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Alert: SEC "Looking At" Rule 10b5-1 Trading Plans (April 2007)

SEC Rule 10b5-1 provides company insiders (usually executives but also any person who has stock or options) with a means to diversify their interest in company stock, and a way to manage media and market reactions to executive sales. When these prearranged trading plans are properly created, they provide a defense against charges of insider trading if you later trade under the plan while you know important confidential information about your company. (For details, see the relevant content section on myStockOptions.com.)

Typically, these pre-established 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.
Example: A written one-year contract between executive and broker 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.
In more than a third of Fortune 500 companies, at least one executive has sold company shares under a Rule 10b5-1 trading plan.

SEC "Looking At This—Hard"

In a speech about a range of topics, the SEC's Enforcement Director Linda Chatman gave an unpublicized warning that the SEC is looking at abuses in these plans:

[E]xecutives with plans sell more frequently and more strategically ahead of announcements of bad news. This raises the possibility that plans are being abused in various ways to facilitate trading based on inside information. We're looking at this—hard. We want to make sure that people are not doing here what they were doing with stock options. If executives are in fact trading on inside information and using a plan for cover, they should expect the "safe harbor" to provide no defense.
As with stock option backdating, academic research on these plans has drawn the SEC's interest. A study by Professor Alan Jagolinzer, of Stanford Graduate School of Business, shows that executives who trade within a 10b5-1 plan outperform their peers and the market. The SEC has discussed the paper with Professor Jagolinzer.

Proceed With Caution And Follow Best Practices

Before you set up a Rule 10b5-1 trading plan or discontinue an existing one, contact company counsel and your lawyer: practices under this rule, adopted in 2000, are still developing and are now under SEC scrutiny. While these prearranged trading plans do not need to be irrevocable, the rules are unclear on ending a plan before it is fully executed, setting up multiple short-term plans, and selling immediately after adoption.

Best practices have evolved. For example, your company may require you to enter into plans during a particular window of time, and to wait until the next window period to make the first trade. It may also prohibit scheduling automatic trades during regular blackout periods (e.g., two-week period surrounding a quarterly earnings announcement). The SEC may investigate if you trade under a plan, or discontinue it, before bad news about your company causes a stock-price drop.

Further Reading

For further information about Rule 10b5-1 trading plans, see the section SEC Law: Rule 10b5-1 plans on myStockOptions.com . Bruce Brumberg, the editor-in-chief of myStockOptions.com, recently made a presentation on insider trading education and prevention, including Rule 10b5-1 trading plans. This detailed PowerPoint version of that speech, which covers a range of related developments and compliance suggestions, is available in PDF at myStockOptions.com in the section SEC Law: Insider Trading.

 

Editorial Staff, myStockOptions.com