Insider Trading Compliance: Trends & Legal Developments

1. PRESENTERS Trends and Legal Developments Impacting Insider Trading Compliance Policies and Procedures and Rule 10b5-1 Plans The Society for Corporate Governance Chicago Chapter Meeting | September 10, 2019 Jeffrey AyersGeneral Counsel and Corporate Secretary Career Education Corporation JAyers@careered.com Michael DiverPartner and Co-Chair of Securities Litigation and Enforcement Practice Katten michael.diver@katten.com Katherine SmithAssociate General Counsel and Assistant Secretary Exelon Corporation Katherine.Smith2@exeloncorp.com Lawrence Levin Partner and Co-Chair of Securities and Public Company Practice Katten lawrence.levin@katten.com

2. Topics to Be Discussed • Insider Trading Defined • Current Enforcement Environment and Trends • FINRA and SEC Surveillance Activities • Special Blackout Periods • Changing Insider Groups • Cybersecurity Considerations • Hedging, Pledging and Gifts • Employee Training • Rule 10b5-1 Plans – Practices and Legislative Developments

3. Insider Trading Defined • There is no rule-based prohibition on “insider trading”. • Rather, the restrictions on trading while aware of material non-public information have developed through the interpretations of the general antifraud provisions of the federal securities laws. • This has led to inconsistencies in the application of insider trading laws by the courts and the SEC, and lingering uncertainty about how the laws will be applied in certain areas (e.g., tipper/tippee liability). • Notwithstanding the uncertain legal landscape, insider trading continues to attract significant scrutiny by civil and criminal authorities.

4. Insider Trading Defined (cont.) • Section 10(b): Prohibits “manipulative or deceptive devices or contrivances in connection with the purchase or sale of any security.” • Rule 10b-5: Prohibits “use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, • To employ any device, scheme or artifice to defraud, • To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading, or • To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”

5. Insider Trading Defined (cont.) • A person violates the insider trading laws when he or she: • Purchases or sells a security • While aware of material, non-public information (“MNPI”) • In breach of a fiduciary duty or a duty of trust or confidence • With scienter – an intent to defraud or recklessness • Potential derivative liability for failing to establish, maintain and enforce controls to prevent illegal insider trading

6. Insider Trading Defined (cont.) • Materiality • Would a reasonable investor consider the information important in making an investment decision or is the information reasonably likely to affect the market price of the security? • Analysis is highly fact-specific, judgmental and applied in hindsight • Non-Public • No dissemination in a manner reasonably designed to provide broad distribution with sufficient time for the market to absorb information • While aware of • More stringent “on the basis of” evidentiary standard no longer applies

7. Insider Trading Defined (cont.) • A person aware of MNPI must either “disclose or abstain”. He or she may trade: • When the information is publicly disseminated; OR • When the information is no longer material due to: • Subsequent developments • Passage of time • Protective provisions in Confidentiality Agreements or other transaction documents: • Restrictions on issuer’s sharing MNPI • Agreement to make public disclosure (with deadline) • Disclaimers of duties of trust and confidence/obligation not to trade

8. Insider Trading Defined (cont.) • Insider trading laws have been predominantly developed through cases involving the equity markets. But the laws have been applied to transactions in the debt and credit markets. • Securities covered by insider trading laws should be construed broadly to encompass transactions in: • Common stock • Other equity securities (e.g., preferred stock) • Convertible securities • Certain debt securities (e.g., high yield bonds) • Derivative securities linked to or exercisable for securities of the company

9. Insider Trading Defined (cont.) Theories of Liability: • Classical: Insider (traditional or temporary) trades while aware of MNPI in violation of a fiduciary duty owed to shareholders • Traditional Insiders: directors, officers, employees, controlling shareholders • Constructive Insiders: accountants, lawyers, investment bankers – those persons who have “entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes . . . and the corporation [expects] the outsider to keep the disclosed non-public information confidential.” SEC v. Lund (C.D. Cal. 1988) (citing Dirks v. SEC (1983)). • Misappropriation: Non-insider trades while aware of MNPI in violation of breach of duty of trust or confidence owed to the source of the information. Trading on confidential information is deceptive because it deceives those who entrust the trader with the confidential information.

10. Insider Trading Defined (cont.) • Court have extended the misappropriation theory duty of trust or confidence outside the employer and advisor context. • SEC Rule 10b5-2. Duty of trust or confidence may arise pursuant to: • An agreement (oral or written) • History, pattern or practice of sharing confidences, such that person sharing MNPI expects that recipient will maintain confidentiality • Certain family relationships

11. Insider Trading Defined (cont.) G&K Services, Inc. Enforcement Action • In May 2019, SEC settled insider trading charges against a man who obtained confidential information about a pending corporate merger from a long-time friend (the general counsel of a public company) and used it to generate more than $250,000 in trading profits. • According to the SEC’s complaint, the friend took home a folder, labeled with a code name, that included a confidentiality agreement and a few other merger-related documents. The defendant found the folder and, unbeknownst to the friend, viewed its contents while changing into golf shoes in the friend’s home office and then purchased stock of the target company in his ex-wife’s brokerage account and also encouraged his girlfriend to buy that company’s stock. The target company’s stock rose upon the announcement of the transaction, resulting in the illicit trading profits. • According to the SEC, the defendant traded based on material, non-public information that he had obtained “in breach of a duty of trust and confidence to the friend.”

12. Insider Trading Defined (cont.) Tipper/Tippee Liability • Tipper/Tippee liability attaches (under either classical or misappropriation theory) when: • A tipper breaches a duty of trust or confidence by disclosing MNPI to a tippee • And he or she receives a “personal benefit” • The Supreme Court has said that it does not need to be “pecuniary” benefit • The tippeeknows or should have known that the MNPI was disclosed in breach of a duty • Tippee trades while aware of the MNPI

13. Insider Trading Defined (cont.) Insider Trading Prohibition Act • Unanimously approved by the House Financial Services Committee in May 2019. Has not yet been taken up by the full House. • Would eliminate the need to show that a tipper received a “personal benefit.” • Would make it a violation of law for a person to: • trade while aware of MNPI “if such person knows, or recklessly disregards, that such information has been obtained wrongfully, or that such purchase or sale would constitute a wrongful use of such information” or • “wrongfully communicate” MNPI to another person who trades on the basis of that information and where that trading is “reasonably foreseeable.”

14. Current Enforcement Environment and Trends • SEC finished FY 2018 with 821 enforcement actions. • Returned $794 million to harmed investors. • Collected over $3.945 billion in penalties and disgorgement. • Insider trading actions still a significant focus (10% of standalone actions). • Vast majority of SEC insider trading actions brought as either settled matters or in actions filed in parallel with criminal indictments.

15. Current Enforcement Environment and Trends (cont.) • The SEC and Justice Department have continued to crack down on insider trading by attorneys and their family members. • In February 2019, the SEC filed insider trading charges against a former senior attorney at Apple who had served as Apple’s global head of corporate law and corporate secretary, received confidential information about Apple’s quarterly earnings announcements in his role on Apple’s disclosure committee and was responsible for securities laws compliance at Apple, including compliance with insider trading laws. According to the SEC’s complaint, the attorney used confidential information to trade in Apple securities ahead of three quarterly earnings announcements, making approximately $382,000 in combined profits and losses avoided.  The attorney was also indicted on criminal charges.  • In April 2019, the SEC charged a former associate general counsel and assistant corporate secretary at SeaWorld Entertainment with insider trading, where that attorney traded based on non-public information that the company’s revenue would be better than anticipated for the second quarter of 2018. That attorney also pleaded guilty to a criminal insider trading charge.

16. FINRA Surveillance Activities • Equities, Bonds and Options  Surveillance handled by FINRA on behalf of exchanges • Insider Trading Surveillance Group within Office of Fraud Detection and Market Intelligence – reviews trading activity and investigates potential insider trading • SONAR – FINRA’ s electronic trading surveillance system • Looking for unusual trading – matching up to news stories/rumors, etc. • Looking at any trading ahead of major announcements (mergers in particular) • FINRA may discipline broker-dealers and affiliated individuals for insider trading or failure to maintain supervision and controls to prevent insider trading • FINRA refers most cases of suspected insider trading to the SEC (90-95%) and/or the Justice Department • FINRA cannot sanction persons not registered with FINRA

17. SEC Surveillance Activities • SEC’s Enforcement Division also reviews trading data, using sophisticated techniques. • Market Abuse Unit established an Analysis and Detection Center • Use of “trader-based” approach, focusing on traders whose patterns of trading and relationships to other traders are potentially suspicious • In a July 10, 2019 announcement of the filing of insider trading charges against an accountant and her friend, the SEC noted that it “used some of our latest advanced software to analyze trading data.” • SEC has subpoena power to compel documents, cell phone records, etc., and compel testimony • Increased tips through whistleblower program • Periodic enforcement “sweeps” to detect problematic trading activity

18. Special Blackout Periods • Special (event-specific) blackout periods often relate to one of following, if significant: • pending or proposed merger, acquisition or tender offer; • new product developments; • cybersecurity incident, including data breach; • financial and accounting developments (e.g., guidance change or potential restatement) • legal or regulatory proceedings; and • pending senior management changes. • Issues to address: • Who makes the determinations of whether such a special blackout is needed? • To whom do these special blackouts apply and how is it communicated?

19. Changing Insider Groups • Quarterly blackouts and pre-clearance procedures usually apply to: • Directors, • Officers, • Personnel focused on: • accounting, finance and internal audit; • investor relations; and • legal and regulatory. • Family members of the above. • Issues to address: • Who makes the determination of who should be covered and how is it communicated? • When is this list reviewed for possible updating?

20. Cybersecurity Considerations • SEC issued updated guidance in 2018 cautioning companies: • to “be mindful of complying with the laws related to insider trading in connection with information about cybersecurity risks and incidents, including vulnerabilities and breaches.” • that “while companies are investigating and assessing significant cybersecurity incidents, and determining the underlying facts, ramifications and materiality of these incidents, they should consider whether and when it may be appropriate to implement restrictions on insider trading in their securities.” • that “companies would be well served by considering how to avoid the appearance of improper trading during the period following an incident and prior to the dissemination of disclosure.” • A significant cybersecurity incident, including a data breach, may require a special blackout and require the imposition of trading restrictions for IT personnel, including the data breach response team.

21. Cybersecurity Considerations (cont.) • Issues to address: • Do you have a process in place whereby appropriate legal and other personnel will be notified by IT personnel in the event of a potential material cyber breach? • How do you determine whether or not a cybersecurity incident should require imposition of a special trading blackout?

22. Hedging • Usually involves the insider's purchase of a financial instrument that is designed to protect the insider from a decline in the value of the company stock (e.g., the purchase of a put option or entering into a variable prepaid forward sale contract). • In December 2018, the SEC approved final rules to require companies to disclose in proxy or information statements for the election of directors any practices or policies regarding the ability of employees or directors to engage in certain hedging transactions with respect to company equity securities. • New Item 407(i) of Regulation S-K will require a company to describe any practices or policies it has adopted regarding hedging, or, if the company does not have any such practices or policies, to disclose that fact or state that hedging transactions are generally permitted. • Companies generally must comply with the new disclosure requirements in proxy statements for the election of directors during fiscal years beginning on or after July 1, 2019.

23. Hedging (cont.) • Institutional Shareholder Services (ISS) has a voting recommendation guideline that says that any hedging by executive officers or directors is a “failure of risk oversight” on the part of the board of directors, which could lead ISS to make a negative recommendation regarding the election of some or all of the company's directors. • Appears that most companies are including a flat prohibition on hedging in their insider trading policies. • Issues to address: • How does your company address hedging matters?

24. Pledging • A major concern with pledging is a forced, or inadvertent, sale of a company’s stock when there is a margin call or loan foreclosure. • A forced sale of company stock to cover margin calls may result in a: • Violation of the Insider Trading Policy if insider has MNPI or is otherwise in a blackout period; • Section 16 violation; • Unfavorable publicity for the company. • Appears that most companies include a flat prohibition on pledging in their insider trading policies. • If pledging is permitted, any exceptions to pledging restrictions should be carefully considered and subject to pre-clearance. • ISS recommends a vote “against the members of the committee that oversees risks related to pledging, or the full board, where a significant level of pledged company stock by executives or directors raises concerns.“

25. Gifts • Practice varies widely with respect to gifts, including: • No mention of gifts (only to a “purchase or sale”); • Prohibit gifts during blackouts if it will provide an “economic advantage” to the insider (e.g., a larger tax deduction); • Allow gifts to family members who agree to be bound by the blackout; • Allow “bona fide gifts” – look at the relationship between donee and donor (e.g., gifts to charities, churches or non-profit organizations would be permitted but gifts to dependent children would not); and • Allow gifts, subject to pre-clearance.

26. Gifts (cont.) • February 2018 survey on TheCorporateCounsel.net: • For gifts to non-family members (e.g., charitable, educational or similar institutions) during a blackout period: • 47% of respondents allow employees to make such gifts – but they must first pre-clear the gift; • 30% of companies don’t permit these types of gifts; and • 14% allow gifts and don’t require pre-clearance. • For gifts to family members during a blackout period: • 38% of respondent companies don’t allow them; • 37% allow them but require pre-clearance; and • 14% allow these gifts and don’t require pre-clearance.

27. Employee Training • Onboarding – Education about Insider Trading Policy is typically part of “onboarding” process for D&Os and employees and may include a required certification that they have received and read the policy. • Ongoing Compliance Procedures: • Annual certifications • Training modules (e.g., live, taped or online) • Routine reminders of blackout and window periods • Providing updates to the policy

28. Rule 10b5-1 • Rule 10b5-1 sets forth two affirmative defenses for insiders to avoid liability; one for individuals and one for entities. • Rule 10b5-1 provides a person with an affirmative defense if: • before becoming aware of the material, non-public information, he or she had entered into, in good faith, a binding contract to trade, provided instructions to another person to execute a trade on his or her behalf, or adopted a written plan for trading securities; and • the contract, instructions, or plan (1) expressly specified the amount, price, and date of the purchase or sale; (2) provided a written formula or algorithm, or computer program, for determining amounts, prices and dates; or (3) did not permit the person to exercise any subsequent influence over how, when or whether to effect purchases or sales, provided that any other person who did exercise such influence was not aware of the material, non-public information when doing so; and • the purchase or sale occurred pursuant to the contract, instructions or plan.

29. Rule 10b5-1 – Practical Considerations • A number of legal and practical considerations must be taken into account when establishing a 10b5-1 plan: • Company Insider Trading Policy must specifically permit 10b5-1 plans to be adopted by insiders; some company plans require insiders to sell under a 10b5-1 plan and others prohibit 10b5-1 plans entirely • Where 10b5-1 plans are permitted, provisions regarding the following are often included: • Compliance officer prior approval; • Publicity/disclosure; • Right to approve modifications or terminations; • Required “Waiting” periods; and • Required “Cooling Off” periods.

30. Rule 10b5-1 – “Waiting” and “Cooling Off” Periods • “Waiting Period” – specified period after a plan has been entered into but before trading can begin • Practice varies, according to TheCorporateCounsel.net survey in 2017: • 33% of companies require a minimum 30-day waiting period; • 28% require a waiting period until the next window opens; • 15% of companies don’t require any waiting period; and • 11% of companies require a waiting period of two weeks or less. • “Cooling Off Period” – specified period between termination of one plan and putting in a new plan • Practice varies but the longer the better; 30 days appears to be the most common but many wait until the next window period opens

31. Rule 10b5-1 – Plan Modifications • Cannot modify the plan while aware of material, non-public information; a transaction is not pursuant to the 10b5-1 plan if the insider alters or deviates from the plan. • Cannot change the amount, price or timing of transactions. • Cannot enter into or alter a hedging transaction. • However, this does not otherwise preclude concurrent transactions outside the plan.

32. Rule 10b5-1 – Plan Terminations • The SEC has indicated you can terminate a plan, even when you are aware of MNPI. • “Not against the law not to trade.” • Plan must be entered into in good faith – a pattern of establishing and cancelling plans may raise questions. • Some companies specifically prohibit plan terminations by insiders.

33. Rule 10b5-1 – Council of Institutional Investors Proposal for Changes • Plans may only be adopted during open trading windows. • Prohibited from adopting multiple, overlapping plans. • Plans are subject to a mandatory delay, preferably of at least three months, between adoption of the plan and the first trade. • There should not be frequent modifications or cancellations of plans.

34. Rule 10b5-1 – Council of Institutional Investors Proposal for Changes (cont.) • Require disclosure of plan adoptions, amendments, terminations and transactions. • Boards of companies that have adopted plans should: • adopt policies covering plan practices; • periodically monitor plan transactions; and • ensure that company policies discuss plan use in the context of guidelines or requirements on equity hedging, holding and ownership.

35. Rule 10b5-1 Plans – Legislative Developments The Promoting Transparent Standards for Corporate Insiders Act (H.R. 624) – 2019 Directs the SEC to study Rule 10b5-1 plans and determine whether the statute should be amended to do any of the following: • Limit the ability to adopt certain plans to issuer-adopted trading windows; • Limit the ability of issuers and insiders to adopt multiple, overlapping trading plans; • Create a mandatory delay between the adoption of the plan and the first trade date under it; • Limit the frequency that issuers and insiders may modify or cancel trading plans; • Require filing with the SEC of trading plan adoptions, amendments, terminations and transactions; and • Require boards of issuers who have adopted Rule 10b5-1 plans to adopt policies to cover plan transactions and to periodically monitor plan transactions. Directs the SEC to issue a report to Congress within one year containing its findings and to revise Rule 10b5-1 consistent with the results of the study.

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