Broker Check

Diversify with a 10b5-1 Plan

Today many executives are looking for a way to diversify their company stock without running afoul with the SEC for insider trading violations.  The problems of Enron, World Com and Martha Stewart are in the headlines so insider trading is an issue that all executives must face today.  They do not want to end up like Ex-Imclone Systems, CEO Samuel Waksal, who is in federal penitentiary today serving a 7-year prison term and owes over 4 million dollars in fines for his role in an insider trading scandal.

Individuals and corporate entities are often prohibited from trading their stock due to the corporation’s insider trading policies or blackout periods.  Even when they have an opportunity to trade stock they are prohibitive because they may have “material, non-public information”. 

If you are a considered an insider when can you ever safely say you do not have any material, non-public information? I would guess almost never!  So you might ask how can you ever safely trade your stock?  Simply stated, by creating a 10b5-1 plan.  If you never heard of this plan you might ask what is a 10b5-1 plan and how can it help you trade their stock without violating the SEC rules?

In October of 2000 the SEC amended and updated the rules in an effort to clarify the questions surrounding insider trading.  These rule changes spelled out how an insider may trade their stock without violating the rules.  Under the Securities Act of 1934, section 10b5-1 an executive insider can trade their stock if he or she demonstrates that the transaction was made as part of a predetermined, systematic trading plan that was established before the executive became aware of any material, non-public information. Additionally, a 10b5-1 plan could provide an “affirmative defense” against insider trading litigation, providing the rules are followed and it is not a scam. 

The SEC did not spell out details on how these plans would be constructed, but did offer flexibility by identifying certain prerequisites for the “affirmative defense”.  In brief, the following conditions must be met to allow the “affirmative defense”:

First, you must establish a 10b5-1 plan when you are not aware of any material, non-public information through a third party such as an advisor, broker/dealer, or trustee.

Second, you must specify the amount of securities to be purchased or sold, and at a predetermined price, on a specific date.  You may use formulas or algorithm, or a computer program for determining amounts, prices and dates.

Lastly, the plan would not allow the insider to exercise any influence or change the plan once it goes into effect.  Of course, the person performing the trade must also not trade on material, non-public information. 

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.  There is no time limit on how long the plan could be in effect, but most of the plans generally run for one year and are then later renewed, if the same aforementioned SEC rules are applied.

Obviously, with a plan in effect the executive, or director could begin to diversify his or her stock holdings possibility, through the process of diversification, potentially lowering their overall financial risk.  Also, a 10b5-1 plan can be designed for someone who might have future liquidity needs like funding for a child’s education requirements.  Certainly, the general public never wants to see insiders selling their stock, but if this plan were announced as part of the executives over all financial plan to diversify the impact would likely be lessen.

If all of 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 became aware of material, non-public information.  These plans can be simple or complex but they all must follow the rules spelled out under section 10b5-1. 

Furthermore, corporations who wish to buy back stock of their company over a period of time can also implement this 10b5-1 plan strategy.  For instance, the corporation could employ a limit order strategy to protect the stock price during black out periods.

The SEC does not require the corporation to establish the 10b5-1 plan, any individual can establish a plan, however we feel that it would be prudent for any individual to inform and discuss their intentions with the corporation before implementing this strategy, because the corporation may have to modify their existing trading policies to enable a 10b5-1 plan.  As always, before entering into any type of securities trading plan consult a knowledgeable securities attorney.

Thom F. Carroll is a financial advisor with Carroll, Frank & Plotkin, LLC and separately, a registered representative with Royal Alliance Associates, Inc., Member FINRA/SIPC. With over 28 years of experience advising CEO’s and high-level corporate executives.  Mr. Carroll offers financial services, such as, comprehensive financial planning, and asset management to high net worth individuals. 

Royal Alliance Associates, Inc. (RAA) nor its representatives or employees provide tax or legal advice. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters. Any information or opinions expressed are solely their own and do not necessarily reflect those of (RAA) and are for informational purposes only and do not constitute legal advice. These materials are solely informational based upon publicly available information believed to be reliable and may change without notice. RAA shall not in any way be liable for claims relating to them and makes no express or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in, or omissions from them. RAA has no obligation to tell you when opinions or information in this material change. Individuals executing a 10b5-1 trading plan should keep the following important considerations in mind: (1) 10b5-1 trading plans should be approved by the compliance officer or general counsel of the individual’s company. (2) A 10b5-1 trading plan may require a cessation of trading activities at times when lockups may be necessary to the company (i.e., secondary offerings, pooling transactions, etc.). (3) A 10b5-1 trading plan does not generally alter the restricted stock or other regulatory requirements (e.g., Rule 144, Section 16, Section 13) that may otherwise be applicable. (4) 10b5-1 trading plans that are modified or terminated early may weaken or cause the individual to lose the benefit of the affirmative defense. (5) Public disclosure of 10b5-1 trading plans (e.g., via press release) may be appropriate for some individuals. (6) Most companies will permit 10b5-1 trading plans to be entered into only during open window periods.

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