Avoid Insider Trading Accusations with a 10b5-1 Plan

Executives of public companies often receive a large part of their compensation in the form of equity. While this can be beneficial, as it may align company performance with an executive’s goals, it’s not always the case. Sometimes, equity compensation vests based on time and not performance, so the alignment isn’t guaranteed. Nonetheless, the potential for income growth remains as executives guide the company to success.

However, as part of their job, executives typically have access to “material nonpublic information” about the company. If they sell stock based on this information, they would be guilty of violating federal, and possibly state, insider trading laws. Therefore, executives who receive compensation in the form of stock, stock options or restricted stock units (RSUs), need to manage their share sales very carefully.

Fortunately, the Securities Exchange Commission (SEC) offers a solution — the 10b5-1 plan. If you are an executive or director of a public company, here’s what you need to know about setting up such a plan:

What is a 10b5-1 plan?

SEC Rule 10b5-1 defines the prohibition on insider trading. But it also provides an avenue to allow executives to trade shares of stock, and therefore diversify their holdings, without being accused of insider trading.

A 10b5-1 plan is a contract you file with the SEC that explicitly states you plan to sell company equity on a future date. It can be used for stock sales, stock option exercises, company repurchase programs, individual stock repurchase programs and restricted stock grant sales.

The plan must either detail the specific amount of stock, price and date; or it can be a formula, such as: “I plan to sell one-third of my available vested shares on the 10th trading day of the third quarter, as long as the price is above $10 a share. “The instructions can specify either a market order or a limit order.

Plan details do not need to be made public. But company acknowledgment of the plan is required. And it may be in your best interest to have the company disclose that a plan exists in a Form 8-K. A Form 8-K is a report companies must file with the SEC to announce significant events that shareholders should know about, such as acquisitions, bankruptcies or changes in executive leadership.

Do I need a 10b5-1?

If you are a high-ranking company official or board director with access to material nonpublic information and plan to sell shares, then establishing a 10b5-1 plan can be beneficial. Not having a 10b5-1 plan may present serious risks if you intend to sell shares. It provides a clear framework for selling shares at predetermined conditions, such as specific prices or dates, protecting you from accusations of insider trading.

If you do not plan to sell shares, or if you prefer to sell them during open windows after earnings are reported, a 10b5-1 plan may not be necessary. However, for those looking to systematically sell shares, filing a 10b5-1 plan offers added protection and peach of mind.

First, although your company may have its own insider trading policy, filing a 10b5-1 plan further protects you from suspicion if you should happen to sell shares before a major, detrimental event.

Take the case of four Equifax senior executives who sold company shares before the enormous data theft of nearly 148 million personal records was publicly announced in September 2017. They were subject to an internal investigation and according to Bloomberg, a federal investigation involving three of the officials was also launched. According to Bloomberg, “Regulatory filings don’t show that the transactions were part of pre-scheduled trading plans.”

All four were eventually cleared by the Equifax Board of Directors, which determined the executives had no prior knowledge of the breach before the sales, and the trades conformed with the company’s insider trading policy and had received preclearance by the firm’s compliance department.

The company’s report doesn’t say whether the executives had filed 10b5-1 plans beforehand, but they may have avoided serious investigations and bad publicity if they had.

Furthermore, if your investment portfolio has a high concentration of stock in the company you work for, it’s a good idea to gradually decrease your holdings as part of a detailed financial plan to diversify your portfolio and meet your financial goals. After all, most executives continue to earn significant amounts of deferred compensation in the form of equity grants. So, selling shares on a regular, predetermined schedule makes sense.

What should I know about 10b5-1 plans?

• Most companies require that plans be established during open window periods. Additionally, some companies may impose a waiting period before transactions can take place.
• The plan is good for one year. If you cancel it, you cannot establish a new plan for another year. This means you will not have the protection of the plan and will need to trade company stock independently.
• A plan may be modified only if you do not have possession of inside information at the time of the change. It’s best to discuss any modifications with company counsel to ensure compliance.
• Depending on the company’s policy, you may be able to buy or sell stock during blackout periods within the plan. However, if selling shares outside of a 10b5-1 plan, it must occur during an open window.
• Hedging of shares within the plan is not allowed.

How do I set up a 10b5-1?

Your wealth manager can help you determine the price levels and number of shares to benefit your financial goals and protect yourself from insider trading issues. They will then work with the custodian firm, which executes the plan.

Receiving company equity as part of your compensation has the potential to be very rewarding financially, but it requires understanding of the many securities rules. Partnering with a wealth manager who’s experienced with executive compensation and 10b5-1 plans allows you to stay focused on your work, diversify your portfolio and efficiently implement your financial plan — all with more peace of mind.

Ready to take the next step? Talk with us to learn more about setting up a 10b5-1 plan and how it can benefit your financial strategy, especially when you are evaluating your equity compensation plan.