Rule 10b5-1 plans are back in the news. These plans are widely used by officers and directors of public companies to sell stock according to the parameters of the affirmative defense to illegal insider trading available under Rule 10b5-1, which was adopted by the SEC in 2000. Several recent Wall Street Journal articles suggest that some executives may have achieved above-market returns using the plans. These articles are reported to have drawn the interest of federal prosecutors and the SEC enforcement staff. In light of the renewed focus on 10b5-1 plans, companies should review their 10b5-1 policies for conformity with current best practices. I just received a memo from Practice Center Contributor and Davis Polk Partner Linda Chatman Thomsen providing an overview of 10b5-1 plans and some guidelines for their use. Here is an excerpt:
Rule 10b5-1 plans are no strangers to controversy. An academic study published in December 2006 found that, on average, trades under 10b5-1 plans outperformed the market by about 6% after six months. The resulting scrutiny did not lead to a significant uptick in insider-trading prosecutions, but did cause many companies to revisit their executives’ use of the plans. We suggested then that the potential for controversy was not by itself a reason to forego the benefits of employing 10b5-1 plans. We continue to believe that using properly designed plans is a good idea in many cases and can be at least as prudent as discretionary selling under normal insider-trading policies, with trading windows, blackouts and the like. Although regulators and the media may scrutinize trades made under 10b5-1 plans even when above board and done according to best practices, a well-thought-out and implemented 10b5-1 plan may help a company and its executives avoid or ultimately refute accusations of impropriety.
In light of the renewed focus on 10b5-1 plans, companies should review their 10b5-1 policies for conformity with current best practices. Below we provide an overview of 10b5-1 plans and some guidelines for their use.
Overview of 10b5-1 Plans
Under Rule 10b5-1, large stockholders, directors, officers and other insiders who regularly possess material nonpublic information (MNPI) but who nonetheless wish to buy or sell stock may establish an affirmative defense to an illegal insider trading charge by adopting a written plan to buy or sell at a time when they are not in possession of MNPI. (Companies themselves may also employ 10b5-1 plans for stock repurchases.) A 10b5-1 plan typically takes the form of a contract between the insider and his or her broker.
The plan must be entered into at a time when the insider has no MNPI about the company or its securities (even if no trades will occur until after the release of the MNPI). The plan must:
1. specify the amount, price (which may include a limit price) and specific dates of purchases or sales; or
2. include a formula or similar method for determining amount, price and date; or
3. give the broker the exclusive right to determine whether, how and when to make purchases and sales, as long as the broker does so without being aware of MNPI at the time the trades are made.
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