10b5-1 Plans- Insider Trading Defense

What they are, how they work, and when they do not work.

By Mark J. Astarita, Esq.

10b5-1 Plans- Insider Trading Defense

As executive compensation becomes increasingly based on stock options, more and more executives find themselves in an insider trading quagmire when they attempt to sell their securities for reasons having nothing to do with insider trading or their company. Simple investment diversification often mandates such sales. However, a poorly timed sale can, and has, resulted in an insider trading investigation, as news comes to light in the days, weeks or even months after the sales of stock by insiders.

However, insider trading, or rather the threat of an accusation of insider trading, is an issue that every executive who is selling his company’s securities must be concerned about, as an SEC investigation, even if one is innocent, can be a costly, time consuming, and distracting process, which can last for more than a year.

My prior column addresses the issues related to insider trading, but here we will focus on a partial solution, one created by the SEC itself. In August 2000 the SEC adopted Rule 10b5-1 and the “10b5-1 Plan” was born.

Rule 10b5-1 formalizes a defense that has always been available to the corporate insider accused of trading on inside information – I ordered the sale of the stock before I knew of any such information, and therefore I could not have traded on the information. Of course, the Rule, and compliance with the Rule, is a bit more complicated.

In its simplest form, Rule 10b5-1 provides that a purchase or sale by an insider is not trading on inside information if before becoming aware of the information, the person had entered into written plan for the trading of the securities, which, either explicitly, or by a formula, algorithm or computer program, specifies the amount of securities to be purchased or sold, and the trades were executed pursuant to that plan. The 10b5-1 plans can therefore be very simple written instructions to a broker, or complex plans specifying exactly when trades will be executed.

I have assisted executives and broker in the creation and execution of such plans. A properly adopted plan can provide an excellent defense to an insider trading allegation. However, unless the executive simply wants to sell his shares in an orderly fashion, regardless of price, great care must be taken in creating the plan, to insure that the sales are properly handled, because once adopted, the plan cannot be altered.

Rule 10b5-1 specifically provides that the plan, and the execution of the transactions, cannot alter or deviate from the plan, “whether by changing the amount, price, or timing of the purchase or sale”). And therein lies the problem that some executives find themselves in. Changing, the plan midstream voids the defense provided by the Rule.

A problem which arises too often is the deviation from the plan. Whether caused by a poorly drafted plan, or a change in heart by the executive, altering a 10b5-1 Plan will void the defense, and might even highlight potential insider trading. Of course it is possible to change a plan, so long as the executive is still not in possession of material, inside information.

Some executives attempt to cancel their plan, or accelerate the plan. Of course, modification of the plan midstream is counterproductive, and lessens the benefits provided by the plan. Rumors are circulating that the SEC is making informal inquiries into the creation and operation of 10b5-1 plans at various brokerage firms, and asking for detailed information regarding trades executed under such plans.

The source of that buzz might be the insider trading trial of Joseph Nacchio, the former CEO of Qwest Communications International. According to press reports, Mr. Nacchio entered into a 10b5-1 plan, which provided that he would sell off shares in Qwest at a rate of 11,500 shares a day. However, Mr. Nacchio stopped the plan two weeks after he entered into it, and then started selling shares at a significantly faster rate. According to the complaint, as reported by the Wall Street Journal, he sold over 49 million dollars of stock in three weeks. Mr. Nacchio was indicted for insider trading, and was ultimately found guilty and sentenced to six years in prison.

The case points out the importance of a well drafted 10b5-1 plan, and the faithful execution of that plan. Alternatively, a change in that plan needs to be drafted with great care. And if Mr. Nacchio’s predicament were not enough motivation, Linda Thompsen, the head of enforcement at the SEC has stated “[w]e’re looking at this — hard,” according to the WSJ. The quote continues – “[w]e want to make sure people are not doing here what they were doing with stock options,” referring to the mushrooming scandal of executives manipulating the dates they were granted stock options to maximize their profits.

These issues are not only of concern for corporate executives. Brokers who are creating these plans and modifying them, may be opening themselves up for potential regulatory action as the SEC continues its review of the plans, and the operation of those plans.

Last update 5/2/08


Securities Attorney at Sallah Astarita & Cox | 212-509-6544 | mja@sallahlaw.com | Website | + posts

Mark Astarita is a nationally recognized securities attorney, who represents investors, financial professionals and firms in securities litigation, arbitration and regulatory matters, including SEC and FINRA investigations and enforcement proceedings.

He is a partner in the national securities law firm Sallah Astarita & Cox, LLC, and the founder of The Securities Law Home Page - SECLaw.com, which was one of the first legal topic sites on the Internet. It went online in 1995 and is updated daily with news, commentary and securities law related links.