A Plan for Managing Stock Sales: 10b5-1s and SEC Rules

Corporate insiders at publicly traded companies are privy to information that can have a major impact on the share price, such as a Federal Drug Administration (FDA) approval or rejection of a new drug. As a result, corporate trading policies restrict the number of days corporate insiders can buy or sell shares. Often, these policies limit the number of open trading windows to less than 60 days per year.

Overall, insider trading restrictions include blackout periods and exposure to material, non-public information (MNPI).

These trading constraints hamper corporate executives’ ability to manage their holdings, posing a stock concentration risk within their overall investment portfolios.

There is a solution to this problem: Rule 10b5-1

 

Breaking Down Rule 10b5-1

Rule 10b5-1, established by the Securities and Exchange Commission (SEC) in 2000, enables insiders of publicly traded corporations to create trading plans for buying or selling stocks. It’s a clarification of Rule 10b-5[1] (sometimes written as Rule 10b5), created under the Securities and Exchange Act of 1934, the primary set of laws used to investigate securities fraud.

  • Rule 10b5-1 permits major stockholders—executives, board directions, and officers—to establish a plan to sell a prearranged number of shares at preset times, basically placing the investment process on autopilot.[2] Many corporate executives utilize 10b5-1 plans to avoid insider trading allegations.
  • These plans allow the insider to set up a trading plan that permits stock trading during blackout periods before and after corporate events, announcements of important news, and quarterly earnings announcements. The plan should detail the price, amount, and dates when the shares will be sold and established by a formula or metrics. The plans are set up as a contract between the insider (i.e., an executive or board member) and their broker.

Investment managers in private equity funds can also use the 10b5-1 plan to make future purchases or sales of company equity or debt without violating insider trading restrictions. Distressed debt investors can also utilize Rule 10b5-1 to make future purchases or sales of company debt.

 

A Real-World Example of a 10b5-1 Plan

A recent example of the benefits of a 10b5-1 plan was Pfizer CEO Albert Bourla’s sale of nearly $5.6 million worth of stock on November 9, 2020, the same day the drugmaker announced positive early data on its experimental coronavirus vaccine. That day the share price rose about 15%. Bourla’s sale was part of a pre-scheduled 10b5-1 trading plan, adopted on August 19.[3] On that date, Pfizer was enrolling participants in its late-stage trial of the vaccine, but the CEO had no way of knowing if the vaccine would be approved or be successful.

Crucial prerequisites for establishing a plan and creating a defense from insider-trading violations are that the plan is created in good faith at a time when the executive does not have material, non-public information. In Bourla’s case, his plan was in place before the critical news announcement. The plan also sets the price, the number of shares, and dates for transactions; and rules out any future undue influence by the executive via canceling existing plans and putting in place a new one immediately after that.

A sample plan term would state, “exercise an incentive stock option for 20,000 shares of XXX if the stock market price climbs above the option’s strike price of $20.”

 

History of Rule 10b5-1

Rule 10b5-1 was adopted in October 2000 to help resolve confusion about insider-trading rules that resulted from conflicting appeals court decisions. The conflict began when the courts deliberated actions that would lead to charging executives with insider-trading because of their material, non-public information. Some courts ruled that a violation only happens if an executive used the MNPI to buy or sell corporate stock. Other courts deemed that an insider trader violated the rules just for possessing the knowledge—even if it didn’t influence the executive’s decision to trade the shares.

The SEC determined that the broader “possession” based standard would be adopted in deciding insider-trading violations. This led to concern that executives, who often have MNPI, would be burdened with extremely harsh restrictions when managing their corporate shares. As a result, the SEC created Rule 10b5-1 for insiders to set up a transaction plan that adheres to the rule’s guidelines.

 

Rule 10b5-1 Requirements

For a 10b5-1 plan to be effective and grant the insider a defense against insider trader charges, the plan must comply with specific requirements.

  • The plan must be in writing and established in good faith when the executive does not have MNPI.
  • The plan must state the number of shares to be traded, the price that will trigger a transaction, and the dates on which transactions will happen.
  • Once the plan is established, executives are not allowed to try to influence the trade plan, i.e., changing the date of a trade or the number of shares.
  • The plan provides the insider’s broker the exclusive right to decide when to sell or buy shares, as long as the broker completes the trades without MNPI.

Executives can establish a 10b5-1 plan to purchase corporate shares when they reach a certain price. In addition, the plan can be used to exercise both non-qualified and incentive stock options. In this case, the executive may not want a corporate trading blackout to prevent them from a purchase before the options expire. Finally, the insider can specify a date for a large sale to take care of a personal expense such as paying a child’s college tuition or a home purchase.

 

Changes to Existing Plans

Modifications to an existing 10b5-1 plan are permitted if they are enacted when the executive does not have material, non-public information, and in an open trading window. In most cases, the company must approve the changes. Cancellations can happen anytime, even if the executive has material, non-public information.

Nevertheless, executives must be careful about the “good faith” requirement when setting up a 10b5-1 plan. Insiders may forfeit the defense granted by rule 10b5-1 if their changes or cancellations are judged to have been made as part of a scheme to evade insider trading laws. Therefore, before a plan is amended or canceled, an executive should talk with either their lawyer or a corporate counsel to ensure the modification was done properly.

 

Communications about the Plan

Just as in the Pfizer example, corporate executives worry if their stock sales will be announced at an inopportune time, resulting in criticism from the press or its shareholders. As a result, a recommended action is for the company to publicly announce new 10b5-1 plans through a press release, 8-K filing, or a mention in the subsequent 10-Q filing. The company Is not obligated to disclose the plan’s specific terms.[4] However, it’s prudent to mention that a plan was enacted by the executive or a general statement that a few corporate executives have agreed to a sales plan as part of Rule 10b5-1.

Rule 10b5-1 plans enable insiders to trade company shares through corporate trading blackouts, but they do not remove regulatory restrictions on company affiliates as detailed under Rule 144 or Section 16.

Affiliates include a person who controls or is controlled by the company. This label includes officers, directors, and beneficial owners who own more than 10% of outstanding shares. Affiliates who trade stock as part of a 10b5-1 must adhere to certain guidelines according to Rule 144 of the Securities Act of 1933. Restrictions include the volume of shares that can be traded in any three-month period, a notice of sales must be sent to the SEC before or at the time an order to sell is entered, shares must be sold through a broker, and there must be adequate public information about the corporation.

 

Special Considerations

The SEC announced proposed changes to Rule 10b5-1 in mid-December 2021. The changes would enhance disclosure requirements for stock trades and gifts of securities and oblige the person establishing the trades to “certify that they are not aware of material, non-public information.”[5]

 

The Bottom Line

A Rule 10b5-1 plan is a robust tool for public company executives. Nevertheless, dealing with the complexities of insider trading regulations may require assistance from professionals with expertise in Rule 144, Section 16, and 10b5-1. This is especially true now that the SEC has announced that it may change aspects of the plan’s rules. SEC laws do not require companies to disclose the use of Rule 10b5-1 to the public, but it may be a good practice to do so. Announcements of the use of Rule 10b5-1 can help prevent public relations snafus and assist investors in learning the reasons for certain insider trades.

 


[1] Code of Federal Regulation. “Subpart A – Rules and Regulations Under the Securities Exchange Act of 1934.”

[2] Final Rule: Selective Disclosure and Insider Trading: SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 240, 243, and 249
Release Nos. 33-7881, 34-43154, IC-24599, File No. S7-31-99
RIN 3235-AH82
Selective Disclosure and Insider Trading

[3] Will Feur and Nick Wells. Pfizer CEO sold $5.6 million of stock as company announced vaccine data that sent shares soaring. CNBC. November 11, 2020.

[4] Sam Aspinwell, CFP, CPWA. Rule 10b5-1 Plans. Executive Consulting of Raymond James.

[5] SEC Proposes Amendments Regarding Rule 10b5-1 Insider Trading Plans and Related Disclosures. December 15, 2021.

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