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Revisiting Rule 10b5-1 Trading Plans

    Client Alerts
  • August 18, 2017

I am sometimes surprised by the number of insiders who trade in their company’s stock outside of Rule 10b5-1 trading plans. It is often said, with some accuracy, that executive officers, directors and other insiders always possess material nonpublic information (MNPI) due to the very nature of their jobs. And in fact, many insiders are able to actually create MNPI merely by deciding to initiate a strategic change or direct a financial decision. If that is true, or at least arguable under the glare of 20/20 hindsight, then trading outside of a trading plan is a dangerous proposition.

The question, then, is, “Why take the chance?” A trading plan provides an easily implemented affirmative defense against insider trading claims, and courts have consistently deferred to valid trading plans, even under questionable circumstances. Furthermore, it is well-known that the SEC is vigorously pursuing insider trading violations of all shapes and sizes. (See this Doug’s Note.) For that matter, why doesn’t every company require that its insiders trade only under a trading plan?

The elements of a trading plan.

An enforceable trading plan must satisfy the following requirements:

  • The insider was not aware of any MNPI at the time it was adopted.
  • It specifies a non-discretionary trading method.
  • The insider may not exercise any subsequent influence over how, when or whether to make purchases or sales.
  • The insider must enter into the plan in good faith and not as part of a plan or scheme to evade the insider trading prohibitions.

That sounds easy, so what’s the problem?

Honestly, I’m not sure. Some companies may feel that prohibiting trades outside of a plan is unduly restrictive, i.e., an insider should be able to bear the risk if he or she wants to. But that mindset ignores the harsh consequences of an insider trading investigation by the SEC, including legal fees, management time and distraction and reputational damage, even if the insider is ultimately exonerated.

Sometimes companies reason that if the insider truly always possess MNPI by virtue of his or her job (see above), then the requirement that the trading plan be adopted only in the absence of MNPI can never be satisfied anyway. That concern is easily allayed by imposing a holding period between the date of plan adoption and the first trade date. At a minimum, there should be a least one intervening earnings release, and most companies impose a 90-day delay for that reason. Some companies mandate a 30-day delay, but that only partially accomplishes the goal. Less than 30 days is dangerous.

Then there’s the question of trading plan disclosure, which is not required by SEC rule. Some companies are perfectly happy to voluntarily disclose the adoption of a trading plan in Item 8 of Form 8-K. Others worry that disclosure (whether in a Form 8-K or as a footnote to the related Form 4, or both) draws too much attention to an event that would otherwise have minimal fanfare, making it better to avoid trading plans altogether. That reasoning seems to minimize the potential liability of trading outside of a plan and to overlook the benefits of disclosure. For example, disclosure gives the company the opportunity to provide color around the reasons for the insider’s trade and manage the message, rather than letting the market speculate as to the insider’s motivations. It also enhances market perception of the company’s commitment to transparency.

A few bonus tips.

While you are thinking about trading plans, here are a few other tips to keep in mind:

  • A trading plan is not required to have a term limit. However, the market favors trading plans that are specific in duration, rather than open-ended, and are not too short, which might suggest manipulative intent. Most trading plans have a term of six months to two years, with one year being most common.
  • It’s a good idea to enter into a trading plan shortly after a trading window opens, even if there is a cooling off period, to further mitigate the MNPI issue.
  • Most companies designate one experienced administering broker to execute trades according to a company-approved trading plan. Once the trading plan is adopted, there should be no communication between the insider and the broker (other than notices that trades have been executed).
  • Amendments may be made to a trading plan so long as the insider does not possess MNPI at the time of the modification. However, amendments are generally frowned upon because they can create the perception of manipulation or bad faith. Plans may be cancelled without regard to the possession of MNPI, though cancellations before the specified termination date are suspect for obvious reasons. Likewise, avoid overlapping trading plans.
  • Rule 10b5-1 prohibits insiders from entering into hedging transactions or positions related to trades covered by a plan.
  • Trading plans eliminate the awkward conversations and difficult analysis, not to mention time investment, that sometimes arise when an insider requests clearance to trade under the company’s insider trading policy.