Best Practices for Corporate Executives to Avoid Insider Trading Accusations

Dmitriy Smirnov

January 7, 2025

Securities Law

Insider trading accusations can severely damage reputations, careers, and company credibility. Several recent cases involving high-profile executives emphasize the importance of adhering to best practices for compliance with securities laws. Below, we outline essential strategies for corporate leaders to avoid accusations of insider trading, using recent cases as cautionary tales.

Understand and Respect Blackout Periods

A blackout period is a timeframe during which “covered persons,” typically executives, directors, and key employees with access to material non-public information, are prohibited from trading the company’s securities. These periods help prevent insider trading by ensuring that covered persons do not trade while potentially in possession of material non-public information. Violating these periods can lead to significant penalties. For example:

Andras Sebok (Wizz Air): Sebok was fined £123,500 by the UK’s Financial Conduct Authority for conducting 115 trades worth over £4 million during restricted periods before earnings announcements.

Best Practice: Always verify blackout schedules and ensure you comply with the company’s insider trading policy. To further safeguard against violations, companies should implement a pre-clearance policy, requiring covered persons to seek approval from the company’s compliance officer before executing any trades during sensitive periods.

Any such policy should include the following provisions:

• Quarterly Blackout Periods: No insider may conduct transactions involving the company’s securities during a quarterly blackout period, typically beginning 15 calendar days before the filing of quarterly or annual reports and ending two business days after the public release of financial results.
• Event-Specific Blackout Periods: The company may impose additional blackout periods during significant non-public events. No trading is permitted until the information is made public.
• Post-Termination Transactions: If an insider possesses material non-public information at the time of their termination, they are prohibited from trading until the information becomes public or immaterial. If the termination occurs during a blackout period, they must wait until the blackout period concludes.

Follow Proper Use of 10b5-1 Trading Plans

A “10b5-1 trading plan” is a written agreement between a corporate insider and a brokerage firm, where the insider pre-determines the specific details of when and how they will buy or sell shares of their company’s stock, allowing them to trade even if they later gain material non-public information (MNPI), as long as the plan was set up when they did not have such information, essentially acting as a defense against insider trading accusations.

Example: A CEO sets up a plan with their broker to sell 100 shares of company stock each month on the 15th, at the market price, for the next six months, starting today when they are not aware of any MNPI.

Key Points:

• No Insider Information: The plan must be established when the executive does not have material non-public information.
• Pre-determined Details: The plan must specify the number of shares to sell, the price (market or limit), and the sale dates.
• Independent Broker Execution: The broker executes the trades autonomously, so that even if the executive gains inside information later, he can argue that the trades were set in motion before he (purportedly) gained that knowledge.
• Cautionary Tale: Terren Peizer (Ontrak Inc.): Peizer sold over $20 million of stock while in possession of material non-public information, using improperly structured 10b5-1 plans. This led to his conviction for insider trading.

Best Practice: Use 10b5-1 plans with ample cooling-off periods and avoid modifying them when in possession of non-public information. To effectively use a 10b5-1 plan, it must be established in good faith, well in advance of any material information becoming available, and followed strictly. A properly implemented plan can provide a defense against insider trading accusations, but it does not provide complete immunity if material non-public information was used during the trade.

Avoid Trading During Financial Distress

Executives must exercise heightened caution when their companies face financial instability, as trading during such periods can raise red flags for regulators.

Cautionary Tale: James Herbert II (First Republic Bank): Herbert sold $6.8 million worth of stock before the bank’s collapse, leading to scrutiny of Morgan Stanley for failing to monitor insider trades effectively.

Best Practice: Refrain from trading when the company is facing financial difficulties or significant corporate events.

Do Not Trade on Material Non-Public Information (MNPI)

But what is MNPI? It is not possible to define every category of Material Non-Public Information. In a nutshell, information should be regarded as material if there is a reasonable likelihood that it would be considered important to an investor in making an investment decision regarding the purchase or sale of the company’s securities. Here are some examples:

• Financial results
• Known but unannounced future earnings or losses
• News of a pending or proposed merger
• News of the disposition or acquisition of significant assets
• Significant developments related to intellectual property
• Significant developments involving corporate relationships
• Changes in dividend policy
• New service or product announcements of a significant nature
• Stock splits
• New equity or debt offerings
• Significant litigation exposure due to actual or threatened litigation
• Departure or acquisition of executive talent or company leadership

Best Practice: Ensure you are fully separated from access to confidential information before making trades. If you are in a position where occasional access to MNPI is part of your role, make sure you respect blackout periods and preclearance rules, and consider a 10b5-1 trading plan. This is true whether the company is public or private, as insider trading is not limited to transacting in shares of publicly traded companies based on MNPI. For example, in 2021, a former executive of a private technology startup was charged with insider trading for selling shares after learning confidential financial data, and in 2019, an investor was fined for trading shares of a private pharmaceutical firm based on non-public clinical trial results. If you are in a position where you have access to MNPI, make sure you respect blackout periods and preclearance rules, and consider a 10b5-1 trading plan.

Cautionary Tale: Barry Siegel (Foot Locker): Siegel was charged with insider trading after using non-public information about the company’s sales and inventories, even after his termination.

Foster a Culture of Compliance

Companies should provide regular insider trading training and establish clear policies to prevent violations. It is critical ensure mandatory training on insider trading laws and company policies and establish a robust internal monitoring system for trades by key personnel.

Potential Criminal and Civil Liability and/or Disciplinary Action

Pursuant to federal and state securities laws, insiders may be subject to criminal and civil fines and penalties as well as imprisonment for engaging in transactions in a company’s securities at a time when they have knowledge of Material Nonpublic Information regarding the company. Liability for insider trading extends beyond the insider’s direct involvement in a securities transaction based on MNPI—it also extends to “tipping.” Insiders may also be liable for improper transactions by any person (commonly referred to as a “tippee”) to whom they have disclosed Material Nonpublic Information regarding the company or to whom they have made recommendations or expressed opinions on the basis of such information as to trading in the company’s securities. The Department of Justice has charged tippers, and the SEC has imposed large penalties even when the tipper did not profit from the trading.

Conclusion

The cases of Peizer, Sebok, Herbert, and Siegel illustrate how easily insider trading accusations can arise from improper trading activities. By understanding and implementing best practices, corporate executives can protect both their professional integrity and their company’s reputation. Compliance should be seen as a proactive measure, not just a regulatory obligation. For more guidance on corporate compliance strategies, contact our firm today. 

If you receive a Wells notice, an SEC subpoena for documents or request for testimony, a FINRA 8210 or FINRA OTR, or any similar request from a state securities regulator, contact Fridman Fels & Soto, PLLC to speak with an experienced SEC defense attorney immediately to protect your rights and respond effectively. 

For more guidance on corporate compliance strategies, contact our firm today. If you receive a Wells notice, an SEC subpoena for documents or request for testimony, a FINRA 8210 or FINRA OTR, or any similar request from a state securities regulator, contact Fridman Fels & Soto, PLLC to speak with an experienced SEC defense attorney immediately to protect your rights and respond effectively.

Alejandro Soto is a former senior official with the SEC and leads Fridman Fels & Soto, PLLC’s Securities Litigation and SEC Enforcement Defense Practice Group.