When a company sees a sudden, sharp decline in its share price, there is a significant public relations risk if the executives have sold shares just prior to the dip. While 105b-1 plans were developed to provide executives with a defense against insider trading claims, overly permissive or frequently changed plans may not hold up to scrutiny. This increases the risk of a costly legal investigation and could drive adverse votes from investors.
A recent academic paper, “
Gaming the System: Three ‘Red Flags’ of Potential 10b5-1 Abuse” addresses major red flags and offers advice on plan structure to mitigate risks. The paper was authored by David F. Larcker, Stanford University, Bradford Lynch, University of Pennsylvania, Phillip J. Quinn, University of Washington, Brian Tayan, Stanford University, and Daniel Taylor, University of Pennsylvania.
Potential Red Flags:
- Minimal cooling-off period: The shorter the cooling-off period, the higher the risk of negative perception that the plan is opportunistic.
- Single-trade plans: These plans are inconsistent with the intent of 10b5-1 as they do not conform to the expectation that trades will be governed by a “regular, pre-established program.”
- Circumventing blackouts: While executives are prevented from trading during a blackout window, the research found several plans that appeared to circumvent such rules by allowing executives to adopt plans and start selling shares before earnings release.
The paper offers the opinion that the SEC should more closely regulate such plans and require companies to disclose the plans and when trades are made pursuant to the plans. The paper also calls on boards to oversee the plans more closely, adopt best practices such as requiring a cooling off period of 4 to 6 months between adoption and the first trade, and prohibiting the adoption of single-trade plans. A recent
Center survey on 10b5-1 plans found that most companies already meet these requirements (but only a quarter disclose the adoption of plans publicly for NEOs).
Stock sales are an easy target for political figures and are almost never reported on in a positive light. Therefore, utilizing best practices, eliminating problematic provisions, and providing clear disclosure are useful risk mitigation strategies.
