Navigating Public Perception Around Rule 10b5-1 Plan Transactions

If you’re familiar with the concept of insider trading, you know that those with access to material, non-public information about a company are prohibited from trading in the company’s stock on the basis of such information.

The possession of “material non-public information” has long made it a challenge for executives and other employees who are routinely privy to sensitive information to trade in their company’s stock. Think about it – the CEO of the company likely always has some knowledge of information that is not yet disclosed to the public – good, bad or neutral. So, when is it truly okay for the executive (or any other employee in that situation) to trade the company stock?

Rule 10b5-1 eased this conundrum, as it permits insiders to create a trading plan in advance that automatically executes trades in the future. Introduced in 2000 by the SEC, Rule 10b5-1 allows major holders to sell a predetermined number of shares at a predetermined time. Many corporate executives use 10b5-1 plans to create an affirmative defense against accusations of insider trading. Ultimately, the insider hopes to distance themselves from the perception of having been materially ‘in the know’ when instructing a trade to occur.

Let's look at an example: An executive adopts a 10b5-1 plan that instructs a sale of 500 shares when the stock price hits $100/share. The stock price lingers between $80-$95 per share for about 6 months, and then one day great revenue results fuel a stock price increase to $102/share. As the stock price crosses the $100 threshold, the CEO’s sale of 500 shares automatically occurs since that order was already in place. The executive takes the perspective that the sale is a result of the auto-pilot plan which has been in effect for months, and not tied to specific information about the company’s revenue. The public hears word of the sale, and starts to label the transaction as ill-timed - how did this trade just happen to occur on the day of the revenue announcement? 

In practice, the perception around 10b5-1 plans and how they play out in the real world is often different than the cut and dry “I was distanced from making my instruction to sell and the actual transaction.”  More and more, I am seeing negative reports about stock sales made by executives under a “trading plan” timed to coincide with good news and stock price increases. But is that really a negative? Isn’t that how a Rule 10b-1 trading plan is supposed to operate? The whole point is for a trade to execute at a pre-determined time or price. So, when the stock price hits that price, what’s the issue?

Interestingly, it seems like public assessment of stock trades doesn’t always capture the intent behind a trading plan. Now, I’m not saying that there aren’t instances of an executive entering a plan knowing full well that the stock price may rise, or fall based on some pending undisclosed news. However, that’s not the intent of the majority of insiders as far as I can tell.

This week, shareholders of Under Armour asked a judge to advance class action litigation that has been pending for years now. The core of the plaintiff argument is that the company misled investors about revenues while the CEO concurrently sold shares under a 10b5-1 plan, at a profit.

Now, I note that the SEC did conduct a multi-year investigation into the revenue issue, ultimately ending in a $9 million settlement that neither admitted nor denied the allegations. Also, neither the CEO nor CFO were personally charged by the SEC for anything, including their stock trades. It’s hard to know whether a stock trading plan was entered into under false pretenses or was just simply an unfortunate coincidence when other challenges are at play. In most cases, I choose to believe that the trading plan was created and operating just as 10b5-1 intended it.

A great example of a plan operating as it should comes from vaccine news for Pfizer. When the company's (now) well-known COVID-19 vaccine was approved by regulators, the stock price saw a nice upward bump. At the same time, the CEO was spotlighted for selling stock under his 10b5-1 plan. I saw articles titled “Lucky CEO” or “CEO Cashes Out.” The trades were indeed well timed, but most importantly - tied to an existing 10b5-1 plan that had been in place prior to the transactions and the news of vaccine approval. Isn’t that the whole point? Don’t we want the stock price to go up as a result of some good company news, and for executives to reap rewards along with the rest of shareholders?

I have no knowledge of the inner workings of either of these companies. I haven’t the faintest idea whether a nefarious intent fueled a 10b5-1 plan. What strikes me the most is that 10b5-1 related trades seem to get a bad rap more often than they should. At best, they seem to be perceived as “lucky” or a “cash out.” It seems for shareholders, as the old saying goes, “perception is reality.” So, what is an insider to do about avoiding less than stellar public perception when they sell shares for a profit under a 10b-51 plan?

Communication About 10b5-1 Plan Terms May Help Reduce Shareholder Perception Gaps

First off, more detailed communication may be better in this case. I often see generic footnotes on Form 4 filings that “this occurred under a trading plan.” Kudos for the footnote, but without any details around the plan, it seems like much is left to the public’s imagination. Perhaps a tad more robust disclosure (When was the plan adopted? How many shares subject to the plan?) may help. I’m not a lawyer, so best to check with your legal advisors on the best way to beef up and word such disclosures.

Waiting Periods Create Distance Between Trading Plan Adoption and Trades

In addition, if the executive is repeatedly the subject of scrutiny around timing of transactions, it’s time to consider whether a waiting or cooling off period may change that. Our survey data (NASPP/Deloitte 2020 Domestic Stock Plan Administration Survey) reports that 21% of responding companies with 10b5-1 plans do not have any form of waiting period before allowing trades under the plan. Trending practices reported under the survey suggest a waiting period of at least 1-3 months (35%) or waiting until the next open window/quarter (25%). The waiting period seems like good practice, but can only influence shareholder perception if it's disclosed. This may be an important element to consider in beefing up disclosure footnotes. 

It’s time to consider whether 10b5-1 practices may need adjustment to better manage public perception of the corresponding trades made under such plans.