An "Exotic Permutation" in the Use of 10b5-1 Plans

By Cydney Posner

When The Wall Street Journal does a major investigation into some trading activity that looks mighty suspicious, prosecutors are usually quick to follow. In this case, federal prosecutors, including the SEC and two U.S. Attorney's offices in NY have launched criminal investigations into whether corporate directors and the investment funds they manage have abused 10b5-1 plans and essentially traded on inside information, based on recent reporting in the WSJ.

According to a WSJ analysis of regulatory filings reported in these articles, the use by outside directors of 10b5-1 plans has skyrocketed, climbing 55% since 2008, and the use by all other corporate insiders has risen by 36%. The WSJ identified 2,210 outside directors who, since 2006, reported using 10b5-1 plans to sell shares. Perhaps of even more significance, "instead of selling a fraction of their shares at regular intervals, as envisioned when regulators created the plans as a way for executives to diversify their holdings, some directors use the plans to sell heavily in a short time." In addition, from 2006 through 2011, the study found that nearly a quarter of non-management directors with 10b5-1 plans "sold more stock in one month under the plans than in the surrounding two years….Some used 10b5-1 trading plans to unload all or the bulk of an investment fund's holding in a company, in a spate of selling."

An SEC spokesman confirmed that, although Rule 10b5-1 "doesn't prohibit board members from using the plans to allow outside investment funds to trade shares[,] this wasn't specifically contemplated when such plans were devised a dozen years ago to give executives a way to sell some shares of their own companies despite being exposed to nonpublic information about it. It is, he said, an ‘exotic permutation.'"

Not surprisingly, prosecutors are questioning whether insiders are really using the plans to dump their shares when they have inside information. The WSJ reports that "George Canellos, the SEC's co-enforcement chief, said at a legal conference on April 26 that ‘10b5-1 plans are issues that we grapple with regularly in insider trading cases.'" (See also my articles from 6/1/06, 3/9/07, 4/4/07, 10/10/07, 6/4/09 and 11/28/12.)

And some investors have urged the SEC to modify the rules. (See, e.g., my article dated 1/3/13 regarding the rulemaking petition filed by the Council of Institutional Investors.) The articles report that CIC "has been told that the SEC is ‘looking into' the issue…."

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