Understanding Rule 10b5-1 Plans and Reporting Abuse to the SEC

Rule 10b-5-1(c)(1) offers a safe harbor defense against insider trading claims under the Securities Exchange Act of 1934 for company insiders who want to buy or sell shares of a company about which they may have non-public information. This defense provides a set of parameters to follow to establish a presumption that material non-public information (MNPI) did not influence their trading decision.

10b5-1 trading plans are essentially complex legal agreements between a corporate insider, such as an officer or director, and a brokerage firm, which provide details about how the insider wants to trade their stock, which must be entered into before they are in possession of MNPI.

The agreement must include details such as amount of stock to be purchased or sold, date(s) of execution, and order type (market or limit). It’s estimated that more than 50 percent of S&P 500 companies have executives who use 10b5-1 plans.

The benefit of the 10b5-1 trading plan is that it promotes transparency while permitting insiders to access liquidity. That is because trades made by directors or officers pursuant to a 10b5-1 plan are executed based on the predetermined plan and after the “cooling off” period has expired, which is more than 90 but less than 120 days after a plan has been adopted.

In short, a 10b5-1 trading plan allows insiders to trade company stock without the risk of violating (or being accused of violating) insider trading laws. These plans are not a guarantee of immunity but instead provide a safe harbor for insiders to trade even if they are in possession of MNPI, if their trades are executed according to the plan and consistently with the rules governing those plans.

10b5-1 Abuse

In recent years, there have been significant concerns raised about the ways in which insiders may be abusing Rule 10b5-1 plans. For instance, insiders may cancel plans if they see that they are unprofitable, or they may adopt trading plans while in possession of MNPI, which constitutes a violation of Rule 10b-5-1(c)(1). Such violations, if discovered, could result in enforcement actions leading to civil penalties, disgorgement of profits, and other remedies.

Given the nuanced nature of such abuses, whistleblowers are essential in uncovering such violations and protecting investors. This guide is designed to help whistleblowers understand their legal options if they become aware of a director of officer in violation of Rule 10b-5-1.

Under the SEC Whistleblower Program, large monetary awards of up to 10% to 30% of monetary sanctions may be available to whistleblowers in actions brought by the SEC and related actions brought by certain other regulatory and law enforcement authorities.

Continue reading to learn more.

Rule 10b5-1 primarily applies to insiders of publicly traded companies, including, but not limited to, directors and senior officers. Additionally, the rule extends to entities and individuals who hold more than 10% of the company’s voting shares, recognizing their significant influence and potential access to sensitive information. To establish a valid Rule 10b5-1 plan, specific guidelines must be followed. Key criteria include:

• Clear Trading Parameters: The plan must clearly define the price and amount of securities to be traded, which may involve setting specific prices or using predetermined formulas or metrics. Additionally, the plan should specify the dates or timeframes for planned trades.
• Broker Discretion: The plan must grant the broker exclusive authority to execute trades based on the specified parameters, provided the broker does not possess any MNPI at the time of the trade. In other words, the insider cannot retain the authority to cancel the trades once the parameters have been satisfied.
• No Access to MNPI: Insiders entering a 10b5-1 plan must not possess any MNPI regarding the company or its securities at the time the plan is adopted or modified.

This framework ensures that 10b5-1 plans operate independently of insider knowledge, minimizing the risk of insider trading. Any deviation from the rules established by the SEC could lead to severe repercussions, including substantial civil fines, the surrender of profits earned through the plan, and other potential legal actions. Whistleblowers who have information about such abuses can anonymously report violations of Rule 10b5-1to the SEC and may become eligible for an award and protection.

What is the cooling-off period?

This period applies before any trading can commence under the plan. A cooling-off period for directors and officers of the later of:

1. 90 days following plan adoption or modification; or
2. Two business days following the disclosure in certain periodic reports of the issuer’s financial results for the fiscal quarter in which the plan was adopted or modified (but not to exceed 120 days following plan adoption or modification) must occur before any trading can commence under the trading arrangement.

A cooling-off period of 30 days applies for persons other than issuers or directors and officers before any trading can commence under the trading arrangement or modification.

Correct Use of 10b5-1 Plan

John Smith, the CEO of “Innovate Corp,” a technology company developing advanced AI chips, holds a substantial number of company shares.

To diversify his portfolio while avoiding potential insider trading violations, he establishes a 10b5-1 trading plan with his broker. This plan instructs the broker to sell 1,000 shares of Innovate Corp stock on the 15th of each month for next year, regardless of market price.

Subsequently, Innovate Corp announces a significant breakthrough in AI chip development, causing the stock price to surge. However, the pre-determined sales continue as scheduled.

Assuming all other requirements under Rule 10b5-1 are followed, this pre-set schedule ensures that John Smith’s trades are not influenced by the positive news, providing him with a safe harbor from potential insider trading allegations while allowing him to gradually diversify his holdings.

Incorrect Use of 10b5-1 Plan

Now imagine if John’s plan instructs the broker to sell 1,000 shares of Innovate Corp stock on the 15th of each month for the next year, but only if the stock price is below $50 per share. Then Innovate Corp announces a significant breakthrough in AI chip development, causing the stock price to surge. John Smith, aware of this positive news, instructs his broker to modify the 10b5-1 plan to include a price floor of $45.

This is inconsistent with the requirements of Rule 10b5-1.

The key issue here is the modification of the 10b5-1 plan after John Smith becomes aware of the material non-public information (the AI chip breakthrough). By modifying the plan based on inside information, John Smith is essentially using the plan to attempt to circumvent insider trading restrictions.

For 10b5-1 plans to be effective, they must be carefully drafted and adhere to federal securities laws. Failure to adhere to the rules laid out by the SEC may result in civil penalties, disgorgement of profits, and/or other remedies.

These plans can be subject to fraud and abuse. Below are some of the examples of fraudulent abuse of these plans:

• Failure to Disclose: Insiders may fail to disclose to their financial advisors or brokers that the insider is in possession of MNPI when they enter into the plan.
• Backdating or Pre-dating Plans: Insiders may backdate or pre-date the adoption of their 10b5-1 plans to make it appear as if they were in place before the insider received MNPI.
• Modifying Plans Based on MNPI: Insiders may modify their 10b5-1 plans, such as by changing price thresholds or trading windows, after receiving MNPI.
• Circumventing Cooling-Off Periods: Insiders may attempt to circumvent the mandatory cooling-off periods by adopting or modifying plans shortly before receiving MNPI.
• Lack of True Blindness: Insiders may retain some undisclosed control over the timing of trades under the plan.

These abuses can undermine the integrity of the public markets by creating an uneven playing field for all investors, leading to an erosion of trust in the markets. If you suspect 10b5-1 plan abuses, reporting them to the SEC can be a significant step in protecting investors and potentially receiving a substantial award.

Whistleblowers with information about an insider violating a 10b5-1 trading plan may report their concerns under the SEC Whistleblower Program. This program provides protection and awards between 10% and 30% of any monetary sanctions collected in actions brought by the SEC and related actions brought by certain other regulatory and law enforcement authorities.

Other features of the SEC Whistleblower Program include the following:

• Broad Scope: the program covers a wide range of securities law violations, including insider trading, 10b5-1 plan abuses, and other forms of market abuse.
• Confidentiality: whistleblowers’ identities are typically kept confidential, and strong protections are in place to safeguard them from retaliation.
• Anonymity: whistleblowers can report their concerns anonymously and file for awards anonymously, but they must do so with the help of an attorney.
• Anti-Retaliation: employers may not retaliation against an employee in the terms and conditions of employment who has reported conduct to the SEC.

As of the end of fiscal year 2024, the SEC has awarded more than $2.2 billion to 444 individual whistleblowers since the Program’s inception in 2011.

Terren Peizer (2023)

In a 2023 case, the SEC charged Terren S. Peizer, Executive Chairman of Ontrak Inc., with insider trading. Despite possessing MNPI about OnTrak’s deteriorating relationship with its largest customer, Peizer executed two Rule 10b5-1 trading plans to sell over $20 million of Ontrak stock.

These plans were allegedly adopted while Peizer was aware of the negative information, enabling him to avoid over $12.7 million in losses when the customer terminated the contract and Ontrak’s stock price plummeted 44%.

The SEC alleged that Peizer abused his position and violated Rule 10b5-1, and is seeking penalties including disgorgement of profits, civil penalties, and an officer and director bar. Peizer was also charged criminally for the same conduct.

Charter Communications (2023)

In a 2023 case, the SEC charged Charter Communications with violating internal accounting controls related to its stock buybacks. Charter used “accordion” provisions in its Rule 10b5-1 trading plans, allowing for changes to the amount and timing of buybacks after the plans were adopted.

The SEC found that these provisions did not meet the conditions of Rule 10b5-1, rendering the buybacks inconsistent with board authorization. This occurred due to insufficient internal controls that failed to analyze the impact of the accordion provisions on the validity of the trading plans.

Charter agreed to cease-and-desist from further violations and pay a $25 million penalty without admitting or denying the SEC’s findings.

If you have information about a potential Rule 10b5-1 violation by an insider or an issuer, you should consider contacting an attorney with expertise who can help you file a tip with the SEC.

Consulting with a qualified securities lawyer can significantly increase your chances of a successful whistleblower claim and maximize your potential award while ensuring your rights and interests are protected.

It’s also important to note that if you wish to file anonymously, you are required to have an attorney represent you in connection with your whistleblower tip. Get in touch with our firm today for a free and confidential case evaluation. In many cases, we don’t get paid unless we get an award for you.