On September 21, 2022, the U.S. Securities and Exchange Commission (“SEC”) charged the CEO, Sheng Fu, and former president, Ming Xu, of Chinese-based technology company Cheetah Mobile Inc. (“Cheetah Mobile” or the “Company”) with insider trading for selling Cheetah Mobile American Depository Shares while in possession of material nonpublic information. Notably, the trades at issue — sales totaling 96,000 shares to avoid losses of approximately $203,290 and $100,127, respectively, in advance of a negative disclosure — were made pursuant to a Rule 10b5-1 plan that the two executives had jointly established. However, the SEC determined that their plan did not shield them from liability because they entered into the plan only after becoming aware of material non-public information — a significant drop-off in advertising revenues from the Company’s largest advertising partner. This case reflects the SEC’s recent heightened scrutiny of trading by executives and potential abuses of Rule 10b5-1 plans and highlights the importance of adhering to best practices when entering into such plans.
The SEC’s Findings
The SEC’s Order Instituting Cease-and-Desist Proceedings (the “SEC Order”) against Fu and Xu found that Fu and Xu violated the antifraud provisions of the Securities Exchange Act of 1934 (the “Exchange Act”) and that Fu also violated the antifraud provisions of the Securities Act of 1933 and was a cause of Cheetah Mobile’s violations of issuer reporting requirements under the Exchange Act. According to the SEC Order, in 2015 and 2016, Cheetah Mobile “earned up to one-third of its revenues by placing within its applications third-party advertisements provided by its largest advertising partner” which was a division of a major social medial platform. In the summer of 2015, the advertising partner informed the Company that it was going to change its algorithm that determined fees for ad placements and that unless Cheetah Mobile improved the quality of its ad placements, the algorithm change could “half the revenues” that the partner paid to the Company. Revenues from the advertising partner thereafter fell 11% from Q3 2015 to Q4 2015 and declined 30% in Q1 2016. During Cheetah Mobile’s Q1 2016 earnings call, however, Fu attributed “softness” in its Q1 revenue to greater-than-expected “seasonality.” The SEC Order further stated that in late March 2016, while aware of the negative revenue trend, Fu and Xu entered into their joint 10b5-1 plan. Fu and Xu then sold 96,000 shares under that plan before Cheetah Mobile disclosed, in May 2016, lower-than-expected revenue guidance for Q2 2016 and that it did not meet previously-issued revenue and earnings guidance for 2016. This disclosure caused the Company’s stock price to fall 18%, and Fu and Xu’s sales prior to the disclosure allowed them to avoid losses of approximately $203,290 and $100,127, respectively.
The Settlement and Undertakings of Fu and Xu
Without admitting or denying the SEC’s findings in the SEC Order, Fu and Xu agreed to cease-and-desist orders, certain mandatory reporting to the SEC relating to trading and future 10b5-1 plans, and to pay civil penalties of $556,580 and $200,254, respectively. Fu also agreed to restrictions on any future Rule 10b5-1 plans that he might establish in the future. Specifically, for a period of five years, any such plans will need to be reported to the SEC within 48 hours of execution, incorporate a 120-day “cooling off period” between the date on which the plan or any amendment goes into effect and the first date of any transaction pursuant to the plan and Fu is prohibited from maintaining more than one Rule 10b5-1 plan at any given time with respect to Cheetah Mobile securities.
SEC’s Increased Scrutiny of Rule 10b5-1 Plans and New Proposed Amendments to Rule 10b5-1
The SEC’s enforcement action against the Cheetah Mobile executives reflects SEC Chair Gary Gensler’s stated intention to crack down on trading, particularly by executives, made pursuant to Rule 10b5-1 plans. Gensler has publicly stated that Rule 10b5-1 plans have “led to real cracks in our insider trading regime” and has warned “if insiders don’t act in good faith when using 10b5-1 plans, those plans will not offer them an affirmative defense.” Chief of the SEC Enforcement Division’s Market Abuse Unit Joseph G. Sansone echoed these comments in announcing the Cheetah Mobile action, stating: “While trading pursuant to 10b5-1 plans can shield employees from insider trading liability under certain circumstances, [the Cheetah Mobile] executives’ plan did not comply with the securities laws because they were in possession of material nonpublic information when they entered into it.”
The restrictions imposed in the SEC Order on Fu’s future Rule 10b5-1 plans also mirror the SEC’s proposed amendments to Exchange Act Rule 10b5-1, which were published on December 15, 2021 and are summarized in more detail here. For example, under the proposed amendments, all 10b5-1 plans of corporate officers and directors will be subject to a mandatory 120-day “cooling off period” following initial adoption or modification before trading under the plan could commence. The proposed amendments also prohibit overlapping or concurrent 10b5-1 plans for open market trades in the same issuer’s securities and impose a limit on 10b5-1 plans to execute a single trade to one plan within any 12-month period. The proposed amendments also require enhanced disclosures by issuers of Rule 10b5-1 plans entered into by their officers and directors.
The Cheetah Mobile case is a stark reminder that the SEC (and, in particular, its Market Abuse Unit’s Analysis and Detection Center) is scrutinizing and will continue to scrutinize trading by corporate insiders, particularly surrounding significant disclosures and resulting stock price movement, even if those trades are made pursuant to 10b5-1 plans. It is, therefore, critical to ensure that all Rule 10b5-1 plans are entered into during open trading windows, when the insider does not have material non-public information, and in good faith.
 “Order Instituting Cease-and-Desist Proceedings,” In the Matter of Sheng Fu and Ming Xu, File No. 3-21118 at 9–12 (Sept. 21, 2022) (“SEC Order”), https://www.sec.gov/litigation/admin/2022/33-11104.pdf.
 SEC Order at 9–12.
 Gary Gensler, “Prepared Remarks: CFO Network Summit” (June 7, 2021), https://www.sec.gov/news/speech/gensler-cfo-network-2021-06-07#.
 SEC Press Release, “SEC Charges Cheetah Mobile’s CEO and its Former President with Insider Trading” (Sept. 21, 2022), https://www.sec.gov/news/press-release/2022-169.
 SEC Proposed Rule, Rule 10b5-1 and Insider Trading, 17 CFR Parts 229, 232, 240 and 249
[Release No. 33-11013; 34-93782; File No. S7-20-21], https://www.sec.gov/rules/proposed/2022/33-11013.pdf.
Caroline H. BullerjahnPartner
Deborah S. BirnbachPartnerCo-Chair, Complex Litigation & Dispute Resolution
Sean M. DonahuePartnerChair, Public Company Advisory Practice