rule 10b5-1 plan, however, must be established in good faith when the person establishing it is not in the possession of MNPI. According to the Order, the CEO and CTO received regular updates on Advertising Partner-derived revenue and knew of the algorithm change and resulting negative revenue trend when the trading plan was adopted. Cheetah's CEO and CTO therefore were not entitled to invoke the Rule 10b5-1 affirmative defense.
Noteworthy Points
The enforcement action raises several interesting points:
First, the Commission did not bring charges against the Company, itself, for the material misstatements in its
Second, by taking action against the CEO and CTO for adopting a Rule 10b5-1 plan while in possession of MNPI, the
Third, as part of the settlement, the CEO and CTO agreed that for a five-year period, they will take affirmative steps to provide “guardrails” against trading while in possession of MNPI.
With respect to the CEO, certain undertakings in the Order set forth below incorporated aspects of the
i. A requirement to provide notice of the establishment, modification or cancellation of any trading plan that purports to be established pursuant to Rule 10b5-1 to the Chief of the Market Abuse Unit within the
ii. A 120-day cooling off period before any transactions can be made pursuant to a new or modified Rule 10b5-1 plan with respect to Cheetah securities; and
iii. A prohibition against maintaining, directly or indirectly, more than one Rule 10b5-1 plan at any time with respect to Cheetah securities.
Notably, Cheetah's own legal department was integrated into the CEO's undertakings: the Order requires prior approval of Cheetah's legal department within 48 hours of the CEO entering into any transaction with respect to Cheetah securities other than a transaction pursuant to a Rule 10b5-1 plan.
In addition, with respect to both the CEO and the CTO, the Order establishes significant
i. Notice, within 48 hours, of any transaction, whether directly or indirectly made, in Cheetah securities;
ii. Notice, within 30 days of the Order, of all brokerage accounts that they own or control, directly or indirectly, which can trade securities on
iii. Notice, within 48 hours, of the opening of any
iv. An annual written certification certifying compliance with their respective undertakings set forth in the Order by identifying the undertakings and providing a narrative description of compliance supported by exhibits sufficient to demonstrate compliance.
The identity of the parties bears mentioning. Cheetah, a
The
Risk Mitigation Measures
This enforcement action sheds light on how the Commission envisions the allocation of responsibility in administering Rule 10b5-1 plans. Issuers, insiders and those who administer Rule 10b5-1 plans should take guidance from the undertakings in the Order and ensure their policies and procedures comply with the requirements of Rule 10b5-1, as amended.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
Mr
DC 20037-1128
Tel: 202663 8000
Fax: 202663 8007
URL: www.pillsburylaw.com
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