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An Ounce Of Prevention

How do you limit the potential legal liability for conduct that is inherently risky, but generally beneficial to society? One way is to create regulatory safe harbors that shield individuals from liability if they abide by certain restrictions.

The Washington Post had an interesting article in yesterday's paper on a safe harbor created by the SEC for corporate insider trading. Under SEC Rule 10b5-1, put into place in 2000, a person's purchase or sale of securities is not "on the basis of" material nonpublic information if, before becoming aware of the information, the person enters into a binding contract, instruction, or trading plan (as defined in the rule) covering the securities transaction at issue. The article discusses how the corporate executives of Trex Co, a Va.-based maker of composite deck boards, are likely to benefit from this safe harbor.

"Trex stock plunged more than $10 a share the day after the earnings shortfall was announced June 22, costing stockholders roughly $150 million in the value of their shares. By selling their shares before the problem was revealed, Trex chief executive Robert G. Matheny and directors Anthony J. Cavanna and Andrew U. Ferrari together got almost $1 million more for their stock than they would have if they had waited to sell after the announcement. Insider trading records compiled by Thomson Financial show that in the first three weeks of June, Cavanna sold Trex stock worth $1.4 million, Matheny sold $968,000 and Ferrari sold $381,000. Ordinarily, big insider sales just before bad news is announced would trigger outcries from shareholders and probably an investigation by the Securities and Exchange Commission. That hasn't happened because the Trex officials acted under an SEC rule that allows corporate officers, directors and other insiders to sell stock at any time, under almost any circumstances, without running afoul of insider trading regulations -- so long as the sales are 'pre-arranged.'"

The use of these stock trading plans may also assist Trex in defending against the securities class action that has been brought against the company. Plaintiffs often allege that a company's officers were motivated to engage in securities fraud so that they could profit by selling their company stock at an artificially inflated price. Some courts have begun to cite the existence of stock trading plans as negating any such inference, making Rule 10b5-1 an example of a regulatory safe harbor spilling over into private tort litigation.



Rafael Mangual
Project Manager,
Legal Policy

Katherine Lazarski
Manhattan Institute


Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.