Your company’s public offering can bring tremendous financial opportunities. Making the most of them requires careful planning. However, as an employee, blackout periods and concerns about insider trading hang over your decisions about when to buy or sell your company shares. To clarify the obligations of insiders and make it simpler for them to make legitimate trades, the U.S. Securities and Exchange Commission (SEC) adopted Rule 10b5-1 in August 2000. The rule allows company insiders to set up plans for making trades while avoiding the appearance of insider trading.
What is Rule 10b5‐1?
Rule 10b5‐1 is the SEC’s clarification of Rule 10b5, a part of the Securities and Exchange Act of 1934 that prohibits insider trading. While the U.S. Supreme Court had defined insider trading as trades made “on the basis of non-public information,” lower courts disagreed about whether simply possessing such information barred one from trading or whether only the information’s use in making trade decisions was prohibited.
The SEC clarified that awareness of material nonpublic information while trading constitutes trading on the basis of that information. At the same time, however, Rule 10b5‐1 established an affirmative defense for those who adopt “a written plan for trading securities” prior to making trades while in possession of material nonpublic information. These trading plans are commonly referred to as 10b5-1 plans.
What is a 10b5‐1 plan?
A 10b5-1 plan is a binding contract that is specifically designed to meet the legal requirements of Rule 10b5-1:
- It specifies the number or value of shares to be traded, the price at which they will be traded, and the dates of trades.
- Alternatively, the plan can specify an algorithm, written formula, or computer program for determining the above.
- The plan must be entered into in good faith (i.e., not for the purpose of evading the rule).
- The plan’s owner must not exert any influence over when, how much, or for what price the underlying securities are traded.
How does an affirmative defense work?
An affirmative defense is a legal argument against allegations of wrongdoing. In the case of insider trading, following a good-faith 10b5-1 plan is the legal path the SEC laid out for trading securities issued by a company about which one has material nonpublic information. If you follow that path, it’s presumed that you’re not engaged in wrongful activity. A 10b5-1 plan isn’t an absolute defense to insider trading allegations, however, as evidence that the plan was undertaken in bad faith can call the defense into question.
When can I establish a 10b5‐1 plan?
You can establish your plan anytime you’re not aware of any material nonpublic information about the issuer of the securities to be traded. To avoid any suspicion that you’re aware of material nonpublic information, the best times to enter into a 10b5-1 plan are shortly after the release of a periodic report, such as the filing of a 10-Q or 10-K.
How do I make trades under a 10b5-1 plan?
While legally, almost anyone other than you can make the trades specified in your 10b5-1 plan, a broker typically fills this role. In some cases, the company specifies a broker that their employees must use to execute 10b5-1 trades of their stock. Whoever makes the trades, though, it’s important to avoid communicating with them after implementing your 10b5-1 plan. Communicating with the plan administrator can create the appearance that you’re influencing trade decisions, which is specifically prohibited by the rule.
Should I include stocks other than my company’s shares in my 10b5‐1 plan?
Most often, employees and executives establish 10b5-1 plans to trade stock in their own companies. However, if you have access to material nonpublic information about other publicly traded companies, such as your company’s suppliers or clients, you may want to include them in your plan as well.
Can I build complex trading strategies into my 10b5‐1 plan?
Yes! Although 10b5-1 requires prices, amounts, and dates of trades to be determined in advance, you can set up any formula you like to make these determinations. For example, you can set dates for trades or you can direct trades to be made at minimum and/or maximum prices that change according to specified criteria. You can even design a plan that incorporates multiple different trading strategies. A fiduciary investment advisor with experience in 10b5-1 plans can help you design a plan that fits your specific needs and goals.
Can I change or terminate my 10b5-1 plan?
If you meet all the requirements to initiate a 10b5-1 plan, then modifying it is permissible. (Remember, you cannot modify the plan when you have access to material nonpublic information about the company that issued the underlying securities.) Terminations are not prohibited at any time. Bear in mind, however, that it’s generally unadvisable change or terminate a 10b5-1 plan because this can create the appearance that you’re attempting to evade the rule’s prohibitions. If the SEC suspects this, they can challenge the affirmative defense against insider trading allegations that a 10b5-1 plan provides.
Expert Help with IPO Planning
The IPO process is fraught with important financial decisions that have complex tax implications for employees. WRP helps employees and executives in pre-IPO companies navigate the complexities of the IPO process. We can custom design a financial strategy to suit your unique vision, values, and goals.