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Rule 10b5-1 Stock Trading Plans

Overview of a 10b5-1 Trading Plan

In a public company, a number of people may come into possession of material, non-public information about the company.  When this happens, and they want to trade in the company’s stock, they are unable to do so on the grounds that this can be construed as illegal insider trading.  The SEC’s Rule 10b5-1 gives them a defense against this insider trading liability by allowing them to create a trading plan.  This trading plan creates a pre-established buying or selling program of a specific duration.  With such a plan in place, an individual cannot be held liable under insider trading allegations.  The key concepts that a person must follow in order to make use of this defense are that:

1. Before becoming aware of material, non-public information, the person entered into a binding contract to buy or sell the security, instructed another entity to conduct these trades for the person’s account, and adopted a written plan for doing so.
2. The contract specified the amount of securities to be purchased or sold and the price at which and the date on which the trades were to occur, or included a formula for determining the amount, price, and date of purchase or sale, and did not permit the person to subsequently alter the trading instructions in the plan.
3. The person must be able to prove that subsequent trades were pursuant to the contract.  This proof is not possible if the person subsequently altered or deviated from the plan, or entered into a hedging transaction with respect to those securities.

The SEC has held that a person is allowed to cancel a trading plan, on the grounds that they cannot be held liable for trades that have not yet occurred.  Given this SEC position, someone with access to insider information could cancel a plan in order to avoid selling stock at unusually low prices.  It is also possible to enact a series of short-duration trading plans, so that a person could constantly adjust the plan to more closely match short-term market prices.  These methods of trading plan management remove much of the downside risk from using a trading plan.  However, they increase the risk of an allegation being raised that an employee is attempting to circumvent the intent of the Rule.

Every brokerage uses its own 10b5-1 trading plan.  The basic format of such plans adheres to a layout where the person engaging in securities trading specifies the type of trading program to use.

Problems With a 10b5-1 Trading Plan

The primary downside of adopting a trading plan is the reduced level of trading flexibility, since a person cannot precisely tailor his trades to daily market conditions.

Podcast

A discussion of 10b5-1 trading plans is available on Episode 95 of the Accounting Best Practices podcast. Listen Now.

Related Topics

Insider securities reporting
Proxy solicitations
Reporting non-GAAP information
Rule 144 stock sales
SEC filing codes