Rule 10b5-1

What is the 'Rule 10b5-1'

Rule 10b5-1 is established by the Securities Exchange Commission (SEC) to allow insiders of publicly traded corporations to set up a trading plan for selling stocks they own. Rule 10b5-1 allows major holders to sell a predetermined number of shares at a predetermined time. Many corporate executives use 10b5-1 plans to avoid accusations of insider trading.

BREAKING DOWN 'Rule 10b5-1'

Rule 10b5-1 allows insiders to be able to make predetermined trades while following insider trading laws as well as avoiding accusations of these as well. There is a general overview and set planned guidelines for establishing a suitable 10b5-1 plan.

It is not uncommon to see a major holder sell some of his shares at regular intervals. For example, a director of XYZ Corporation may choose to sell 5,000 shares of stock on the second Wednesday of every month. To avoid conflict, 10b5-1 plans must be established when the individual is unaware of any material non-public information.

Overview of a 10b5-1 Plan

Under Rule 10b5-1, directors and other major insiders in the company – large shareholders, officers and others who are able to access material nonpublic information (MNPI) – are able to establish a written plan that details when they will be able to buy or sell shares at a predetermined time on a scheduled basis. It is established this way so that the insiders have the ability to buy or sell shares when they are not in the vicinity of MNPI. This also allows companies to utilize 10b5-1 plans in large stock buybacks.

For the insider to enter into this plan, he must not have any access to the MNPI regarding anything about the company as well the company's securities. The plan must follow three distinct criteria to be valid:

1. The price and amount must be specified (this may include a set price) and certain dates of the sales or purchases must be noted.

2. Metrics behind the method of buying or the sales method must be qualified, determining the math behind determining the price and date.

3. The plan must allow the broker the right to determine when to make the sale or purchase as long as the broker does so without any MNPI to coincide with insider trading laws.

Guidelines

It is recommended that companies allow an executive to either amend or adopt a 10b5-1 plan when the executives are allowed to trade the securities in tandem with their insider trading policy; Rule 10b5-1 stops any insiders from changing or adopting a plan if they are in possession of MNPI.

There is nothing in the SEC laws that make it necessary to disclose the use of Rule 10b5-1 to the public, but that doesn't mean companies shouldn't release the information anyway. Announcements of utilizing Rule 10b5-1 are helpful to ward off public relations problems and helps investors understand the logistics behind certain insider trades.

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