At the top of nearly all publicly traded organizations, you’ll find key employees restricted from trading company stock for designated portions of each calendar year; typically, a window of time before and after all major financial reporting deadlines and surrounding any large events like mergers and acquisitions.
These restrictions exist because such individuals are privy to material non-public information (MNPI) regarding the company’s activities and performance. Access to such information and consequent trading on such information would be a direct violation of the Securities and Exchange Commission regulations on insider trading. Simultaneously, these individuals are often some of the largest individual shareholders of company stock through outright ownership and granted stock options.
So, how do such individuals navigate this paradox – large portions of their compensation with limited means to realize its value? Generally, they are simply bound to sell and or exercise these assets during the limited windows in which they are not restricted. An acceptable strategy, sure, but wouldn’t it be nice if there was a method that allowed greater flexibility while still adhering to regulatory restrictions?
Well, simply put, there is. Enter the 10b5-1 Plan. As may be evident by its name, the practice is one born from the extensive regulatory rulebook of the Securities and Exchange Commission. While its origin story is of little interest, its purpose is worth understanding. Rule 10b5-1 allows insiders of publicly traded corporations to establish a trading plan to sell a predetermined number of shares of company stock at a predetermined time.
More simply put, the rule allows those subject to trade restrictions to schedule the sale of company stock at a future date and price regardless of the blackout periods* they may be subject to.
For instance, an executive and his financial advisor have established a strategy to target gains of 50-75% (above grant price) for the exercise and subsequent diversification of his or her company stock option grants. Unfortunately, a blackout period is approaching, and it is likely that the stock price will cross that targeted threshold during this time. With this in mind, the individual may choose to establish a 10b5-1 limit order plan (during the open trading window) to exercise the granted shares should they, in fact, reach the targeted price during the blackout period.
While advantageous, adopting such a plan is not simply a practice that can be loosely documented or casually executed. In fact, implementation of such a plan requires careful cooperation between the individual and the corporation’s legal department – not to mention the individual’s financial and tax advisors.
Many large corporations are familiar with the practice and will already have an established set of procedures for the adoption of a 10b5-1 plan. In such cases, if agreed to be advantageous by you and your advisors, getting started may be as easy as contacting your human resources compensation specialist.
With smaller companies, it may be more difficult, in that the plan and its characteristics will need to be formulated and adopted from scratch. This is where you will need your advisors to engage your company’s legal counsel as both parties will need to ensure that the plan’s characteristics adhere to SEC guidelines. Such considerations can be rather complex, but in simplest terms, they must ensure that the proposed trades neither capitalize on MNPI, nor be of a scale to materially influence the price of the stock upon execution.
As with any investment strategy, implementation of a 10b5-1 plan requires careful consideration of many factors, but it does provide a little-known solution to a common dilemma. If you believe such a strategy may provide a solution for you, begin the conversation with your financial advisor. You never know, you might just teach THEM something!
*A blackout period is a company policy or rule setting a time interval during which certain actions are limited or denied. It is most used to prevent company insiders from trading stock based on insider knowledge.