What Is Rule 10b5-1?
Rule 10b5-1, established by the Securities and Exchange Commission (SEC) in 2000, allows insiders of publicly-traded corporations to set up a trading plan for selling stocks they own. It is a clarification of Rule 10b-5 (sometimes written as Rule 10b5), created under the Securities and Exchange Act of 1934, which is the primary vehicle for the investigation of securities fraud.
Rule 10b5-1 permits 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.
- Rule 10b5-1 allows company insiders to set up a predetermined plan to sell company stocks in accordance with insider trading laws.
- The price, amount, and sales dates must be specified in advance and determined by a formula or metrics.
- Both the seller and the broker making the sales must not have access to any material nonpublic information (MNPI).
Understanding Rule 10b5-1
Rule 10b5-1 allows company insiders to make predetermined trades while following insider trading laws and avoiding insider trading accusations. It is recommended that companies permit an executive to either adopt or amend a 10b5-1 plan when its 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 material nonpublic information (MNPI).
It is not uncommon to see a major shareholder sell some of their shares at regular intervals. A director of XYZ Corporation, for example, may choose to sell 5,000 shares of stock on the second Wednesday of every month. To avoid conflict, Rule 10b5-1 plans must be established when the individual is unaware of any MNPI. These plans usually exist as a contract between the insider and their broker.
Under Rule 10b5-1, directors and other major insiders in the company—large shareholders, officers, and others who have access to MNPI—can establish a written plan that details when they can buy or sell shares at a predetermined time on a scheduled basis. It is set up this way so that they are able to make these transactions when they are not in the vicinity of MNPI. This also allows companies to utilize 10b5-1 plans in large stock buybacks.
Requirements for Rule 10b5-1
There is a general overview and set planned guidelines for establishing a suitable Rule 10b5-1 plan. To be valid, the plan must follow three distinct criteria:
- The price and amount must be specified (this may include a set price) and certain dates of sales or purchases must be noted.
- There must be a formula or metrics given for determining the amount, price, and date.
- The plan must give the broker the exclusive right to determine when to make sales or purchases, as long as the broker does so without any MNPI when the trades are being made.
For insiders to enter into a Rule 10b5-1 plan, they must not have any access to MNPI regarding anything about the company as well the company’s securities.
There is nothing in the SEC laws that makes 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 useful in warding off public relations problems and helping investors understand the logistics behind certain insider trades.
On Dec. 15, 2021, the U.S. Securities and Exchange Commission announced proposed changes to Rule 10b5-1. The changes would greatly increase disclosure requirements for stock trades and gifts of securities, and require the person setting up the trades to "certify that they are not aware of material nonpublic information." They also would add new conditions to the use of the affirmative defense to insider trading liability, including the establishment of a 120-day cooling-off period before any trading can commence.