June 27, 2014

SEC Rule 10B5-1 Trading Plans

By Ronil Chandra, Assurance Services Partner

SEC Rule 10B5-1 Trading Plans Assurance


Rule10b5-1 of the Securities Exchange Act of 1934, addresses the issue of when insider trading liability arises in connection with a trader’s “use” or “knowing possession” of material non-public information. This rule provides that a person trades “on the basis of” material nonpublic information when the person purchases or sells securities while aware of the information. The rule was adopted to provide clarity regarding insider trading which is prohibited under Rule 10b-5. Prior to the adoption of Rule 10b5-1, various courts had described and interpreted insider trading as trading based on factors ranging from “use” to “on the basis of” material nonpublic information.

Rule 10b5-1 allows directors, executives, employees and others (collectively “insiders”) who may come into possession of material non-public information about a company to adopt a trading plan which can provide an affirmative defense against any allegations that trades under the plan were based on such information. Rule 10b5-1 plans provide protection from insider trading to companies and individuals in possession of material non-public information. Affirmative defense is available to insiders as long as a plan was created prior to obtaining material non-public information. If information was obtained prior to the formation of a plan, affirmative defense may no longer be available. Affirmative defense is not available is matters of wrong doing or manipulation.

Rule 10b5-1 Plans

A Rule 10b5-1 Plan is a written plan designed for insiders for trading securities (typically, in most cases, equity securities) without the repercussions, legal ramifications or potential loss of professional reputation resulting from insider trading violations.

Benefits of a Rule 10b5-1 Plan

Rule 10b5-1 plans provide several benefits to those in possession of material nonpublic information. Some of these benefits of establishing a Rule 10b5-1 plan are:

  • An affirmative defense to insider trading.
  • Public perception of companies and their management teams, given the rapid pace of news spreading through social media outlets.
  • Legal cost of defense.

Affirmative defense can be demonstrated that the purchase or sale occurred pursuant to the plan. This can be done if the individual making the investment was not aware of material nonpublic information and that the entity policies to prevent and detect insider trading. Furthermore, it is important to demonstrate that the plan was entered into in good faith and not part of plan or scheme.

Establishing a Rule 10b5-1 Plan

A Rule 10b5-1 Plan can be established by any person (including non-insiders) and typically established through a lawyer or investment/financial advisors. Careful consideration regarding the details of the plan need to be made prior to establishment as the terms of the plan should be specific. The plan should typically include the following:

  • A defined time period, including the specific dates of purchases or sales
  • The class and number of shares (including options)
  • A formula or similar method for determining amount, price and date

Other Factors

Once a plan has been established, it is important that no subsequent influence is exercised by insiders over the plan’s transactions. This is primarily due to public perception that a plan was not established to act as a safe harbor for insiders whose intent was to misuse material non-public information for personal gain. In addition, careful consideration with regards to modifications to the plan should be made and discussed with legal counsel and an investment advisor. Plans are allowed to be terminated prior to their defined time period.

Certain transactions such as hedging not permitted under these plans. There is no specific requirement for public announcement, but companies tend to make announcements due to possibility of negative publicity, and generally will disclose the existence of a plan via press release and Form 8-K.

Best Practices

The following best practices should be followed when implementing a plan:

  • Require approval of the plan and disclose to the public upon approval
  • Establish plans during open trading windows in order to avoid the perception that a person has material non-public information prior to the formation of the plan
  • Waiting period – many companies impose a waiting period upon the completion of the formation of the plan and the date of the initial trade of the security as a matter of risk management and public perception. There is no guideline regarding the number of days required; however, typical practice can range from 10 to 30 days.
  • Avoid multiple brokers – negative perception can be created when multiple brokers are used by insiders.
  • Disallow modifications, terminations and even suspensions during open trading periods
  • Maintain constant communication with legal advisor

Rule 10b5-1 Plans provide insiders with affirmative defense for material non-public information, so that a plan is established prior to possession of such information. There are specific requirements to establish a plan. Careful consideration and planning are essential prior to the creation of a plan.

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