Using a 10b5-1 trading plan
As a public company CFO (or other officer or director), you’ll probably use a 10b5-1 trading plan at some point to sell your company shares—if you haven’t already.
The Securities and Exchange Commission's Rule 10b5-1 creates a safe harbor for company insiders like you who want to sell shares without fear of being accused of illegal insider trading.
As a refresher, the SEC rule basically states that you can sell shares with a presumption that you had no material nonpublic information if the trade occurs pursuant to a predetermined plan established before you possessed any material nonpublic information.
Sounds straightforward, right? Unfortunately, the SEC’s new chair, Gary Gensler, thinks there are “cracks” in 10b5-1 trading plan rules today. Indeed, Chair Gensler recently announced that the SEC is considering freshening up Rule 10b5-1 altogether as outlined in a speech at the CFO Network Summit in June 2021.
The “Cracks” in 10b5-1 Trading Plans
In his speech, Chair Gensler highlighted four areas where he believes 10b5-1 trading plans could be improved:
- A “cooling off” period
- Cancelling 10b5-1 trading plans
- Mandatory disclosure requirements
- Limits on 10b5-1 plans
Let’s look closer at each of those.
The “Cooling Off” Period
In his remarks, Chair Gensler stated that the fact that a “cooling off” period does not exist before insiders make their first trade could lead to a “loophole to participate in insider trading.” He is referring to the current rule’s lack of a mandatory waiting period between the implementation of the plan and a plan’s first trade.
Of course, the majority of directors and officers would not willingly participate in insider trading. But Stanford research suggests that a subset of executives “use 10b5-1 plans to engage in opportunistic, large-scale selling of company shares.”
A cooling off period ensures that directors and officers do not inadvertently appear to be selling shares based on undisclosed material nonpublic information.
Cancelling 10b5-1 Trading Plans
Today the rules place no limitations on cancelling 10b5-1 plans. The concern is that bad actors could cancel a plan once they possess material, nonpublic information, according to Chair Gensler.
For example, an executive might cancel a plan that would have automatically sold shares upon learning that something is about to happen that would make selling later more lucrative.
Mandatory Disclosures
Chair Gensler highlighted the fact that “comprehensive data on the structure and use of 10b5-1 plans is not widely available either to the public or to the Commission.” This is supported by the Stanford research I shared earlier. A lack of data certainly makes hiding improper activities easier.
Limits on 10b5-1 Plans
Current rules place no limits on the number of 10b5-1 that company insiders can adopt at one time. Chair Gensler thinks that “insiders might mistakenly think they have a ‘free option’ to pick amongst favorable plans as they please.”
Having said that, Chair Gensler went on to clarify that even today, “If insiders don’t act in good faith when using 10b5-1 plans, those plans will not offer them an affirmative defense.”
Best Practices for 10b5-1 Trading Plans
There has been scrutiny around 10b5-1 trading plans for years, with research discussing the potential pitfalls dating back to the early 2000s. So it’s no surprise that it’s back in the spotlight.
Whether or not the SEC cracks down on the regulation of 10b5-1 trading plans anytime soon, well-informed company insiders will follow best practices when it comes to adopting and using 10b5-1 trading plans.
Remember, insider trading is a serious allegation. In fact, it’s one allegation that can lead to massive derivative lawsuit settlements.
So what are these best practices? Here are seven you might consider when engaging in company 10b5-1 trading plans:
1. Public Disclosure
When trading your company’s shares pursuant to a good 10b5-1 trading plan, be sure to promptly disclose that the shares were traded pursuant to a 10b5-1 plan. This just means dropping an appropriate footnote in the required Form 4 filing.
For extra credit, consider disclosing the implementation of your 10b5-1 trading plan on a Form 8-K at the time the plan is adopted. While this is not required by the SEC as of yet, some practioners consider this to be a best practice.
Doing this will, however, make it harder to cancel an implemented plan even when there is a legitimate reason to do so simply because you might feel compelled to file an 8-K disclosing the plan being cancelled.
2. 30-Day Gap
Consider having at least a 30-day gap between the adoption of a new 10b5-1 plan and the first trade. Sixty or ninety days would be even better. This gap will minimize any appearance of improper behavior.
3. Limited Modifications
Once adopted, there should only be minimal (if any) modifications. If and when changes are made to a plan, make sure there is at least 30 days (more would be better) between the modifications and the first trade made under the modified plan.
4. Minimal Terminations
Suspensions and terminations of the 10b5-1 plans should be minimal. If you, as an insider, are uncomfortable with this restriction, you might instead consider shorter duration plans (like six or nine months). In all cases, there should be at least 30 days between the adoption of a new plan and the first trade made.
5. Small Sales Over Time
Rather than just a few large sales, consider a number of smaller sales over time. This regular cadence of sales can help minimize the concern that you might appear to be exploiting material nonpublic information just because your timing happened to be fortuitous.
6. Isolation of Trading Plan Broker
If your 10b5-1 trading plan allows for any discretion on the part of your broker, consider having the broker who administers your 10b5-1 plan be someone other than your broker for other securities.
Fewer conversations with the 10b5-1 plan broker means less of an opportunity to convey information—advertently or inadvertently—that might help the 10b5-1 plan broker who has discretion over trades improve the returns from the plan.
In addition, consider setting up communication protocols with the 10b5-1 plan broker if your plan allows for broker discretion. For example, you might establish that all communications are limited to written communications. This can help rebut any future suspicion that you were feeding material nonpublic information to the broker.
7. No Trading Outside the Established Plan
Once you establish a 10b5-1 trading plan, you should only trade the company’s stock pursuant to 10b5-1 plans. Trades made outside of the current plan are not afforded the protection from 10b5-1.
Worse, such trades make it harder for a suspicious regulator to believe that you implemented your 10b5-1 trading plan as a normal part of a preplanned diversification strategy and not for any nefarious reason.
Do all of these best practices make 10b5-1 trading plans seem like a hassle? No doubt. But a little bit of hassle and upfront planning is a great trade in exchange for avoiding an investigation by the SEC or the Department of Justice.
Remember that the stakes are high. The cost of defending yourself from a charge of insider trading can be bankrupting, and significant jail time is a possible outcome if criminal charges are brought against you.
Compared to that, the paperwork involved in setting up a good 10b5-1 trading plan seems like a relatively small price to pay for the benefit the safe harbor that the trading plan provides.
