SEC Regulation of 10b5-1 plan - FT Letter 6 Jan 2022
Your article “Lax rules allow corporate fat cats to dump stock” (Opinion, December 23) referred to a study by David Larcker et al entitled “Gaming the System” which explains how the US Securities and Exchange Commission created a special exemption in the early 2000s, allowing insiders to sell shares even if they know something material, under a pre-programmed sales schedule, known as a 10b5-1 plan.
To overcome potential opportunistic trading by insiders under this 10b5-1 plan, Larcker et al’s study supports a four to six months cooling off period before the automated trading could start, as first suggested by former SEC Chairman Clayton. The authors recommend a ban on single-trade 10b5-1 plans and on plans that are adopted and those that start just before next earnings announcement. Such recommendations are expected to mitigate loss-avoidance timed sell trades by insiders using the 10b5-1 plan as a safe harbour to trade on their private price-sensitive information. to their unfair advantage.
Larcker et al’s recommendations focus more on “sell” trades, which predominate as our data shows that 95 per cent of the trades undertaken under the 10b5-1 plans are sell transactions, significantly more than their normal open market sell trades outside these plans of 67 per cent.
There is evidence that insiders sell a stock for a variety of reasons, but they would refrain from doing so for fear of depressing the stock price if they possess material non-public information which may attract regulatory scrutiny and potential shareholder lawsuits. However, the main motivation to purchase a stock is to seek profit. Therefore, we think that an additional recommendation for the boards to execute could be to balance out the automated sell trades with the buy trades. This will make managers use the 10B5-1 plan to maintain their required level of stock holding to align their interests with the shareholders rather than making open market buys that yield high abnormal return on average.
Finally, the study focussed on the timing of the sell trades in relation to earnings announcements, which are predictable and part of the regulatory disclosure, rather than other voluntary news announcements which are likely to come as a surprise to the market, and, therefore have more impact.
Knowing the dates of the pre-arranged automatic trades, insiders can make their private voluntary disclosures coincide with the dates of those trades. One such recent case involved Pfizer’s chief executive who sold $5.6m when the company announced that its Covid-19 vaccine was highly effective, and its shares rose 7 per cent. Had the announcement been the day after, the sell trade would have raised only $4.8m.
A week later, the shares fell when rival Moderna reported higher success rate.
Therefore, the SEC could also require insiders to hold off on pre-planned trades until after any news announcements.
Meziane Lasfer and Xiaoke Ye
Bayes Business School, City, University of London
London EC1, UK