Pros & Cons: Rule 10b5-1

Pros of Rule 10b5-1:

For a senior manager, some of the benefits of having a formal program to manage the sale of your employer’s stock may include:

• Elimination of risk related to insider trading.
• Reduced risk of a concentrated holding.
• An ability to plan sales around vesting (or other) events.
• Tax-efficient transfer of wealth to family, charity, etc.
• Access to liquidity at predetermined future dates.
• An opportunity to construct an optimal investment portfolio.

 

Cons of Rule 10b5-1:

Some of the cons of a Rule 10b5-1 plan are related to the 'flawed legislation':

• Predetermined sales dates may cause for execution (sale) of the stock trade at a price that could be lower than the average price over a period for the executive's stock, on the day of trade execution (i.e. subject to normal market fluctuations).
• 10b5-1 Plans do not need to be filed with the SEC, creating a loophole for executives to exploit (they can later claim that the sale was part of a 10b5-1 disposition, although it may not have been).
• The executive can – at any time – decide to cancel or change the plan (implying an ability to manipulate the sales plan to fit the stock price).
• There is no requirement for how long the plan has to be in place, before trading can begin (meaning that one could e.g. start a 10b5-1 sales plan, and trade later that same day).

Some suggested improvements:

• Companies could be required to disclose the terms of the disposition plan, and trading arrangements, as part of their SEC filings.
• A time limit could easily be implemented, e.g. the plan has to be in place for 30 days before trading can commence.
• Once implemented, the executive cannot have the ability to cancel or change trades.
• The more detailed the plan, the lower the risk of suggested impropriety.
• Executives should ideally be in one plan, and not several at once.

There are several formal groups that use a variety of different methodologies to lobby the SEC to issue proper guidance on some of the issues above.  It is also possible that there may be new amendments to Rule 10b5-1 in the near future.

As usual, the chasm between the intent of the regulation and the knack that 'street-smart' people have in creating and/or finding loopholes around government regulations… is a great divide that is not easily crossed!