Generally, corporate insiders are limited in their
ability to trade company shares for a variety of reasons, including the
possession of material, nonpublic information, as well as
company-imposed “blackout” periods when no trading is permissible.
The new SEC rule, called Rule 10b5-1, allows the executive to
prearrange a plan that can more effectively operate under these
restrictions. Here’s how it works.
Any 10b5-1 trading plan must be made at a time when
the corporate insider does not possess material insider information
(what’s “material” remains somewhat ambiguous). Second, the more
time the executive can put between creation of the plan and the actual
trades, the better. Also, the plan must not conflict with any company
insider trading rules, or with other federal or state corporate insider
laws, such as “short-swing” trading rules under Section 16 of the
Securities Exchange Act of 1934, or Rule 144, which governs insider
trading. The plan must be entered into in good faith, provide clear
instructions for determining the number of shares, price and date on
which the securities are to be purchased or sold, and the plan cannot
permit the individual to exercise any subsequent influence over how,
when or whether to effect transactions.
Assuming these restrictions are met, the executive
can design and implement one of two trading strategies under the new SEC
rule. One strategy is a nondiscretionary plan where the insider might
specify that a certain number of shares be sold on a particular date.
This might be in anticipation of a single event, such as the down
payment for a home or the payment of college tuition, or on a scheduled
basis such as the last trading day of each quarter for a certain number
of quarters.
Should the executive become aware of material,
nonpublic information in the interim between the institution of the plan
and any given trading date, or upon the trade day itself, the trade can
still be executed and the executive should be insulated from any violation
of the insider trading rules. This is especially helpful to executives
with soon-to-expire stock options which they might not be able to exercise
and sell because they’ve suddenly come into material information.
The other strategy is for a third party to execute
trades on behalf of the executive at any time the third party deems
appropriate according to pre-determined guidelines set by the executive.
For example, the insider might specify a threshold price at which a
certain number or percentage of stock options is to be exercised and then
sold. Or the stocks could be put in a trust and then sold at the third
party’s discretion.
The insider can modify the plan, as long as the
insider is not aware of material, nonpublic information at the time of the
modification. Another favorable element of these plans is that they can be
terminated at any time, even if the insider has material insider
information at the time. However, some commentators say that a pattern of
terminations might jeopardize protection under the new rule, as the SEC
mandates that these plans must be entered into in “good faith.”[see
company stock in computer file under stocks] [see company stock in
computer file under stocks]
Each strategy has its advantages and disadvantages.
For example, nondiscretionary trading means the executive could end up
selling in a down market. Giving discretion to a third party could cause
problems if the third party doesn’t manage the trades to the insider’s
liking.
This is a new and somewhat complicated rule, so
insiders should consult both corporate counsel and their financial advisor
in order to be sure they establish a permissible plan and determine the
best option. The rule has been used little to date, but some commentators
expect the plans to pick up in popularity when the stock market rebounds. [WSJ, company
stock file, computer file on stocks]If executed properly, this will
allow insiders to better manage and diversify away from their corporate
stock, so that their overall portfolio is not so vulnerable to the market
swings of their company and their industry.
June 2001 — This column is produced by the Financial Planning Association, the
membership organization for the financial planning community.
