What Is Rule 10b5-1?

Rule 10b5-1, established by the Securities and Exchange Commission (SEC), allows 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.

Understanding Rule 10b5-1

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

It is not uncommon to see a major shareholder sell some of his 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 material insider information. These plans usually exist as a contract between the insider and his or her broker.

Overview of a Rule 10b5-1 Plan

Under Rule 10b5-1, directors and other major insiders in the company—large shareholders, officers, and others who have access to material nonpublic information (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 material insider information. This also allows companies to utilize 10b5-1 plans in large stock buybacks.

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. To be valid, the plan must follow three distinct criteria:

  1. The price and amount must be specified (this may include a set price) and certain dates of sales or purchases must be noted.
  2. There must be a formula or metrics given for determining the amount, price, and date.
  3. 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.

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.