Securities and Exchange Commission (SEC) Rule 10b5-1 provides insiders of public companies an affirmative defense against allegations of trading in material nonpublic (insider) information when buying or selling their company’s stock. Under Rule 10b5-1, insiders establish trading plans whereby they plan to buy or sell a predetermined number of shares through one or more transactions with an independent third-party broker up to two years in advance. Insiders are presumed to be less likely to act on inside information relating to the value of their company’s stock when they plan transactions in advance than when they do not.
In the article titled, When and how are Rule 10b5-1 plans used for insider stock sales?, Fich, Parrino, and Tran (2023) study a sample of 13,930 stock sales by 1,629 CEOs of 1,322 different public companies over the period 2013 to 2020 to determine when Rule 10b5-1 plans are used and their effectiveness in mitigating insider trading. Of those stock sales, 8,554 are identified in SEC Form 4 filings executed through Rule 10b5-1 plans.
Empirical tests indicate that sales of Rule 10b5-1 plans by CEOs are more likely in companies that face higher litigation risk. Also, plan trades are more likely during the 40 trading days Before a quarterly earnings announcement and are less likely during the 40 days After such an announcement. This evidence is consistent with CEOs choosing to trade under plans when the likelihood of facing accusations of trading over material nonpublic information is greater. This is also consistent with CEOs using Rule 10b5-1 plans to sell their shares during corporate blackout periods, which typically prohibit trading before earnings are announced.
Sheet et al. (2023) also examine whether the profitability of CEO stock sales varies with the use of the 10b5-1 rule plan by calculating the cumulative abnormal returns (ACRs) in the 40 days before and 40 days after the sale of actions. Planned and unplanned selling returns trace an inverted “V” shape often associated with opportunistic stock selling. However, the evidence indicates that off-plan sales are, on average, preceded by a larger average price increase than off-plan sales. This difference is consistent with greater opportunistic behavior by CEOs selling outside of 10b5-1 rule plans and persists when the analysis is limited to restricted stock sales. Notably, while the level of opportunistic behavior for blueprint sales is lower than for off-plan sales, examination of the timing of Rile 10b5-1 blueprint sales suggests that trade dates are deliberately chosen to increase absolute value. earnings from transactions. .
Sheet et al. (2023) also find that the level of opportunism associated with plan sales is relatively high when focusing on sales in which the CEO has a lot of money at stake. In this test, the authors set a high CEO incentive stock sales as the 25% of sales with the highest transaction value relative to the CEO’s business-related wealth. When only high CEO incentive stock sales are taken into account, both planned and unplanned sales show larger increases in pre-sales and larger decreases in post-sales average BCRs. It is important to note that the level of opportunism associated with CEO incentive stock sales are similar for planned and unplanned transactions.
The study also examines ways in which CEOs can circumvent the intent of Rule 10b5-1. Analytics reveal that the quality of information within the selling CEO’s company tends to improve more in the fiscal year in which a 10b5-1 plan sale occurs than in the fiscal year in which an off-plan sale takes place. The results also suggest that out-of-plan sales and high sales CEO incentive plan sales are more likely to be timed to benefit the CEO or associated with opportunistic transaction-based earnings management than weak CEO incentive plan sales.
File and. al. (2023) also report evidence of the elimination of planned sales under Rule 10b5-1. Eliminating a sell can be accomplished by canceling the plan or using a limit order within the plan. Since plan cancellations and the use of limit orders are rarely disclosed, the authors identify instances where a sale is likely to have been eliminated by investigating the trading habits of individual CEOs. Unlike the inverted “V” shape described above, the average ACRs for sales identified as likely to have been eliminated have a normal “V” shape. This pattern suggests that some CEOs benefit from inside information and avoid losses associated with declining stock prices by canceling a Rule 10b5-1 plan or using limit orders.
Finally, additional tests suggest that opportunism among 10b5-1 rule plan sales and among non-plan sales is limited in well-governed companies. Notably, however, the same tests also indicate that the governance mechanisms considered by Fich et al. are not effective in limiting opportunistic behaviors associated with CEO incentive sales in plans.
This study should be of interest to corporate governance policy groups and regulators concerned with limiting the ability of public company executives to enrich themselves at the expense of their company’s shareholders. The results suggest that some CEOs are successfully exploiting weaknesses in the 10b5-1 framework for personal gain.
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