It’s common for startup executives to plan to sell shares to cover major expenses such as taxes that are due for the previous year’s options exercise, a child’s college tuition, or buy a new home.
While this can be a useful strategy, it’s essential to plan your share sales carefully. Without a detailed plan in advance, you could be unable to make sales when you desire—even if you plan to sell immediately after the lockup period has expired or following an earnings announcement. It’s like going to make guacamole for the big party, but not having a knife to cut the avocados.
Executives may be barred from selling even when other employees are not.
If you are an executive in your company, it’s important to understand that there may be times when your employees are allowed to sell shares, but you are not. This is because Rule 10b5-1 of the Securities and Exchange Act prohibits insider trading, which the SEC has declared includes any trades made when aware of material nonpublic information. Because executives are more often aware of such information than their employees, they are subject to more frequent trading restrictions.
A 10b5-1 plan allows company insiders to avoid unnecessary trading restrictions.
Fortunately, Rule 10b5-1 gave us a way to navigate the somewhat unpredictable nature of insider trading-based restrictions. When insiders adopt “a written plan for trading securities” at a time when they are not aware of material nonpublic information, they may execute the prescheduled trades that the plan details. This involves much more than simply making notes to yourself about when you’ll execute trades, however. To meet the legal requirements of Rule 10b5-1, the trading plan must be a binding contract that specifies dates as well as the quantity or value of shares to be traded and at what prices. These details may be expressed either explicitly or as an algorithm.
10b5-1 plans must be carefully constructed and made in good faith.
When a company insider adopts a valid 10b5-1 plan, they create an affirmative defense to allegations of insider trading. This means that courts will presume that trades made pursuant to a valid 10b5-1 plan are legally permissible. It’s not an absolute get-out-of-jail-free card, however. Evidence that the plan was adopted in bad faith (for the purpose of engaging in insider training with impunity) will weigh against this presumption, calling the affirmative defense into question.
On December 15, 2021, the SEC announced proposed changes to Rule 10b5-1 that would create additional requirements for trading plans created under the rule. These would include a mandatory cooling off period before any trades could be made under such a plan, limiting single-trade plans to one per year, and enhancing the good-faith requirement. Even in absence of these changes, it’s advisable to build a waiting period into your trading plan as well as ensure the plan covers a long enough time period to avoid the appearance of impropriety. It’s common for issuing companies to require waiting periods of 2 weeks to a month and for plans to last for six months to two years.
10b5-1 planning can support your long-term financial goals.
While the requirements of 10b5-1 may seem restrictive, it’s important to note that a knowledgeable investment advisor can help you construct a sophisticated strategy—or even multiple strategies—that can be implemented via a 10b5-1 plan. For example, your plan can set specific minimum and maximum trade prices, and these prices can vary based on criteria that you choose. This gives your plan the flexibility to adapt to shifting forces while making the factors influencing your trades clear and transparent. It is permissible to modify a 10b5-1 plan while it’s in effect; however, this is generally not advised because it can raise suspicions of misconduct.
Making guacamole requires ripe avocados, but also the right tools and a little bit for forethought. Likewise, implementing a 10b5-1 plan requires you to sit down and make a plan that aligns with your needs, goals, and priorities. In this way, it can be one of your greatest allies in your quest for financial growth. Working with a trusted fiduciary advisor to identify your goals and charting a course to reach them will give you the knowledge and resources you need to make the most out of your company’s IPO or SPAC merger.
WRP specializes in helping employees and executives in pre-IPO companies navigate the often long and complex journey to IPO in a way that supports their overall financial health and long-term goals. For more tips, browse our blog or our free resource library!