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Other Articles
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Government Regulations
New "10b5-1 Plan" Helps Solve Executives’ Diversification Problems
By Thomas Carroll
Financial Advisor, Carroll, Frank & Plotkin, LLC
In October 2000, the Securities and Exchange Commission updated “The Securities Exchange Act of 1934,” a law designed to prevent trading fraud, in an effort to clarify the ambiguities of the existing insider trading rules.
In doing so, they also spelled out how corporate insiders can trade their stock without violating the regulations.
Under section 10b5-1 of the act, corporate insiders can trade their stock if they demonstrate that the transaction was made as part of a predetermined, systematic trading plan established before the insiders became aware of any “material, non-public information.”
Furthermore, the amended rules describe how section 10b5-1 could provide an “affirmative defense” against insider trading litigation. The SEC does not provide details for establishing these plans, but did offer flexibility by identifying certain prerequisites for a “10b5-1 Plan” and “affirmative defense.” In brief, the following conditions must be met:
First, the “10b5-1 Plan” must be established at a time when the insider is unaware of any “material non-public formation” and be through a third party such as an advisor, broker/dealer, or trustee.
Second, the plan must predetermine the number of shares to be traded, at what stock price, and on what date. You may use formulas, an algorithm or a computer program for determining amounts, prices and dates.
Finally, once the plan is established, the insider cannot exercise any influence, stop or change the plan. While there is no specific plan duration, most plans are effective for one year and can be renewed if the aforementioned SEC rules are observed. Of course, the advisor or broker is also prohibited from possessing any “material, non-public information” when executing the trade.
A simple example of a “10b5-1 Plan” might read as follows: Sell 10,000 shares on the first day of each quarter at a price no lower than $50 per share. There is a lot of flexibility in the plan design, but all the rules must be strictly followed. If these conditions are met, then the insider’s knowledge of “material, non-public information” is not an issue when the stock is traded, even if the executive later becomes aware of such information.
With a “10b5-1 Plan” in effect, the executive, director or other corporate insider could begin diversifying his or her stock holdings without the constant worry of violating the SEC insider- trading rules.
Additionally, a “10b5-1 Plan” can be designed for someone who might have future liquidity needs like funding for a child’s education. Moreover, corporations who wish to buy back stock of their company over a period of time can also implement a “10b5-1 Plan.”
For instance, a corporation during blackout periods could employ a “limit order” strategy to protect the stock price. This would help the corporation protect the stock price during the buyback period.
The SEC does not require the corporation to establish the “10b5-1 Plan.” Any individual can establish a plan. However, most advisors agree that it would be prudent for individuals to inform and discuss their intentions with the corporation before implementing this strategy, since the corporation may have to modify their existing trading policies to enable the new plan.
As always, before entering into any type of securities trading plan first consult a knowledgeable securities attorney.
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