Gensler Identifies Insider Trading Plans and Equity Trading Rules as Areas of SEC Focus

11 June 2021 Publication
Author(s): Thomas J. Krysa Brooke D. Clarkson Adrian L. Jensen Kathryn Marie Throo

This week, SEC Chair Gary Gensler identified Rule 10b5-1 stock trading plans and equity trading rules as fresh areas of regulatory focus for the SEC. Gensler mentioned these areas during prepared remarks at the CFO Network Summit on June 7, at the Global Exchange and FinTech Conference on June 9, and at a meeting of the SEC Investor Advisory Committee on June 10.        

Rule 10b5-1 trading plans provide a mechanism for corporate insiders to buy and sell company stock outside of open trading windows pursuant to a trading plan so long as the plan is adopted in good faith while the corporate insider is not in possession of material nonpublic information.  In his remarks this week, Gensler said the trading plans have caused “real cracks” in the SEC’s insider trading regime and he has asked the staff to consider how to “freshen up” Rule 10b5-1.  Potential changes on the table include mandating a four to six month cooling off period before an insider can trade after establishing a trading plan, limitations on how and when plans can be canceled, beefing up company disclosure requirements regarding the plans, and limiting how many plans an insider can adopt.  It seems apparent from Gensler’s comments that he believes corporate insiders may have been abusing Rule 10b5-1 plans by adopting or canceling plans, or shifting strategies between existing plans, while in possession of material nonpublic information.  Notably, Gensler emphasized that the act of cancelling or modifying any Rule 10b5-1 plan calls into question whether the plan was entered into in good faith, and, in the absence of good faith, the use of the plan would not provide an affirmative defense to insider trading – perhaps foreshadowing future enforcement actions related to the abuse of Rule 10b5-1 trading plans.

Also in appearances this week, Gensler explained that recent technological advances such as commission-free brokerage apps and changes in market segmentation and concentration, have necessitated taking a fresh look at the current equity trading rules.  He noted that in January 2021, only 53 percent or so of equity trading occurred through the NASDAQ and New York Stock Exchange, with the rest occurring through dark pools and wholesale brokerage firms.  He noted that one wholesaler has publicly stated that it executes nearly half of all retail trading volume in the off-exchange space.  According to Gensler, both the gamification of stocks and market concentration and segmentation issues have led to a rise in “payment for order flow” where brokers receive payments from wholesalers to direct order flow to them.  Gensler questioned whether this practice leads to best execution, whether investors are paying hidden costs to execute their trades, and whether brokers had inherent conflicts of interest.  He emphasized that best execution means just that, and not merely better execution.  Gensler also questioned the continued use by wholesalers of the NBBO (or national best bid and offer) as a competitive benchmark of best execution since the NBBO does not reflect the entirety of trading in the equity markets and NBBO is priced in penny increments while wholesalers transact at sub-penny increments.  Gensler stated that he has directed the SEC Staff to make recommendations for regulatory changes related to best execution, payment for order flow, computation of the NBBO, and Regulation NMS (which addresses the national market system for equity trading).  Finally, noting that “time equals risk,” Gensler stated that the Staff is considering whether the settlement process could be shortened using existing technology from T+2 to T+1, or even same-day settlement.  Given Gensler’s clear focus on best execution and payment for order flow, it would not be surprising if the SEC pursues additional enforcement cases in this area as well.

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