Is the Level of Profitable Trading by Insiders Under 10b5-1 Plans Just Serendipity?
By Cydney Posner
Rule 10b5-1 plans are once again under the microscope. In an article from the Wall Street Journal, the authors discuss the WSJ's study of regulatory records since 2004 on thousands of company stock trades by insiders during the five trading days before their companies released "material, potentially market-moving" news: "Among 20,237 executives who traded their own company's stock during the week before their companies made news, 1,418 executives recorded average stock gains of 10% (or avoided 10% losses) within a week after their trades. This was close to double the 786 who saw the stock they traded move against them that much. Most executives have a mix of trades, some that look good in retrospect and others that do not." The "fortuitous" results from trading under 10b5-1 plans has certainly surfaced as an issue in the past. (See News Briefs dated 3/9/07, 10/10/07, and 6/4/09.)
The WSJ also "compared the trading of corporate executives who buy and sell their own companies' stock irregularly, dipping in and out, against executives who follow a consistent yearly pattern in their trading. It found that the former were much likelier to record quick gains. Looking at executives' trading in the week before their companies made news, the Journal found that one of every 33 who dipped in and out posted average returns of more than 20% (or avoided 20% downturns) in the following week. By contrast, only one in 117 executives who traded in an annual pattern did that well. 'We've found a lot of evidence that these insiders do statistically much better than we'd expect,' said… an associate professor of business administration at Harvard University who co-wrote a study published this year about the performance of insiders who time their trades. 'The perch that they have—they not only have proximity to this private information, but they can actually affect the outcomes.'"
The article cites a number of problems with 10b5-1 plans: The plans are not made public and can be cancelled or changed without public disclosure. In addition, executives can trade outside of 10b5-1 plans if they choose (but then of course they do not benefit from 10b5-1). Moreover, although insider executives may not set up valid 10b5-1 plans when they have material nonpublic information, there is no rule about how long the plans must be in place before trading under the plans can begin.
A follow-up article discusses the call by investors and analysts for more disclosure about 10b5-1 plans. According to an SEC spokesman, the SEC "considered requiring executives to disclose information about 10b5-1 plans eight years ago but the proposal was dropped after Congress declined to include it in related legislation [SOX]. 'If we heard significant calls for reproposal of that requirement, the commission certainly could take it up again in the future,' the SEC spokesman said." According to the article, the disclosure provision "got lost in the shuffle."
Some investors argue that more information about 10b5-1 plans would allow them to better understand a firm's management and business. According to one analyst, "'Knowing what parameters were set, when the plan was put in place and if it's been suspended—these are all things shareholders deserve to know, especially given the success rates executives have had with their trades.'"
Academics say that, contrary to the SEC's intent, "the introduction of 10b5-1 plans has made it easier for executives to take advantage of private knowledge about their firms. 'This was a huge gift to insiders' said … a law professor at the University of Chicago Law School. 'The SEC claimed this would reduce the probability of insider trading but it has had the opposite effect. CEOs are really abusing this rule.'"
Both of these stories are chock full of unpleasant examples. Will the SEC follow-up with new rule proposals?