SEC Rule 10b5-1 provides a defense against charges of insider trading if you later trade stock while you know confidential, important information about your company. A Rule 10b5-1 trading plan is a program for the periodic purchase and/or sale of your stock that meets the requirements of this SEC rule. When properly created, these plans provide company insiders (usually executives but also any person who has stock or options) with a way to diversify their interest in company stock and, hopefully, manage the media and market reaction to executive stock sales.
How These Plans Work
Typically, Rule 10b5-1 trading plans specify the number of shares to be sold (or purchased) at the price and date detailed and/or have a formula or algorithm that triggers the trade and the number of shares involved. In the interpretation of experts, a simple limit order (e.g. sell 5,000 shares when the stock hits $22) does not create a Rule 10b5-1 trading plan. If its conditions are met, Rule 10b5-1(c) sets forth an "affirmative defense" in litigation over insider trading. When stock-trading occurs under one of these plans before the outset of the alleged fraud, the plan can undermine any inference of suspicious trades for assessing scienter (i.e. fraudulent intent).
These requirements include:
- your sales or purchases followed a detailed plan or arrangement that was established when you were unaware of "material" undisclosed information about the company
- your transactions were made either by an independent person who must follow your advance instructions on when to trade or by a person you granted discretion, leaving you with no subsequent influence (e.g. pursuant to a blind trust, power of attorney, or broker's discretionary account)
Example: A written one-year contract between executive and broker that instructs the broker to sell 10,000 shares on the first trading day of each month and twice as many shares (20,000) if the price has increased by 5% since the prior sale date.
Before you set up a Rule 10b5-1 trading plan, contact company counsel and your lawyer: practices under this rule, adopted in 2000, are still developing. Most companies require you to enter into plans during a particular window of time (some companies also require the first trade to be deferred into the next window), and prohibit scheduling automatic trades during regular blackout periods (e.g. two weeks before a quarterly earnings announcement). See the FAQ on the evolving best practices for Rule 10b5-1 plans.
Remember To Follow Rule 144 And Section 16
All the other requirements for stock sales, such as those for executives under Rule 144 and Section 16, still apply. Rule 10b5-1 concerns only an insider-trading defense against violations of Rule 10b-5.
Alert: The SEC is also looking into abuses of Rule 10b5-1 trading plans. It has focused particularly on modifications and terminations of plans and on questioning whether holders of plans truly did not know market-moving information when they prearranged trades under the plan. For example, in June 2009 the SEC charged the former CEO of Countrywide Financial, Angelo Mozilo, with insider trading. The SEC alleged that he "established four executive stock sale plans for himself in October, November, and December 2006 while he was aware of material, non-public information concerning Countrywide's increasing credit risk and the expected poor performance of Countrywide-originated loans." He then later exercised options and sold company stock under these written trading plans. Eventually, in October 2010, Mr. Mozilo agreed to pay the largest-ever SEC penalty by a public company executive, along with a $45 million disgorgement of ill-gotten gains to settle the disclosure violation and the insider-trading charges.
According to two articles published by The Wall Street Journal in late 2012 ("Executives' Good Luck in Trading Own Stock" on Nov. 27 and "Trading Plans Under Fire" on Dec. 13), the SEC may sharpen the regulations on Rule 10b5-1 plans. The authors of these articles weigh examples and data that raise questions about the timing of trades by some executives.