Tired Of Trading Windows? Meet The 10B5-1 Plan.
If you’re a tech professional, your compensation package likely includes stock options or restricted stock units (RSUs) as a form of equity compensation. Equity compensation is a way for companies to incentivize employees to work hard and align their interests with the company.
However, as an employee, you may be concerned about how to sell your company stock—especially in light of insider trading policies that your company has in place. This is where a 10b5-1 plan comes into play.
Let’s explore what a 10b5-1 plan is, how it works, and the risks and rewards associated with implementing such a plan.
WHAT IS A 10B5-1 PLAN?
A 10b5-1 plan is a type of trading plan that provides an affirmative defense for corporate insiders (including employees, executive officers, directors, and officers) to sell company stock without creating a potential insider trading liability.
This plan is named after Rule 10b5-1 of the Securities Exchange Act of 1934, created by the Securities and Exchange Commission (SEC) to prevent insider trading.
WHAT IS SEC RULE 10B5-1?
SEC Rule 10b5-1 is a securities exchange act that allows for a pre-established plan for trading securities entered by an insider of a publicly traded company.
The plan outlines a schedule of stock trades that will occur automatically, regardless of any material nonpublic information the insider may have during the trade.
The plan outlines a schedule of stock trades that will occur automatically, regardless of any material nonpublic information the insider may have during the trade.
The purpose of Rule 10b5-1 is to allow insiders, such as executives and employees, to sell their company stock without violating insider trading laws, minimizing the potential for insider trading liability. These laws prohibit insiders from buying or selling securities based on material nonpublic information that they possess.
To comply with insider trading laws, insiders are typically restricted from selling company stock during specific periods known as "blackout periods." The company typically imposes these blackout periods around significant company events, such as earnings releases, mergers and acquisitions, and other important news events.
However, for insiders who need to sell company stock outside of these blackout periods, a 10b5-1 plan can be an effective way to do so without running afoul of insider trading laws.
HOW DOES A RULE 10B5-1 PLAN WORK?
Rule 10b5-1 plans are typically created with the assistance of a broker or other financial advisor. The plan outlines a predetermined schedule of trades, including selling company stock, purchasing other securities, or a combination of both.
The trades are executed automatically by the broker-dealer, such as Schwab or E*TRADE, according to the schedule outlined in the plan. The insider is not involved in the actual execution of the trades, which helps ensure that the trades are made without material nonpublic information.
Rule 10B5-1 plans can be either a "discretionary plan" or a "non-discretionary plan."
A discretionary plan allows the broker to exercise some discretion in executing trades.
a non-discretionary plan is more rigid and prevents deviation from the predetermined schedule.
Once a Rule 10B5-1 plan is established, the insider is generally prohibited from making any trading arrangements on the company equity securities (like selling company stock or trading options on the company stock).
WHAT ARE THE RISKS OF A RULE 10B5-1 PLAN?
While Rule 10b5-1 plans can be an effective way for insiders to sell company stock outside of blackout periods, there are still risks to consider with these trading plans.
One of the most significant risks is the rigidity of a 10b5-1 plan. Once entered into the plan, the stated timeline of the plan must be fully carried out unless all the shares listed within the plan have been sold. Twelve months is a very common timeline that companies require for you to enter into a 10b5-1 plan. This means during those twelve months, if you wish to sell company shares outside of your plan or at prices different than what you listed, you will not be allowed to do so, even if you are not in possession of material non-public information. The circumstances in which you can exit a plan may vary by company and you should spend time understanding the conditions required for you to exit a 10b5-1 plan before you enter one.
While you can elect for limit orders or market price orders, rule 10b5-1 plans may not always protect insiders from market volatility or unexpected news events that can affect the value of the company's stock.
If the value of the stock drops significantly after the insider has established a Rule 10b5-1 plan, the insider may still be seen as profiting from insider knowledge.
Another risk associated with Rule 10b5-1 plans is that it may limit an insider's ability to take advantage of market opportunities. For example, if the insider believes the stock is undervalued, but their Rule 10b5-1 plan limits their ability to buy more shares, they may miss out on potential gains.
Finally, if a Rule 10b5-1 plan is not established properly, it could result in legal consequences for the insider. For example, if the insider engages in trades inconsistent with the plan and insider trading policies, or if the plan is established to circumvent insider trading laws, the SEC could launch an investigation and potentially bring charges against the insider.
WHAT IS THE UPSIDE OF USING A RULE 10B5-1 PLAN?
Despite the risks associated with a rule 10b5-1 plan, there are also potential benefits for insiders who use this plan to sell their company stock.
One of the most significant rewards is the ability to diversify your investment portfolio. Many tech professionals receive a substantial portion of their compensation through company stock. By establishing a 10b5-1 plan, insiders can gradually sell their company stock and reinvest the proceeds in other investments, which can help to reduce the overall risk of their investment portfolio.
A 10b5-1 plan can also provide a sense of security for insiders concerned about the potential for insider trading allegations. By establishing a plan in advance and following it strictly, insiders can demonstrate that they are not acting on material nonpublic information.
Lastly, a 10b5-1 plan can be an effective way for insiders to generate liquidity from their company stock while staying in good faith with their employer's adopted insider trading policies. Many insiders hold large positions in company stock, which can be difficult to sell during blackout periods. By establishing a 10b5-1 plan, insiders can gradually sell their stock over time, which can help to provide financial flexibility.
WHEN SHOULD I CONSIDER A 10B5-1 PLAN?
Whether or not it makes sense for an individual to use a 10b5-1 plan depends on their individual circumstances and investment goals.
Here are some factors to consider when determining whether a 10b5-1 plan is right for you:
Investment portfolio diversification: If your investment portfolio is heavily concentrated in company stock, a 10b5-1 plan can be a good way to gradually reduce that concentration and diversify their portfolio.
Liquidity needs: If you need cash for a major purchase or life event, a 10b5-1 plan can provide a way to generate liquidity from their company stock. By gradually selling shares over time,you can generate cash without having to sell your entire position at once, potentially driving down the stock price.
Insider trading concerns: If you are an insider and are concerned about the potential for insider trading allegations, a 10b5-1 plan can provide a way to sell shares without giving the appearance of trading on material nonpublic information.
Market conditions: If you believe that the market is overvaluing their company's stock, it may make sense to establish a 10b5-1 plan to gradually sell shares and take advantage of the high stock price. On the other hand, if you think that the stock is undervalued, you may want to hold onto your shares or buy more rather than sell through a 10b5-1 plan
Personal financial goals: Ultimately, whether or not a 10b5-1 plan makes sense for you depends on your personal financial goals and circumstances.
ARE THERE ANY OTHER CONCERNS WITH A 10B5-1 PLAN ADOPTION?
It’s important to be aware of the cooling-off periods (which is the time required before a plan can go from submission to implementation).
In 2022, the SEC amended cooling-off period regulations. They specifically outlined the following:
Directors and officers: With respect to directors and officers, the applicable cooling-off period is the later of (i) 90 days after the adoption or modification of the trading plan or (ii) two business days following the filing of the Form 10-Q or Form 10-K for the fiscal quarter in which the plan was adopted or modified. In any event, the required cooling-off period is to be, at most, 120 days following the adoption or modification of the plan.
Other persons: With respect to persons other than issuers, directors, or officers, the applicable cooling-off period is 30 days after the adoption or modification of the trading plan.
FINAL THOUGHTS
A 10b5-1 plan can be an effective way for tech professionals to sell their company stock outside of company-allowed trading windows. However, there are risks associated with this type of plan, including the potential for a perception of impropriety and the risk of legal consequences if the plan is not established properly.
Despite these risks, there are also potential rewards for insiders who use this type of plan to diversify their investment portfolios, generate liquidity from their company stock, and provide a sense of security. If you are considering establishing a 10b5-1 plan, it is important to consult with a financial advisor and ensure that the plan is established properly to minimize the risks and maximize the rewards.
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