California Department of Corporations Issues Final Rule Adopting Rule 10b5-1(c) Defense

Originally published on this site August 2001

As noted on this site, concern arose when the SEC's 10b5-1(c) trading defense became effective that it would not apply to California's insider trading statute. That statute, Cal. Corp. Code ยง 25402, renders unlawful purchases or sales in California "at a time when" an insider "knows material information about the issuer gained from" a relationship that gives the insider access to nonpublic information.

Worry no longer. On August 14, 2001 (effective July 31, 2001), the California Department of Corporations adopted Rule 260.402, which had been issued as an emergency regulation (effective for 120 days) on March 14, 2001. The Rule recognizes the 10b5-1(c) defense. The rule (Title 10, Chapter 3, Section 260.402 of the California Code of Regulations) states:

For purposes of Section 25402 of the Code, an issuer or person described in Section 25402 shall not be deemed to have purchased or sold an issuer's security at a time when that person knows material information about the issuer if the issuer or such person demonstrates that the purchase or sale of the issuer's security was in accordance will (sic) Rule 10b5-1(c) promulgated under the Securities Exchange Act of 1934, as amended, 17 CFR Section 240.10b5-1(c).

In adopting the emergency regulation in March, the Department had issued a press release in which the Commissioner of Corporations stated, "If a stock transaction is legal in New York and legal in Nebraska, it should be legal in California. The new state regulation provides relief to investors and corporations from unnecessary litigation. In short, this regulation ensures that the rule of reason and the rule of law converge." See New State Rule Allows California Investors to Avoid State-Specific Insider Charges; California Corporations Department Conforms State to Federal Law (Mar. 21, 2001). This strong support for the defense is consistent with my position that as a practical matter, it would be make no sense to have a State regulator disapprove of insiders' attempts to comply with federal insider trading law.

The final rule is the same as the emergency regulation (right down to the error in the word "will"), as all five comments on the proposed rule were favroable. In the most interesting portion of the Statement of Reasons accompanying the final regulation, the Department construed the California securities laws' prohibition on insider trading when the following elements are present:

  1. a relationship (e.g., an officer, director, or control person) with the issuer that provides access to knowledge of facts that are material;
  2. knowledge of facts which are material at the time of the transaction (whether the person knows that the facts are material or not);
  3. the material information is such that it would significantly affect the market price of the issuer's securities; and
  4. knowledge that the information is not available to the public.

Thus, the standard for materiality is objective, but the standard for nonpublic is subjective.

The Finding of Emergency for the emergency regulation had been posted on the Department of Corporation's Internet site at, but apparently it is no longer posted. Interestingly, the Finding had opined that "[n]either the California Corporations code nor the rules adopted thereunder address the point in time at which the non-public information becomes disqualifying for purposes of materiality." This allows the argument that under present law, even absent the regulation, selling stock pursuant to a plan adopted when an insider did not know any material nonpublic information does not constitute a violation of the statute.

I salute the Department of Corporations, including its Commissioner, Demetrios A. Boutris, for its prompt and reasonable action.