UPDATES! What is a Rule 10b5-1 trading plan?
A Rule 10b5-1 plan is a prearranged trading plan under SEC Rule 10b5-1 that 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.
Many companies now either require or strongly encourage their executives and directors to set up Rule 10b5-1 plans for trading company stock. Your company may even let you sell shares through these plans during regularly scheduled quarterly blackout periods.
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.
Plans Under Scrutiny
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.
Potential abuses in 10b5-1 plans continue to be a subject of academic research and prompt pushes for rule changes. (See, for example, the academic paper Gaming the System: Three "Red Flags" of Potential 10b5-1 Abuse and a commentary on it from the law firm Cooley.) In 2021, a letter from three Democratic members of the Senate Committee on Banking, Housing, and Urban Affairs urged the SEC to adopt specific reforms to prevent what they perceive as abusive 10b5-1 plan practices and to improve disclosure.
In January 2019, the US House of Representatives passed the Promoting Transparent Standards for Corporate Insiders Act, which requires the SEC to study specific features in Rule 10b5-1 trading plans and revise the rule based on its results. As stated in a commentary from the law firm Cahill Gordon & Reindel, the proposed law seeks to order the SEC to address perceived gaps and abuses in Rule 10b5-1.