With the recent volatility of the stock market, shareholders may be keeping a closer eye on large, lucrative equity transactions made by executives via 10b5-1 plans. The Securities and Exchange Commission (SEC) certainly is. Chair Gary Gensler highlighted the need to “freshen up” rules for the plans back in June, and the Investor-as-Owner Subcommittee of the SEC Investor Advisory Committee has released draft recommendations and discussed the topic at its recent meeting.
10b5-1 trading plans are intended to eliminate notions of insider trading activity by creating a more systematic approach for executives to buy or sell stock. Most plans are entered by way of a third-party broker, and such plans will detail the number of shares to trade, along with a date and price at which the transaction will occur. Any large insider equity purchases are closely monitored by investors, as they could be taken as a sign that executives suspect upcoming strong stock price performance. By contrast, shareholders may surmise future underperformance when an executive sells off a large portion of stock. The adoption of 10b5-1 plans aid to quell some of the speculation around sizeable executive trading activity and the possible insider information they could be privy to at the time of the trade.
The draft regulations proposed by the subcommittee have significant overlap with certain emerging best practices for 10b5-1 plans. These include a “cooling-off period”, mandatory disclosure surrounding plan adoption, and a limitation on both the number of simultaneous plans entered into by executives and when an executive can terminate an ongoing 10b5-1 plan.
A participant’s plan may potentially include a cooling-off period, from when the plan is adopted to when an executive may begin trading. Currently, approximately 82% of plans have cooling-off periods of less than six months. Gensler proposes the adoption of a mandatory six-month cooling-off period to address potential concerns shareholders may have with executives exploiting their access to non-public material information to make money. A market wide adoption of cooling-off periods with respect to 10b5-1 plans could limit shareholder speculation around what material non-public information an executive may be in possession of when executing trades tied to a 10b5-1 plan.
The subcommittee is also proposing a shift to electronic filing using Form 4, which is accessible to shareholders through the EDGAR portal. Currently, most information around 10b5-1 plans is submitted to the SEC using Form 144, which is in paper format. This limits accessibility to information around these plans, as Form 144s are not readily available online on EDGAR. Transparency is critical to shareholder interests as it provides the base for informed investment decisions.
The proposed revisions also address concerns relating to the timing of plan cancellation. Currently, a plan participant may cancel a 10b5-1 plan at any time, even when in possession of material non-public information. This allows an executive participant more confidence within the market than the average shareholder, especially if say the abrupt cancellation of a plan can be tied back to, say, knowledge of the failure of a drug during a clinical test prior to it becoming public knowledge. Such flexibility has the potential to misalign shareholder value and executive interests, and shareholders may not be keen on an executive having substantially less risk when trading. Additionally, participants can enter into an unlimited number of 10b5-1 plans, adding confusion while further limiting risk.
To address this conundrum, the proposed changes include limitations on cancellations and the number of 10b5-1 plans a participant may adopt. As disclosure surrounding the adoption of 10b5-1 plans is scarce at best due to the submission format, the multiple, overlapping plans have the potential to perplex shareholders, and the desired information may be too convoluted to discover. Transactions that are conducted with absolutely zero speculation of insider trading activity strengthen shareholder trust.
The core function of the 10b5-1 rule is to limit insider trading activity and speculation, while allowing executives to be able to trade and sell shares of the company, which in most cases represent a significant portion of their earnings. As the marketplace grows increasingly complex, the proposed modifications to the 10b5-1 plan have the potential to increase accountability by increasing disclosure and transparency for shareholders. Shareholders may view the proposed changes as a way to limit speculation around possible insider trading activity, and assuage concerns of nefarious actions taken by dodgy executives to line their pockets.