Insider trading. The very mention of the word conjures up images of clandestine conversations, speaking in code, and disposing of cell phones in separate dumpsters. The actual SEC complaints brought in the last few years read better than crime novels. Within days of a suspicious trade by an “unknown purchaser” of options in a company about to be acquired, the SEC can track the source of the anonymous entry to a specific account, often overseas, and freeze the assets. The US Attorney’s office in Manhattan has won over 80 insider trading cases that went to trial in the past five years and lost only one. Law enforcement has expanded the use of wiretaps, and juries are hard-pressed to acquit someone who in their own words knowingly enriched themselves through receiving inside information.

Given this environment, we would expect public companies to closely scrutinize sales of company stock by all insiders, require pre-clearance from internal counsel before selling, expand blackout periods, and mandate share ownership by a percentage of salary. Concurrently, most executives’ wealth is tied up in shares or awards of company stock. With all the restrictions in place—whether by the company, or the government through numerous form filings—how can executives monetize these assets in a consistent manner? 

One of the solutions is that individuals may sell stock under pre-arranged plans that meet the criteria under Rule 10b5-1. For such plans, the rule provides an “affirmative defense” against allegations that a sale was made “on the basis of” material nonpublic information about that security. While an affirmative defense is not a guarantee of immunity from prosecution, it is a significant factor in protecting an executive’s stock sales against allegations of insider trading. 

For a plan to comply with Rule 10b5-1, it must be in writing and established when an executive does not have inside information. An independent party is appointed to administer the plan and execute the trades. Plans may cover both purchases and sales, although sales plans are much more common. 

A complete 10b5-1 plan will include the number or dollar value of shares to be sold, the sale date, and for a limit order, the dates the order will remain open. Once in place, the executive, or any other person who may have material nonpublic information, may not change the parameters of the plan. The Rule does not prohibit modifying or terminating a plan when the executive does not have material nonpublic information, and the company’s trading window is open – but such action is inadvisable. 

One safeguard many plans institute is a “cooling off” period after the plan is signed, during which no sales under the plan may occur. This period may last 30 days or a few months. In addition, sales of securities outside of the plan may be restricted while the plan is in effect. Typically, plans allow flexibility with the date of trade execution in the event of a general market disruption or other unforeseen event. 

10b5-1 plans are popular when used in conjunction with equity awards. They provide the opportunity for the execution of limit orders set above the current market price, if the stock price rises during a company blackout period. A 10b5-1 plan with consistent, uniform market orders over time also can produce results closer to average prices over a given time period. These benefits are especially important when an executive owns in-the-money options whose term will eventually expire. Without a 10b5-1 plan in place, the value of the options may be lost if the issuer prohibits trading in the period before expiration. Similarly, when restricted stock awards vest, the executive may be required to sell shares immediately to cover the payroll taxes due. A 10b5-1 plan can help mitigate the conflict of selling shares during an issuer blackout period.

​Andrew Schwartz (CEP, CPA), has more than 12 years of experience with the administration and taxation of equity compensation.​​​​​