Rule 10b5-1
Rule 10b5-1 is a regulation established by the Securities and Exchange Commission (SEC), which offers a safe harbor for company insiders. It allows them to set up pre-determined plans for selling their company’s stock and not violate insider trading laws.
Insiders can create these plans, which outline the share amount, price, and dates for sale. These plans must be set up in advance, and insiders must not be in possession of any confidential information that is not publicly known when creating the plan. This is also known as material nonpublic information (MNPI).
Rule 10b5-1 can provide legal defense against allegations of insider trading. However, it will not protect you if you are in possession of non-public information that you plan to profit from selling shares. The SEC is proposing major amendments to this rule to enhance investor protection.
Requirements for Rule 10b5-1 Plans
- Under Rule 10b5-1, company insiders can create a pre-arranged plan to sell their company’s stock while complying with insider trading regulations.
- This plan must specify the exact amount, price, and dates of the sales beforehand, using a predetermined formula or objective criteria.
- To ensure fairness, neither the seller nor the broker involved in the transactions can be in possession of confidential MNPI.
Understanding Rule 10b5-1
Rule 10b-1 allows insiders of companies to make trades, so long as they follow specific trading laws.
It’s recommended that companies allow executives to adopt or amend a 10b5-1 plan, which allow them to trade in alignment with their insider trading policy, preventing any insider trading from occurring if they are in possession of material nonpublic information (MNPI).
It’s quite common for an executive to sell their shares.
For example…
Let’s say a director wants to sell 10,000 shares at the end of each month. Under Rule 10b5-1, the plan to trade, including the predetermined amount, price, and dates, must already be established when unaware of MNPI. If the executive has access to MNPI, it must be clearly detailed when they can buy or sell shares beyond the MNPI. In other words, trading plans can be set up only after MNPI has become public.
Amendments to Rule 10b5-1
There have been amendments to this rule to enhance investor protection. The latest amendment from December 2022 focuses on addressing potential loopholes that could be exploited for insider trading. These three areas are:
- Cooling-off Periods: for persons other than issuers before trading can commence under a Rule 10b5-1 plan. These waiting periods occur after a plan is created or changed before any trades occur and aim to reduce strategically timed trading based off MNPI.
- Limit on Number of Trading Plans: the SEC has limited the number of multiple overlapping plans and restricted the use of single-trade plans to one per year to avoid constant adjustments based on MNPI.
- Improved Disclosures: companies are required to disclose more information about their insider trading policies and the use of 10b5-1 plans, which increases transparency for investors. Those setting up trades must certify that they are unaware of MNPI.
These are just a few of the changes which are a culmination of comments gathered over the course of two decades. The full press release can be found on sec.gov.
Example of Insider Trading and Rule 10b5-1
June 21, 2024
Terren Peizer, former CEO of Ontrak, exploited a loophole in Rule 10b5-1, which allows pre-planned stock trades by insiders. He set up trading plans within days or minutes of learning about a major customer contract termination (bad news for the stock). This suggests he wasn’t following the rule in good faith. By selling before the news hit, Peizer likely avoided over $12.5 million in losses. This case marks the Department of Justice’s first conviction solely based on abusing a Rule 10b5-1 plan, highlighting their stricter enforcement against such misuse.
Rule 10b5-1 and SEC Whistleblower Awards
- Report the Information: You can submit details about the suspected abuse electronically through the SEC’s dedicated portal or by mail. The SEC prioritizes reports with specific, timely, and credible information.
- Protection and Anonymity: The SEC prioritizes whistleblower confidentiality and anonymity. They have a legal obligation to protect your identity and prohibit retaliation by employers.
- Potential Reward: If your information leads to an SEC enforcement action with over $1 million in sanctions, you may be eligible for an award of between 10 and 30% of the collected funds.
Remember, the program focuses on violations, not the rule itself. If you suspect an insider is abusing a Rule 10b5-1 plan to trade on non-public information, consider reporting it to the SEC. To report insider trading anonymously, you must hire an attorney. In insider trading cases, most attorneys (such as ours) will work on a contingency fee, which means they only get paid if they win your case.
