SEC charges public company executives with insider trading despite trading via so-called 10b5-1 rule of trading plans | Winstead PC

Corporate officers and directors sometimes view having a 10b5-1 trading plan as an insurmountable obstacle to facing charges of insider trading. But a recent case announced by the SEC demonstrates that such plans are not bulletproof.[1] If an executive enters into such a plan while in possession of material, nonpublic information, charges of insider trading could result.

The facts of this case are relatively simple. In 2015, Cheetah Mobile, Inc., a company focused on developing content-driven products on mobile computers and mobile games, was informed that its largest advertising partner was changing its algorithm, which would cut revenue in half. that Cheetah Mobile would generate unless it improved the quality of its ad placements. A third of Cheetah Mobile’s revenue was generated by placing third-party advertisements delivered by its largest advertising partner in its apps.

By the end of the year, it was clear that Cheetah Mobile would not be able to implement a solution to prevent a drop in revenue. As a result, Cheetah Mobile’s revenue fell 3% in Q4 2015 and 8% in Q1 2016. This represented a 30% decline in revenue for the largest advertising partner. The CEO failed to disclose to the company’s investors that the negative trend was created by the ad partners’ algorithm shift, instead attributing the low revenue numbers to greater-than-expected “seasonality.” The CEO also failed to disclose the known negative revenue trend to the SEC on his fiscal year 2015 Form 20-F filed in April 2016.

Cheetah Mobile’s insider trading policy prohibited employees from trading in Cheetah Mobile securities and establishing 10b5-1 plans while in possession of MNPI. In March 2016, the CEO and CTO each established a 10b5-1 trading plan with the goal of selling shares of Cheetah Mobile through a private British Virgin Islands company they had formed. By selling their shares in March, the CEO and CTO avoided losses of $303,417 ($203,290 and $100,127, respectively). A month later, in May 2016, the CEO announced that Cheetah Mobile did not expect to meet its expected 2016 earnings due to declining revenue from its largest advertising partner. The announcement sent Cheetah Mobile shares down about 18%.

The main conclusions of the case are as follows:

  • 10b5-1 plans do not provide an ironclad defense in all circumstances. If the officer or insider does not act in good faith or is aware of the material nonpublic information at the time the 10b5-1 trading plan was created, charges of insider trading could arise. follow.
  • Alleged violations of the kind in this action could lead to onerous undertakings, including disclosure of all changes to a 10b5-1 plan to the SEC and the Company’s Legal Department; wait for a cooling-off period of 120 days to transact under a newly enacted 10b5-1 plan; agree to additional trading restrictions; and certifying compliance with these commitments annually.

[1] SEC accuses Cheetah Mobile CEO and former chairman of insider trading, available at https://www.sec.gov/news/press-release/2022-169.

Barbara M. Stokes