10b5-1 Plans Under Attack –

Who is watching your plan?

By Mark J. Astarita, Esq.

Recently the media has caught on to the newest regulatory trend – the investigation and review of 10b5-1 plans. These plans, created by the SEC when it adopted Rule 10b5-1 are used by hundreds, if not thousands of executives, and provide a safe harbor from insider trading allegations when an executive sells his shares in his company.

As executive compensation becomes increasingly based on stock options, more and more executives find themselves in an insider trading quagmire when they attempt to sell their securities for reasons having nothing to do with insider trading or their company. Simple investment diversification often mandates such sales. However, a poorly timed sale can, and has, resulted in an insider trading investigation, as news comes to light in the days, weeks or even months after the sales of stock by insiders.

To help remedy this situation the SEC adopted Rule 10b5-1 and the “10b5-1 Plan” was born. We often assist executives and brokerage firms in the creation and execution of such plans, and a properly adopted plan can provide an excellent defense to an insider trading allegation. Simply put, the plans are detailed, specific plans that are designed to let executives sell off shares at regular intervals, regardless of events inside the company at the time of the sales. For background information, please review my prior columns on Insider Trading and 10b5-1 Plans.

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The problem with the plans, however, is in the execution, and in the fact that some executives attempt to cancel or accelerate, the plan. A recent study out of Stanford University showed that executives who use the plans tend to do better than colleagues who don’t. The study also found plan users tend to make sales in advance of negative news.

The concern is that executives are entering into the plans while they are in possession of negative information about the company. If they are, then the plan does not provide any protection against insider trading, as one requirement for the plan is that the executive is not in possession of material inside information.

Adopting a plan to avoid bad news is a form of insider trading. Modification of the plan midstream can also be deemed insider trading. At a minimum, it is counterproductive, and lessens the benefits provided by the plan. The SEC has stated that modification of a 10b5-1 plan carries with it the risk that the SEC will view the plan or arrangement as inconsistent with the requirement that the plan be entered into in good faith and not as part of a scheme to evade the prohibitions of the rule. Repeated modifications to a plan are therefore highly inadvisable. Early termination of a plan likewise involves significant degree of risk. In order to establish compliance with the good faith requirement of Rule 10b5-1, a Rule 10b5-1 plan should provide for periodic purchases and/or sales over a specified period of time, without modification or termination of the plan.

Rumors are circulating that the SEC is making informal inquiries into the creation and operation of 10b5-1 plans at various brokerage firms, and asking for detailed information regarding trades executed under such plans. The source of that buzz might be the insider trading trial of Joseph Nacchio, the former CEO of Qwest Communications International.

According to press reports, Mr. Nacchio entered into a 10b5-1 plan, which provided that he would sell off shares in Qwest at a rate of 11,500 shares a day. However, Mr. Nacchio stopped the plan two weeks after he entered into it, and then started selling shares at a significantly faster rate. According to the complaint, as reported by the Wall Street Journal, he sold over 49 million dollars of stock in three weeks. He was convicted of insider trading, ordered to pay millions of dollars in fines, and to spend 7 years in jail.

Regardless of the actual facts, the case points out the importance of a well drafted 10b5-1 plan, and the faithful execution of that plan. Alternatively, a change in that plan needs to be drafted with great care. And if Mr. Nacchio’s predicament were not enough motivation, Linda Thompsen, the head of enforcement at the SEC has stated “[w]e’re looking at this — hard,” according to the WSJ. The quote continues – “[w]e want to make sure people are not doing here what they were doing with stock options,” referring to the mushrooming scandal of executives manipulating the dates they were granted stock options to maximize their profits.

And the problem is not only for the executives. Brokers who are creating these plans and modifying them, may be opening themselves up for potential regulatory action as the SEC continues its review of the plans, and the operation of those plans. Call my office to review your plan, before Ms. Thompsen and her group call you.


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