SEC Adopts Selective Disclosure and Insider Trading Rules

Washington, DC, August 18, 2000 - The Securities and Exchange Commission recently adopted new rules to address three issues: the selective disclosure by issuers of material nonpublic information (Regulation FD); when insider trading liability arises in connection with a trader's "use" or "knowing possession" of material nonpublic information (Rule 10b5-1); and when the breach of a family or other non-business relationship may give rise to liability under the misappropriation theory of insider trading (Rule 10b5-2). The new rules will take effect 60 days after publication in the Federal Register.

The Institute submitted a comment letter regarding the rule proposals in late April.

Selective Disclosure: Regulation FD (Fair Disclosure)
To address its concerns about the selective disclosure of material nonpublic information by issuers, the SEC has adopted Regulation FD under the Securities Act of 1993. The new rule requires that whenever an issuer, or person acting on its behalf, discloses material nonpublic information to certain enumerated persons, the issuer must make public disclosure of that same information simultaneously (for intentional disclosures) or promptly (for nonintentional disclosures).

In response to public comments concerning the broad scope of proposed Regulation FD and its potential unintended marketplace consequences, the SEC made several modifications to the final rule "to provide even greater protection against the possibility of inappropriate liability, and to guard further against the likelihood of any chilling effect resulting from the regulation."

Narrowed Scope. Regulation FD will apply only to an issuer's communications with securities market professionals, and holders of the issuer's securities under circumstances in which it is reasonably foreseeable that the security holders will trade on the basis of the information. The regulation will not apply to issuer communications with the press, rating agencies, and ordinary-course business communications with customers and suppliers. Additionally, the regulation will apply only to communications by the issuer's senior management, its investor relations professionals, and others who regularly communicate with securities market professionals and security holders.

No Private Liability. The Release emphasizes that Regulation FD is a disclosure rule, which does not create liability for fraud. The regulation text now includes an express provision stating that a failure to make a disclosure required solely by Regulation FD will not result in a violation of Rule 10b-5 under the Securities Exchange Act.

"Knowing or Reckless" Conduct. To provide additional assurance that issuers will not be second-guessed on close materiality judgments, the Release states that where the regulation speaks of "knowing or reckless" conduct, liability will arise only when an issuer's personnel knows or is reckless in not knowing that the information selectively disclosed is both material and nonpublic.

Eligibility for Short-Form Registration or Resales. The Release expressly provides that a violation of Regulation FD will not lead to an issuer's loss of eligibility to use short-form registration for a securities offering or affect security holders' ability to resell under Rule 144 under the Securities Act.

Registered Offerings and Foreign Issuers. The regulation now expressly excludes communications made in connection with most securities offerings registered under the Securities Act. Additionally, the regulation does not apply to foreign issuers.

Insider Trading: New Rule 10b5-1 ("Use/Possession" Issue)
New Rule 10b5-1 provides that, for purposes of insider trading, a person trades on the basis of material nonpublic information if a trader is "aware" of the material nonpublic information when making the purchase or sale. Despite receiving comments that a "use" standard would be preferable, the Commission determined that "awareness, rather than use, most effectively serves the fundamental goal of insider trading law-protecting investor confidence in market integrity." Rule 10b5-1 also sets forth several affirmative defenses or exceptions to liability, which have been modified in response to comments. These exceptions permit persons to trade in certain specified circumstances where it is clear that the information they are aware of is not a factor in the decision to trade, such as pursuant to a pre-existing plan, contract or instruction that was made in good faith.

Additionally, Rule 10b5-1 provides, as proposed, that an entity may demonstrate that a purchase or sale of securities is not "on the basis of" material nonpublic information if the entity had implemented reasonable policies and procedures to ensure that individuals making investment decisions would not violate the laws prohibiting trading on the basis of material nonpublic information.

Insider Trading: New Rule 10b5-2
(Clarifying Duties of Trust or Confidence in Misappropriation Cases)
Rule 10b5-2 was adopted to clarify when family or personal relationships create "duties of trust or confidence" under the misappropriation theory of the Securities Exchange Act and Rule 10b-5 thereunder. The new rule sets forth a nonexclusive list of three situations in which a person has a duty of trust or confidence for purposes of the misappropriation theory of insider trading: