The U.S. Securities and Exchange Commission (SEC) rules for investors who have insider information could play a big role in how you make transactions, especially if you work for or do business with a large publicly held corporation. Rule 10b5-1 allows any person operating within or doing business with a public corporation to execute one or more transactions in that company’s stock according to a pre-specified trading plan.
Rule 10b5-1 can be especially helpful to the officers, directors and other affiliates of a company in the event that they are accused of making transactions on the basis of material non-public information (MNPI) because it lets them mount an affirmative defense against future accusations of insider trading. Keep reading to find out more on Rule 10b5-1 and how it might affect how you trade in your company’s stock or the stock of a company you do business with.
What is Rule 10b5-1?
To define Rule 10b5-1, Rule 10b-5 must first be stated. SEC Rule 10b-5 is codified at 17 C.F.R.240.10b-5 and is formally known as the “Employment of Manipulative and Deceptive Devices” rule. It specifically addresses securities fraud and says that:
“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
- To employ any device, scheme, or artifice to defraud,
- To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
- To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”
Set up as an amendment to the Securities and Exchange Act of 1934, Rule 10b5-1 was originally proposed in August of 2000 and ultimately went into effect on Oct. 23, 2000.
According to the SEC’s website:
“Rule 10b5-1 addresses the issue of when insider trading liability arises in connection with a trader's "use" or "knowing possession" of material nonpublic information. This rule provides that a person trades "on the basis of" material nonpublic information when the person purchases or sells securities while aware of the information. However, the rule also sets forth several affirmative defenses, which we have modified in response to comments, to permit persons to trade in certain circumstances where it is clear that the information was not a factor in the decision to trade.”
SEC Rule 10b5-1 basically outlines a plan for the legal trading of securities by insiders that allows for exceptions to SEC Section 10(b) and Rule 10b-5 that prohibit the purchase and sale of securities based on material non-public information.
Rule 10b5-1 trading plans can be useful since they give officers, directors and affiliates of publicly traded corporations an affirmative defense against insider trading allegations by allowing them to show that they did not make their transactions on the basis of material non-public (insider) information.
What is a Rule 10b5-1 Plan?
A Rule 10b5-1 plan is a passive investment scheme in which the plan holder relinquishes direct control over transactions. This type of plan provides a mechanism for corporate officers to buy and sell company stock even when they are privy to MNPI.
Making transactions within a 10b5-1 plan provides a corporate insider with an affirmative defense to allegations made under insider trading laws. While most attention focuses on the sale of securities when a company officer has access to MNPI, the 10b5-1 plans also cover the purchase of securities.
Certain specifics must be adhered to in a Rule 10b5-1 plan. These include the price and amount of shares, which are determined via metrics or a formula. The corporate insider must also demonstrate that any questionable transaction or set of transactions were made pursuant to a prior contract, plan or instruction.
The protections under Rule 10b5-1 not only apply to publicly traded stocks but also to private equity. Private equity holders and other investment professionals can use a Rule 10b5-1 plan to make future acquisitions or dispose of company debt or equity without violating insider trading laws.
Why Does Rule 10b5-1 Exist?
The 10b5-1 rule addresses the means by which corporate insiders can trade in that company’s publicly available shares. It can be useful to chief executive officers, chief financial officers, directors, executives and other senior officers of a corporation, as well as to business affiliates in possession of relevant insider information.
High-level corporate officers routinely receive material information about the company that the investing public does not, so a 10b5-1 Rule trading plan addresses this issue by allowing them to arrange in advance for transactions in their company’s stock.
The rule was established in 2000 to provide an affirmative defense for corporate insiders as long as they adopted and adhered to a Rule 10b5-1 plan. On Dec. 15, 2021, the SEC considered some additional proposed amendments to help close potential gaps in the SEC’s insider trading regime.
The proposed changes add four new conditions to the existing affirmative defense under Rule 10b5-1(c)(1) to help address potentially abusive practices that have been associated with the use of this defense in the past. They include:
- Imposing a 120-day cooling-off period that applies to directors and officers for any new or amended 10b5-1 plans. For companies trading in their own securities, the proposal would establish a 30-day cooling-off period.
- Prohibiting overlapping plans and limiting single-day plans to one every 12 months. Insiders currently can enter multiple plans and might seek to cherry-pick the plans as they please.
- Having officers and directors certify that they’re not in possession of MNPI when amending or adopting plans.
- A caveat that all 10b5-1 plans must be entered into and operated in good faith.
Benefits of Rule 10b5-1
Rule 10b5-1 does not create a “safe harbor” for corporate insiders to make insider trades, and it does not eliminate their obligation to refrain from doing so under section 10(b). With those caveats noted, Rule 10b5-1 does provide considerable benefits to company officers, directors and affiliates, including:
- Providing insiders who trade securities under a 10b5-1 plan with an affirmative defense against insider trading allegations
- Giving insiders greater certainty in planning and executing securities transactions
- Allowing more potential opportunities for insiders to sell their shares
- Creating less negative publicity related to insiders’ transactions
- Mitigating the burden on legal counsel and trading compliance officers who would otherwise have to make a subjective determination about the possession or availability of MNPI every time an insider wishes to buy or sell shares
How to Establish a Rule 10b5-1 Plan
Brokers that specialize in this type of plan can typically arrange Rule 10b5-1 plans with varying degrees of complexity. Rule 10b5-1 plans can range from a single, simple trading instruction to much more complicated, formula-based plans that might be administered by a trust, investment company or another third party.
Rule 10b5-1 plans can be established by any person or entity to buy or sell securities in companies they may be an insider of but only when they are unaware of possessing any MNPI and when the plan is not part of a scheme to evade insider trading prohibitions.
Some examples of how a Rule 10b5-1 plan could work for a corporate insider include:
- An officer of a company who receives a large portion of their compensation in stock options could set up a Rule 10b5-1 plan to sell that stock to get cash or diversify their investment holdings.
- An executive could establish a Rule 10b5-1 plan to buy issued shares on a regular basis in order to comply with their company’s stock ownership requirement policy.
- A director who needs cash to pay for their children’s college tuition could set up a Rule 10b5-1 plan to sell shares of their company’s stock before a tuition payment is due.
- A corporation interested in implementing a stock buyback program could set up a Rule 10b5-1 plan for the entity to buy back its shares at certain predetermined price levels.
Rule 10b5-1 plans can also be established by non-insiders, as well as by any affiliate of the company issuing the stock who may become aware of MNPI. For example, a supplier of a particular company or one of its customers could establish a Rule 10b5-1 plan to buy that company’s stock in order to avoid potentially transgressing insider trading laws.
What is the Good Faith Requirement?
The good faith requirement for Rule 10b5-1 plans means that any trading plan operating under it must be entered into “in good faith and not as a part of a plan or scheme to evade the prohibitions” of the rule.
This requirement is a key element necessary for the plan to provide its holder with a credible affirmative defense to accusations of insider trading violations. The good faith provision also gives the SEC the right to challenge an affirmative defense if the agency suspects abusive practices.
A trader would also be excluded from taking this affirmative defense if they canceled or modified their plan to evade the prohibitions of the rule or if they used their influence to time a corporate disclosure to benefit a planned trade. If an insider trading accusation does proceed to litigation, then the plan holder could be asked to provide proof demonstrating their good faith.
Can You Customize a Rule 10b5-1 Plan?
Yes, a Rule 10b5-1 plan can be customized. For example, such a plan can include instructions to perform trades on particular dates, to manage the purchase or sale of securities through a trading algorithm, to exercise stock options and order the sale of the resulting stock and to perform monetization transactions.
Furthermore, a custom 10b5-1 plan could include complicated trading strategies based on the performance of the stock within its industry sector or in relation to a stock index’s performance.
Rule 10b5-1 plans can also be used for trading derivative instruments in addition to debt and equity securities.
Keep in mind, however, that hedging a position or transaction made within a 10b5-1 plan in a way that was not previously outlined in the plan could invalidate an insider’s affirmative defense against insider trading allegations.
Compare Stock Brokers
To execute a Rule 10b5-1 plan, you’ll first need to find an appropriate broker that will let you trade the required stocks, options or other financial products specified within the plan.
Benzinga offers insights and reviews on a wide range of brokers. A list comparing the best brokers appears below.
Is a Rule 10b5-1 Plan for You?
Depending on your position within a corporation and what information you might have access to about that company, you may be seen by the SEC as a company insider. If you think you might be exposed to insider trading allegations for trading with MNPI, then you should consider setting up a Rule 10b5-1 plan.
Frequently Asked Questions
Who does Rule 10b-5 apply to?
Rule 10b-5 applies to anyone, including corporate executives, business affiliates and other public company insiders. It prohibits any individual from making false statements to drive up or deflate share prices, from hiding low revenue or losses in order to inflate a company’s stock price and from using deceptive accounting practices to defraud the public and artificially inflate the price of a company’s stock.
How do you implement a 10b5-1 plan?
A 10b5-1 plan must first be specified and then established with a broker or another agent authorized to act on your behalf in financial matters. It might also be a good idea to have your legal counsel look it over. Your agent then implements the plan for you according to the specific instructions laid out in the plan.