Why is a 10b5-1 Plan Necessary?

As an insider of a publicly traded company, a large portion of your wealth may come from shares you own in your company. Now that you have amassed a large net worth through concentration, to help mitigate risk, it may be prudent to diversify your portfolio by liquidating portions of your company’s stock. Because you are an insider, there are strict rules around selling that stock. A misstep here could lead to litigation and violations of insider trading laws. To provide for “an affirmative defense to insider trading liability”, as well as a fair market for other investors to trade in, the SEC has adopted Rule 10b5-1.

What is Rule 10b5-1?

A Rule 10b5-1 plan is a plan to buy or sell financial securities connected to your company according to a fixed schedule or formula before you are aware of material nonpublic information. The plan can provide for transactions of debt or equity securities. It may be simple or complex. It may be created by an entity or individual. It may place trades according to the performance of your company’s stock, of an index, or of a competitor’s stock. The person entering the plan should not place the trades. The person who will place the trades will be a broker who executes the trades according to the plan.

Elements of a 10b5-1 Plan

Pertinent elements of a plan include the following:

• The Plan either specifies the amount, price, and date of the transactions to be placed, or provides a formula for calculating the amount, price and date.
• A cooling-off period where no trades may be placed. This would apply to directors or officers. It is the later of either 90 days after the plan is adopted or modified, or two business days after financial results in periodic reports.
• For anyone other than issuers, directors or officers, a cooling-off period of 30 days after the plan is created or modified will be enforced.
• Directors and officers must include in their plan that at the time of adoption they were not aware of any material nonpublic information, and they are adopting the plan in good faith.
• All participants must act in good faith.

Summary

Whether you are an executive who has company stock or an employee with material nonpublic information, a 10b5-1 plan may be important to adopt and implement. This is a plan that will allow you to make transactions with financial securities related to your company and will provide a defense against potential allegations of insider trading. By implementing this type of plan, you have “an affirmative defense” that in good faith, you established a plan that will buy or sell securities prior to your having information that the public does not have. It also allows you to still participate in trading, albeit on a limited basis, but gives the ability to move in and out of a position that otherwise may expose you to violations of insider trading laws.