Rule 10b5-1 Trading Plans (#95)
/In this podcast episode, we cover the need for and use of 10b5-1 trading plans for stock purchases and sales by corporate insiders. Key points made are noted below.
In a public company, people may have material information about the company that hasn’t yet been put into any filings with the SEC. If they try to buy or sell shares with that kind of information, then it’s illegal insider trading, and they can get in a pile of trouble.
Rule 10b5-1
And that’s where this Rule 10b5-1 comes in. The SEC created it so that insiders can create a legitimate stock trading plan that won’t get them in trouble for insider trading. This trading plan contains a pre-set buying or selling program, and it’s valid for a certain period of time.
Now, to make a 10b5-1 trading plan valid, it has to contain certain types of information. It has to state which securities to buy or sell, and the allowable price points or ranges to do the trading, and the volumes to trade. In addition, the insider is not allowed to alter the trading instructions in the plan once it’s been set up.
Another key item is that you can’t just set up a trading plan at any old time. It has to be when you’re not aware of any material information about the company that hasn’t already been disclosed to the investment community. To be safe, that means you should initiate the trading plan right after issuing either a Form 10-K or 10-Q, since all material information should be in those documents.
And one other item is that the insider must be able to prove that subsequent trades were, as the lawyers say, “pursuant to the contract” – or in English, that the trades followed the rules that you set up in the trading plan. Obviously, this is tough to prove if you altered the plan or you engaged in some additional trades. So to be safe, once you set up that plan, leave trades up to the broker. Don’t muck around with it.
That all sounds simple enough, and it is – but there’s a twist.
Cancelling a Trading Plan
The SEC has ruled that you can cancel the trading plan, on the grounds that you can’t be held liable for trades that haven’t yet occurred. Okay, so what does that mean?
Let’s say you created a six-month trading plan to sell some stock, and it’s been running for a month. Then you think that the stock price is probably going to decline – or maybe it already has declined. Guess what? You can cancel the plan. So, this means there’s not really much downside risk with a trading plan.
Of course, you could be accused of getting around the intent of the Rule if you cancelled the plan based on insider information. But, the SEC has not yet gone after people for canceling their trading plans, so who knows?
A company might even create a policy to not allow its employees to terminate their trading plans early. By doing so, they’re eliminating that loophole that the SEC opened, and its makes the company look a bit more ethical.
Using Short-Term Trading Plans
You can achieve the same thing, and make it look quite a bit more legitimate, by setting up a series of short-term trading plans. You let each one expire after a short time, and then adjust the terms of the next plan to match market prices. If you follow this approach, then consider creating plans that run for three months a piece. That way, you can legitimately install a new trading plan right after each quarterly SEC filing.
Parting Thoughts
That covers the essentials of a 10b5-1 trading plan. Clearly, they’re quite useful if you’re in a position where you want to trade stock, but you’re always aware of insider information. So, how do you create a trading plan. That’s the easy part. Every brokerage already has a basic template, so you just fill in the blanks and sign it.