The head of the Securities and Exchange Commission (“SEC”) recently announced that the SEC intends to revise existing rules regarding executive stock trading plans in an effort to add transparency and tighten restrictions.
Known as “Rule 10b5-1” trading plans, these plans allow corporate insiders to execute trades of the company’s stock on a pre-determined schedule, providing legal protection against potential allegations of insider trading on material nonpublic information.
Since the SEC passed the rule creating these plans in 2000, investors have long-criticized it for being too permissive as it arguably allows insiders to manipulate the system and reap windfalls. For example, executives do not need to publicly disclose when they enter into a plan and they can easily amend the plan as long as they are not aware of material nonpublic information. However, even if executives are in possession of material nonpublic information, they can cancel the plans and any associated trades at any time. This aspect of Rule 10b5-1 trading plans is particularly controversial because it is seen as having the effect of allowing executives to set up routine sales, and they can then pause or cancel the sales if they know the company will be announcing news that will push the stock price higher. SEC Chair Gary Gensler finds this practice “upside-down,” stating that it “may undermine investor confidence.”
Research shows that investors’ perceptions of the unfairness of these plans are not without support. A January 2021 report published by the Stanford Closer Look Series and conducted by researchers at Stanford University, the University of Pennsylvania, and the University of Washington concluded that some executives use Rule 10b5-1 trading plans to conduct “opportunistic, large-scale selling of company shares.” The researchers also found that some insiders set up plans for a single trade that occurred within 60 days of the plan’s creation. On average, those trades allowed the executives to avoid losses of 4% (defined as the stock’s performance relative to industry peers during the six months following the first sale). SEC Chair Gensler noted that this practice is also concerning, where “there’s currently no cooling-off period required before they make their first trade…. I worry that some bad actors could perceive this as a loophole to participate in insider trading.”
Although weaknesses in the rule have been apparent to many for years, in the past the SEC has stated it was focused on enforcement of violations rather than revising the rule. And yet, the most recent enforcement action brought by the SEC related to trading associated with a Rule 10b5-1 trading plan was nearly a decade ago in January 2012. SEC Chair Gensler said recently that now is the time to “freshen up” the rule: “In my view, these plans have led to real cracks in our insider-trading regime.”
The specific proposed rule changes are not yet known, but they could include, for example, more robust disclosures regarding the adoption, modification, and terms of trading plans. Revisions to the rule could also curb the number of plans executives can set up, limit the number of plan modifications and cancellations, and require insiders to wait up to six months after a plan’s conception before trading. For many investors, these changes cannot come soon enough.