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What are 10b5-1 plans and how are they affected by new SEC rules?

April 28, 2023 | By Wealthstream Advisors Team
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10b5-1 plans can be a great option when divesting from concentrated equity positions in a firm, potentially offering protection against insider trading charges while avoiding the perception of failing confidence.

In this Insight, we explain these plans, how they work, and how they will be affected by new SEC rules changes.

What is a 10b5-1 plan?

Rule 10b5-1 allows company insiders to make pre-planned trades in compliance with insider trading regulations. Under Rule 10b5-1, directors, officers, and other insiders in a company may establish a written plan detailing the prices and dates at which they may buy or sell shares on a predetermined and scheduled basis.

What are the benefits of a 10b5-1 plan?

  • Establishing An Affirmative Defense Against Insider Trading: a fully compliant, good-faith plan provides robust protection against potential claims of insider trading.
  • Diversifying Concentrated Holdings: a 10b5-1 plan provides a legal avenue for divesting from concentrated stock positions earned through equity compensation.
  • Selling Stock Without Hurting Investor Confidence: by establishing sale criteria in advance, a 10b5-1 plan helps avoid the perception that sales are due to falling confidence or profit expectations.
  • Executing Trades Within Blackout Periods: trades planned through a 10b5-1 can be executed without regard to blackout periods for earnings announcements, etc.
  • Organizing Sales for Company Insiders: 10b5-1 plans can help time insider sales to reduce the risk that sales occur too close together and hurt investor confidence.
  • Flexible Selling Options: with options to sell different amounts of stock at different price points and dates, 10b5-1 plans can flexibly accommodate individual sellers’ financial needs.
  • Supporting Long-Term Discipline: setting up planned trades ahead of time can make it easier to avoid the temptation to sell in response to short-term market fluctuations.

Who should consider a 10b5-1 plan?

Equity compensation such as stock options can offer significant benefits. You can learn more about common types of equity compensation in our Insight here. 

However, earning equity compensation can also cause an individual’s portfolio to become heavily concentrated in a single stock position, and consequently poorly diversified. We provide a more in-depth explanation of how to divest from a concentrated stock position in this Insight.

When divesting from a concentrated position of stock, it is often a priority to emphasize that sales are not taking place due to any lack of faith in the associated firm’s future profitability. Demonstrating confidence is important for both internal employees and external investors. By firmly establishing divestment criteria in advance, a 10b5-1 plan avoids any perception that sales are taking place in response to new market developments or insider pessimism.

How can a 10b5-1 Plan provide an affirmative defense against insider trading? 10b5-1 Plan Rules

As reported by Reuters, the Department of Justice recently indicted the CEO of a publicly traded healthcare company in the “first insider trading prosecution based exclusively on use of rule 10b5-1 trading plans.” Now, regulators are investigating Silicon Valley Bank (SVB) executives’ sales via 10b5-1 plans just weeks before the bank’s ultimate collapse. These high-profile insider trading prosecutions have led to fears of increased regulatory scrutiny, and they serve as powerful reminders that insiders must abide by these plans’ legal requirements.

To establish an affirmative defense against insider trading, a 10b5-1 plan must fulfill the following three main criteria:

  1. At the time a plan is established, the relevant corporate insider must not be aware of any material non-public information (MNPI). If an insider has access to MNPI, they are barred from making plan modifications or implementations under Rule 10b5-1. The plan for selling stock may be in the form of a prewritten plan or a binding contract with pre-arranged instructions for a third party such as a broker.
  2. The plan must either predetermine specific prices, dates, and quantities to be sold, or include a fixed algorithm that determines these specifics in response to market conditions. 
  3. The trades that occur must be pursuant to the plan, with no change or influence from the relevant corporate insider.

While the three criteria listed above are the only core requirements to establish an affirmative defense, additional best practices can help avoid any red flags. For example, 10b5-1 plans should be in effect for at least a 12-18 month “cooling off” period between their adoption and commencement of the trading plan. 

For a deeper look at best practices regarding amending, canceling, and hedging 10b5-1 plans, please see our Guide to Equity Compensation here.

Recent SEC rules changes related to 10b5-1

Effective February 27, 2023, the SEC issued new amendments intended to update 10b5-1 rules in light of trading that seeks “to benefit from the rule’s liability protections while trading securities opportunistically on the basis of material nonpublic information.”

These amendments add several new conditions that must be met to provide an affirmative defense. Directors and officers must now “include representations in their plans certifying at the time of the adoption of a new or modified Rule 10b5-1 plan that: (1) they are not aware of any material nonpublic information about the issuer or its securities; and (2) they are adopting the plan in good faith and not as part of a plan or scheme to evade the prohibitions of Rule 10b-5.”

The SEC’s amended rules also include limitations on overlapping plans, which in the past could be strategically established and canceled on the basis of MNPI. Additionally, the SEC now requires a minimum cooling-off period of 90 days for directors and 30 days for other corporate insiders. Single-trade plans will now be limited to just one per 12-month period.

The SEC’s official fact sheet, available for download here, provides a complete list of the rule changes contained in recent amendments.

Working with a financial advisor to create your 10b5-1 plan

Internal corporate counsels are required to approve 10b5-1 plans, but their expertise is purely focused on legal compliance. A corporate counsel will not be able to provide expert advice on best practices for planning your equity transactions. 

Working with an advisor who will partner with corporate counsel is a great way to help structure a plan that will reduce the risks associated with single-stock concentration, protect you from insider trading, and earn optimal returns in alignment with your personal financial goals. An advisor can be particularly helpful for navigating additional complexities, such as equity not held in 10b5-1 plans, including RSUs, options, and vested shares, that need to be taken into consideration.

If you have questions about how to best leverage 10b5-1 plans as part of your personal financial plan, the Wealthstream team is here to help. We encourage you to reach out to schedule a complimentary 30-minute consultation with one of our financial planners.

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