Stock Trading Plans Under Rule 10b5-1

by Boris Feldman*

The Securities & Exchange Commission recently created a new safe harbor for stock trades by company insiders. The safe harbor is an affirmative defense to SEC Rule 10b5-1. The SEC staff has provided a helpful commentary on the new provisions. This FAQ addresses practical implementation issues.

 

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The overall purpose of Rule 10b5-1 is to make it easier for the SEC to enforce the prohibitions on insider trading against persons who trade while in possession of material nonpublic information. At the same time, the SEC created an affirmative defense to enable insiders to trade so long as they did so pursuant to a plan created prior to the time they acquired the material information. In simple terms, if you sell stock pursuant to a properly established plan, you will not be liable for insider trading even if you became aware of material information subsequent to the time you established the plan and before your trade occurred.

 

The trading safe harbor is available to anyone who trades pursuant to a proper plan: employees of the company; outsiders who may learn of material nonpublic information about the company; and the company itself.

 

The regulation contemplates three types of written plans, any of which is sufficient to invoke the safe harbor protection: (i) a document specifying that particular trades will occur at specified prices, on specified dates, for specified numbers of shares; (ii) a document specifying a formula pursuant to which trades will occur; or (iii) a document granting an outsider complete discretion to make the trades, without access to any material nonpublic information about the company.

 

It depends on the type of plan. The simplest plan must be very specific with respect to date, volume, and price: "I will sell 5,000 shares on October 23, 2000 at $15 per share." The "trading model" plan must specify the formula or algorithm to be used in making the trades: "On the twentieth day of every quarter, I will sell sufficient shares at the market price that day to yield $25,000 in proceeds." The "delegation" plan can be relatively general: "I direct Jane Broker to sell up to 50,000 shares of stock over the next year at such times, in such amounts, and at such prices as she deems appropriate." Although the commentary does not specifically address the situation, it is likely that one can combine the second and third models: "I direct Jane Broker to sell 10,000 shares each quarter, so long as the price is at least as high as the 52-week rolling average."

 

Yes. So long as you established the plan before you knew the adverse information, you can go forward with the trade even if you learn of that information before you execute the plan. For example, you adopt a plan on January 1 that provides for a sale of 10,000 shares during the sixth week of every quarter, commencing in May. In late April, you learn that the Company is not on track to meet its targets for the June quarter. The trades scheduled for May under the plan may go forward. Of course, you may not alter the plan to increase the number of shares to be traded once you know the adverse information.

 

Regardless of which type of plan you choose, you should put it in writing and give a copy to the trading compliance officer at your company. Ideally, adopt the plan some time before the actual trades will occur; the longer the time that elapses, the less likely you are to be accused of having access to the nonpublic information when you formulated the plan. Senior executives might, for example, adopt a plan pursuant to which trades would not begin until after the results of the current quarter have been announced.

 

The more you fiddle with the plan, the greater the likelihood that it will be viewed as a sham. If you expect to be adjusting the formula frequently, the safe harbor approach may not be right for you. If you decide to terminate the plan, then a subsequent adoption of a new plan could undermine the value of the defense. The most secure plans will be those with a longer (perhaps fixed) duration that you do not fine-tune along the way. Any changes that you do make will be less vulnerable if they take effect one quarter in the future.

 

Literally, yes. But don’t. Such stock sales would not receive the protection of the plan under the Rule 10b5-1 defense. More important, the existence of parallel selling models – those under the plan and those outside it – could give rise to suspicions that the plan was part of a scheme.

 

Trading windows and blackout periods are a matter of company policy, not federal law. I expect that many companies will modify their internal trading windows to provide that they do not apply to trades made pursuant to a proper plan. In that case, you can schedule trades within the plan at any time during a quarter, regardless of whether or not the window is open for discretionary trades. As a matter of personal preference (and external appearance), I think that the earlier in a quarter (following the earnings release) that trades occur, the better. That way, even if there is a problem with your plan, the odds are lower that you were in possession of material information.

 

At minimum, selling stock in violation of the plan terms will deprive the trades of the safe harbor protection. The SEC (or private plaintiffs) might also point to the violation as evidence of fraudulent intent on your part. Violation might also subject you to sanctions by your company.

 

Public disclosure is not required. In my opinion, officers or directors of public companies would be well-served by disclosing the existence of the plan (though not its precise terms) in shareholder documents. This would minimize the inferences that the market might draw from the timing of particular stock sales by insiders. Disclosure could also be useful in securities litigation to dispel any inferences of misconduct based on the trading.

 

Yes. In shareholder class actions, a key element of plaintiffs’ case is that stock sales by insiders in advance of the negative disclosures provide the motive for the alleged fraud. I believe that courts will apply the Rule 10b5-1 defense to overcome any such inferences where the sales occurred pursuant to a proper plan.

 

I have encouraged clients for years to dispose of their stock through blind trusts. Executive Stock Sales and Securities Class Actions: The Blind Trust Approach. Few have been willing to do so, in part because of the perceived hassles of setting up the trust. Rule 10b5-1 validates this approach and makes it much simpler: for most employees, a plan will provide ample protection. It remains my view that for executives with very large blocs of stock to sell, or with very complicated plans, the added formality of a blind trust may provide enhanced protection, particularly in shareholder lawsuits. Indeed, in the commentary accompanying proposed Rule 10b5-1, the staff stated: "We have not included any express defenses for blind trust trading, because we do not believe this trading creates difficulties under existing insider trading law. When a person places securities in a blind trust, by definition he or she does not make the decisions to purchase or sell securities in that account. Therefore, those trading decisions (which are made by the trustee of the blind trust) should not be attributed to the person for purposes of potential insider trading liability." Proposed Rule: Selective Disclosure and Insider Trading, Releases Nos. 33-7787, 34-42259, etc. (Dec. 20, 1999) (Internet copy), n.91.

 

Yes. The safe harbor is an affirmative defense, not an element of the SEC’s insider trading claim. The SEC can overcome the defense if it shows that plan was actually part of an insider-trading scheme. As noted above, the longer the elapsed time between adoption of the plan and commencement of trading, the tougher this showing will be for the SEC.

 

Yes. The regulation expressly provides that the issuer may establish a repurchase plan that receives the Rule 10b5-1 protections. Note that a standard corporate announcement that the company may repurchase up to x million shares does not constitute a sufficiently specific plan to invoke the safe harbor. In addition, a company may set up internal walls that enable an employee without access to material nonpublic information to engage in repurchases for the company, even though other employees know of such information at the time.

 

*Copyright 2000. Boris Feldman is a member of Wilson Sonsini Goodrich & Rosati, in Palo Alto. This article reflects his views, not his firm’s. Revised October 13, 2000.

 

 

 

 

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