Get background on 10b5-1 along with controversies, current developments, and basics of understanding how to interpret insider activities.
At Verity, our team of analysts has been analyzing insider transactions for nearly 20 years. 2021 was a historic year for insiders. As I shared with CNBC and Wall Street Journal, sales by insiders were up 30% from 2020 and up 79% against a 10-year average. Corporate leaders — including MSFT’s Satya Nadella, AMZN founder Jeff Bezos, and TSLA’s Elon Musk — sold a record $69 billion in stock.
In this article, we’ll explore 10b5-1, the rule that makes some of these trades possible, as well as controversies and current developments.
Rule 10b5-1 allows insiders of publicly traded companies to buy or sell their company’s stock via a trading plan (contract with a broker).
The date, the price, and the number of shares must be specified in advance and determined by a formula or certain metrics. Importantly, no one involved in the purchase or sale can have access to MNPI (material nonpublic information) at the time a plan is adopted or amended. Purchases and sales, however, can be transacted at any time later, including when the insider has MNPI.
*RECENT DEVELOPMENT: On December 15, 2021, the SEC outlined proposed amendments to 10b5-1 to “enhance disclosure requirements and investor protections against insider trading.” The proposal “includes updates to Rule 10b5-1(c), which provides an affirmative defense to insider trading for parties that frequently have access to material nonpublic information.” Read the SEC Fact Sheet >>
The rule was originally intended to provide insiders with legal protection from accusations of trading on MNPI. The theory was that insiders would establish Rule 10b5-1 trading plans while not having MNPI and schedule sales for much later date.
In practice, however, insiders often adopt 10b5-1 plans and use the plans to transact sales at specific price targets. Many insiders opportunistically increase or decrease the pace of their selling at certain prices.
In its current form, Rule 10b5-1 not only allows for opportunistic selling but grants insiders a layer of legal protection in doing so.
SEC Chair Gary Gensler voiced concerns with the current rule in June of 2021. “The core issue is that these insiders regularly have material information that the public doesn’t have,” Gensler said. “So how can they sell and buy stock in a way that’s fair to the marketplace?”
He said that there are times when an insider’s terminating or modifying of a 10b5-1 plan could be “as economically significant as carrying out an actual transaction,” and that the current lack of transparency undermines public faith in the markets.
Many asset managers agree. In the recent Investor Survey, more than 50% of respondents said that the timing of insider activity can offer insight into the quality of corporate governance, while nearly as many considered insider selling to be a strong indicator of future price movement.
In December 2021, the SEC proposed amendments to the current rule that would inject uncertainty and fairness into the process. Simply, the amendments would:
The proposed rules would also require enhanced disclosure regarding Rule 10b5-1 trading arrangements, option grants, and issuer insider trading policies and procedures.
At Verity, we’ve been pointing to opportunistic stock sales under 10b5-1 for over a decade. With the right methodology for behavioral analysis, transactions that occur under these plans can be quite revealing. Here are a couple of behaviors we encounter regularly.
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One behavior we commonly observe involves price targeting. An insider sells when the stock price hits either a new high or a certain level above the price determined at the time of plan adoption.
Transactions based on price targeting often have a pessimistic subtext. The insider is trying to sell when the moment is right because they don’t foresee the price getting much better.
At the same time, insiders often have a minimum sale price threshold – in other words, they will only sell a stock if it is at a certain price or above. The clearest instances occur when an insider has been selling stock monthly under a 10b5-1 plan, but then suddenly stops when the price dips.
Transactions based on a minimum price threshold often have an optimistic subtext. The insider is betting they will make more money by holding. These cases involve methodical selling, but only to a point – many insiders draw a line in the sand as to how low they’re willing to go.
Deviations in behavior can also indicate opportunistic selling. For example, an insider may make uncharacteristic sales during big price swings or trade outside of their 10b5-1 plan after months of adhering to it closely.
In these cases, insiders are telling us something about what they know and how that knowledge affects how they view their company’s valuation. The behavior is perfectly legal, so long as that “something” is public information.
Insider trading data has always been an important piece of the puzzle when determining the valuation of a particular stock. With insider trading volume at historic levels, investment edge that can be gleaned from insider behavior is more important than ever. Time will tell if or how proposed changes to 10b5-1 will protect the market.
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