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‘Too many gaps’: Why the SEC is looking to update insider trading rules

·Washington Correspondent
·3 min read

The rules around insider trading seem simple: Corporate insiders can’t turn a profit or dodge a loss on their stocks while they have pertinent information that regular investors don’t know.

But one exception offers too much of a loophole, critics say. It's called the “safe harbor defense,” and it all comes down to timing.

It's possible for a fishy looking transaction to comply with the current rules if the insider locked in the trade before obtaining the material, nonpublic information. But, as an explainer from the law firm Willkie Farr & Gallagher notes, “There is growing suspicion among enforcement authorities and financial and legal experts that the plans are being abused to obscure more informed insider trading.”

Now Securities and Exchange Commission Chair Gary Gensler is looking to tighten the loophole, as he discussed in a new interview for Influencers with Andy Serwer. “There was something put in place about 20 years ago,” he says of the current rules. “We came on board and thought, there's too many gaps in this area.”

U.S. Securities and Exchange Commission (SEC) Chair Gary Gensler testifies before a Senate Banking, Housing, and Urban Affairs Committee oversight hearing on the SEC on Capitol Hill in Washington, U.S., September 14, 2021. REUTERS/Evelyn Hockstein/Pool
U.S. Securities and Exchange Commission (SEC) Chair Gary Gensler testifies before a Senate Banking, Housing, and Urban Affairs Committee oversight hearing on the SEC on Capitol Hill in Washington, U.S., September 14, 2021. REUTERS/Evelyn Hockstein/Pool

There is currently no federal law that specifically bans insider trading, which has left the SEC and the Department of Justice to police the issue using overall general securities fraud laws.

The SEC's authority in the area grows from Rule 10b-5, which goes all the way back to the Securities Exchange Act of 1934. In 2000, the rules around insider trading were expanded with Rule 10b5-1 and Rule 10b5-2. which cemented the phrase "material nonpublic information" into the public lexicon.

Gensler's proposed changes, which would update the 2000 rules, wouldn't remove the safe harbor defense entirely. Currently, a trade is allowed if the particulars of the transaction were agreed to in advance and the executive in question doesn't have the power to change the order in the interim. But it would strengthen disclosure requirements.

The proposal would add a series of new conditions for allowing insiders to make this defense, and it would add disclosure requirements around corporate buybacks, with more details in quarterly reports.

The rules would allow regulators to more closely scrutinize the trades with provisions like a cooling off period for trades and a new requirement that executives sign written certifications as they enter into timed stock trading plans and other restrictions.

“These proposed amendments aim to address critical gaps in the SEC’s insider trading regime and to help shareholders understand when and how insiders are trading in securities for which they may at times have material nonpublic information,” the SEC says.

'We're taking it up in both ways'

Insider trading has become a front-burner issue for the SEC in recent weeks after a recent Wall Street Journal report that the SEC is looking into whether recent sales by both Tesla (TSLA) CEO Elon Musk and his brother Kimbal violated insider trading rules.

Gensler declined to confirm whether the SEC is investigating the Musk trades. “I'm not going to be able to comment,” he said even before Yahoo Finance’s Andy Serwer finished a question.

But he described insider trading as a key priority for his agency.

“We're taking it up in both ways,” Gensler said of both rule changes and also enforcement of the current rules. “This comes down to trust in our capital markets and trust that there's a level playing field that when you're in the markets, that somebody doesn't have an information advantage from material non-public information.”

The new rules are still under consideration and open for public comment until April 1. After that, according to the SEC's rule-making process, the commission will consider the public’s input and then potentially move towards adoption.

Ben Werschkul is a writer and producer for Yahoo Finance in Washington, DC.

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