With Pfizer and Moderna’s COVID-19 vaccines in the headlines, the companies’ executive teams have also attracted attention because of the sizeable stock sales they benefitted from after positive trial developments were announced. Although the timing of the transactions has raised concerns about potential insider trading, they are legal thanks to SEC rule 10b5-1, which allows executives to trade a pre-determined number of shares at a pre-determined time, making the shares be on “auto pilot” – and avoid blackout trading restrictions.
In this post, we look at how 10b5-1 plans are used in practice, including some best practices to help protect the interests of shareholders, executives and the company itself.
10b5-1 Plan Overview
We expect corporate executives, and in particular the CEO, to be aware of what is happening, from progress on disclosed short-term goals or top secret innovations. After all, the named executive officers are often referred to as “insiders”. The potential conflicts that could arise from insider trading have given rise to blackout windows and other trading restrictions to protect companies and their shareholders from impropriety, and the threat of liability.
Yet for many companies, including those focused on research and development, trading restrictions are the rule, not the exception. Considering the amount of material, non-public information most executives have access to, guardrails must exist in order for executives to be able to sell their own holdings. This is achieved through 10b5-1 plans, as they allow executives to remain virtually independent from the stock sale in theory.
The terms of these plans can vary, but generally they will:
- Specify the number of shares to trade, with price and dates of sale;
- Include a written formula, algorithm or computer program to determine the amount, price and date to be sold; or
- Transfer trading authority to a third party, who does not have material non-public information, prohibiting the insider from exercising any influence over how, when and whether to make the sale.
In order to participate, executives are required to act in good faith by not withholding any further non-public information that could cause a potential shift in the stock price.
Executives often enter into these agreements using an administrative broker, otherwise known as an un-biased third party. The use of an administrative broker further incentivizes the adoption of these plans from the company’s standpoint. The 10b5-1 plan, if administered by an independent third-party, first reduces the liability of potential legal trouble a company could face following an accusation of insider trading against one of their executives. Second, the company is afforded more of a “hands-off” approach to executive stock sales as they are not as involved in monitoring or administering the plan.
Background & Mozilo Action
10b5-1 plans are a relatively new market trend, established by the SEC in 2000 in connection to Rule 10b-5, which prohibits insider trading. Since their inception, they have become an increasingly popular option as harsher guidelines regarding insider trading regulations have been introduced by the SEC and as more companies develop stronger internal guidelines to combat insider trading and implement blackout trading periods. More than 50% of S&P 500 companies have executive who use these plans, more often than not during trading blackouts.
The idea behind 10b5-1 plans is to provide executives an avenue to trade company stock without the risk of conflicts or legal trouble. But it is not so simple. These plans have their fair share of potential pitfalls, as highlighted by the Mozilo action in 2010.
In 2009, the SEC filed charges against former Countrywide Financial CEO Angelo Mozilo and two other former executives for misleading investors. The SEC alleged that they had failed to disclose significant credit risks and engaged in insider trading by establishing four 10b5-1 plans while being aware of material, non-public information concerning Countrywide’s increasing credit risk and expected poor loan performance (SEC Press Release, 10/15/2010). Eventually, the case ended with a total $67.5 million settlement, a record-breaking amount.
The Mozilo case highlights a serious concern with 10b5-1 plans, as it was determined that acting in good faith was not a strong enough guideline. Consequently, more guidelines were introduced. The SEC determined that when a 10b5-1 plan is adopted, trading cannot commence under the plan until the material, non-public information known at signing becomes public. This specific additional guideline aims to strengthen the defense against insider trading among executives and has been well received – but only goes so far.
Due to the limited company involvement, public records detailing 10b5-1 plans can be hard to track down. Executives are also able to enter into multiple, short-term plans at any time. Compounded, these two attributes make it difficult to determine the timeline of contracts and subsequent sales.
Of course, it would be virtually impossible for SEC regulations to account for every possible eventuality, particularly given the flexibility inherent to 10b5-1 plans. Looking beyond regulatory requirements, there are also best practices that companies can follow in order to strengthen their 10b5-1 plans and broader insider trading policies, helping to deter negative investor reactions after the fact.
Best Practices
“Cooling-off” period. This clause mitigates insider trading as it requires an executive to wait an agreed upon amount of time until they can legally sell the shares. The cooling-off period can also detail a time frame when additional shares can be added to a preexisting 10b5-1 plan. Without “cooling-off” periods, executives may begin trading at virtually any point after the adoption of a plan. As these clauses limit trading windows between potentially market-moving news events, they help protect executives from speculative trading accusations.
Public disclosure. Another way to mitigate insider trading stems from publicly disclosing the adoption, amendment and/or termination of 10b5-1 plans. However, many companies feel that 10b5-1 plans fall under private, personal transactions, and thus are not closely monitored by the company. When surveyed, approximately 79% of companies replied that they do not have a policy on public disclosure surrounding 10b5-1 plans, as allowed by regulation. While the freedom for the company to remain silent on potentially contentious executive transactions is appealing, disclosure helps assure investors that plans are adopted in good faith and lessen the risk of any negative press that may arise.
Transparency is key. Other forms of best practice include avoiding the use of multiple, overlapping plans, avoiding short-term plans (most plans are six months to two years) and avoiding making changes to existing plans. All of these best practices help simplify the flow of publicly available information and present a clear way for insider trading rules to be followed. They help to avoid situations where executives are put into the spotlight, as was the case for Pfizer and Moderna – and ensure that when things do go public, the market has the information it needs to put things in context.
The Pfizer Case
Despite raising concerns about insider trading, it appears that the rapid sale of Pfizer stock by its CEO was an example of a legal stock sale through a 10b5-1 plan. Public records show that the CEO of Pfizer entered into a 10b5-1 plan in February and renewed its authorization in August, 2020, according to the same terms. The agreement was that a certain amount of stock would be sold when the share price reached a specific amount.
Notably, the day after the plan was renewed in August Pfizer issued a press release stating it was on track for its vaccine candidate to seek regulatory review, based on the findings of an academic study. This led to questions that the CEO might have been privy to material non-public information. Pfizer responded by stating that the press release did not have material information, as the company had previously announced its expectations for a COVID-19 vaccine and that it did not control of the timing or content of an academic study about the vaccine.
The existence of a timetable, with clear disclosure of the events as they unfolded, helps to mitigate potential concerns about insider trading. Moreover given the context, it is understandable that when Pfizer released the information regarding its vaccine candidate, the stock price shot up — triggering the 10b5-1 plan. Similar conclusions can be drawn when looking into the Moderna executive’s transactions.
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Hannah Fasbender also contributed to this post.