Rule 10b5‐1 Trading Plans and Insiders' Incentive to Misrepresent

Abstract

Insider trading has long been regulated by the federal securities laws. The primary vehicle has been Rule 10b-5,1 the anti-fraud provision promulgated under authority granted to the Securities and Exchange Commission (SEC) in Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act).2 In 2000, the SEC added Rule 10b5-13 to define insider trading as “on the basis of” nonpublic information even if the information was not used in the decision to trade. Rule 10b5-1(c) provides an affirmative defense for transactions under a trading plan that meets its requirements (a “10b5-1 plan”). The affirmative defense is available if, at a time when the insider had no material nonpublic information, the insider commits to the future trades that otherwise might then be subject to insider trading charges.4 The substantive limits of the 10b5-1 plan affirmative defense are unclear. In some cases, insider trading is the primary violation of Rule 10b-5. In other cases insider trading serves as evidence of scienter, or the necessary culpable state of mind, in a broader Rule 10b-5 securities fraud case. The drafters of Rule 10b5-1 and courts in many published decisions involving 10b5-1 plans have not clearly considered the different implications of 10b5-1 plans in these two settings. This article does so. Theoretical economics-based research identifies the incentives for a firm's stock-selling insiders to misrepresent the firm's condition so as to optimize the payoff from their stock sales.5 Empirical economics-based research provides evidence of insiders optimizing proceeds from their stock sales, while also providing evidence that insiders seek to avoid litigation in connection with their sales.6 However, this literature has not yet fully addressed the effect of insider selling under 10b5-1 plans. This article addresses this gap and criticizes the extent to which 10b5-1 plans encourage a firm's insiders7 to strategically time truthful disclosure and misrepresent the content of disclosure,8 often to a further extent than if the sales occurred without the use of 10b5-1 plans. An example of the incentive context at the heart of this article is when a chief executive officer (CEO) or chief financial officer (CFO) orchestrates misrepresentations in periodic financial statements, press releases, or conference calls shortly before a sale occurs under their 10b5-1 plan. Rule 10b5-1(c) shields the insider from liability for a primary insider trading violation of Rule 10b-5 related to the insider information advantage of knowing the basis and of the this even the insider with this is the that the of 10b5-1 plan selling a when insider sales are as evidence of in a broader of The decisions have to two an to proceeds from a stock sale or not a sale occurs under a 10b5-1 plan and or not the insider had the state of at plan a sale under a 10b5-1 plan and an to the sale are to be of than sales plan sales by their sales are in that have been the of an decision an This article proceeds as Rule with a the and insider trading under the federal securities Rule 10b5-1 and other and related to the by the the and the that has addressed trading under 10b5-1 and in the has a to insider sales under 10b5-1 plans as evidence of the incentive for insider selling under a 10b5-1 to provides a to Rule 10b5-1 and to and fraud insiders under 10b5-1 plans. Rule 10b5-1 is a to Rule 10b-5. This Rule the of in Rule 10b-5 then insider trading insider trading be a primary violation of Rule 10b-5 or evidence of in a broader Rule 10b-5 case. Section 10(b) of the Exchange Act provides that is to use or in connection with the or sale of or or in of SEC Section the SEC promulgated Rule the to or to to of a material or to to state a material necessary to the not or to in that as a fraud or The of a under Section 10(b) a material or (a state of a connection the or and the or sale of a the or and The is an and and in the The has clearly that the state of to a under Section 10(b) is than has also in the In an to in the Securities Act which the for by to that not a a of the for Rule 10b-5 to under the and evidence of is at the of the of are to a that with the federal securities Exchange Act Section 10(b) and Rule are clearly to material evidence of insider trading serves in federal securities as the federal securities insider trading to an SEC an in a under the Insider Act of is a by the of In to under Section of also to insider under an of under the Insider and Securities Act of when is trading by a firm's insider a primary violation of Section and when is trading to in a broader Section 10(b) The SEC that has insider insider trading has a basis under the of the federal securities Section 10(b) and Rule in the of SEC the the or a firm's insiders from trading before the the material nonpublic information the In other insider trading liability for insider trading is often of insider trading different are in which insider trading is under the federal securities two of which Rule 10b-5 as a primary violation of Rule 10b-5 or as a to a of in a broader Rule 10b-5 the insider trading be a primary violation of Section 10(b) as a the other trading be to evidence of in Section 10(b) from involving the in a insider trading courts in as to this that an trading as a primary violation of Rule 10b-5 are by the SEC or of to a broader Rule 10b-5 and the insider trading as evidence of Insider stock sales are the primary evidence of in Rule 10b-5 insider stock sales are in an to at the courts than of sales to the of the that the and of by the of sales, sales with trading and from sale in with of the published decisions in these securities not insider stock sales in of insider trading as a primary violation of Rule 10b-5. However, that trading a is evidence that the insider the time to had This in is evidence that information from the in to the the of insider trading and in under Section 10(b) and Rule the SEC added Rule The is to and insider was to the while also an affirmative defense for trades under a 10b5-1 plan. The of the and of the The of Rule 10b5-1 to courts as to the culpable of and use of nonpublic Rule the that of material nonpublic information at the time of a to a as “on the of information, Rule also that insider trading be a primary violation of Rule 10b-5 be a and In Rule the SEC that an knowing or be in some The of a of Rule 10b5-1 that a a decision to a without of material nonpublic information, then of information before the a not trading The that the to a of the material nonpublic information with affirmative which to in is that the information was not a in the decision to Rule these affirmative which are in Rule to a is not the basis material nonpublic information if the before of the information, the a to to for the or a plan for trading the or plan the and to a for the and to or not the to or to effect and the that occurred was to the or plan. is not to a or if, other the the or plan or from the or plan to is when the or plan to was or in and not as of a plan or to the of this the effect of Rule 10b5-1 as for the of an to the the basis in a of insider subject to that the used material nonpublic information in the In a Rule 10b5-1 is an to and of a federal in an SEC SEC In the of for the considered an the of insider trading by that sales of a plan and not by of nonpublic was a and a of the of at the In at a that the was a of from its In the two In the a press the and in the firm's sales and which a stock that decision to was of a plan to a and sale occurred the of the The in an that this with the of that with The that a and that knowing that an insider while in of material nonpublic is not a However, when an insider trades while in of material nonpublic information, a that information was used by the insider in The also that the insider to the with evidence that was no connection the information and the that the information was not The SEC that plan used the information a connection for insider trading that a to avoid liability if the that not or securities of the material nonpublic information that the The the of a plan to defense in an are two of 10b5-1 plans that are used at The of by Rule is a under which stock sales with no of the of these plans to the to the of to This is in to 10b5-1 which for by and other of Rule 10b5-1(c) are an insider is to a 10b5-1 plan at this a of of and transactions to the affirmative is no to the of a 10b5-1 if the insider is selling under a that a of which sales of the of disclosure have long that insiders a to their that the stock sale is under a 10b5-1 plan. This that a sale at the securities or of the 10b5-1 plan at the of disclosure even the of a in the that the insider has a affirmative defense the be to An that Rule 10b5-1 was a that than an of insider trading as the as to that and in an and This to that the of and the federal courts to many the of 10b5-1 other the in of of these evidence by in the of 10b5-1 plan have the Rule and the the by the officer a plan even if is in of nonpublic no of a that a firm's 10b5-1 insiders than the firm's insiders to that 10b5-1 plan might the In other 10b5-1 plans insiders to the basis of decision to has addressed a as to 10b5-1 plan and that The to by Rule 10b5-1 plans insiders an incentive to the of of stock sales and to the of the sales are a of the be to insiders are not to their 10b5-1 plans and a for in that of does not Rule 10b5-1 the or the plan while in of material nonpublic long as an insider in of information is the of the of information and is not the of transactions under the the insider is not the to of disclosure to under a 10b5-1 plan is a the of Rule that is by a or and is in a truthful disclosure than The SEC related to the in its In to the the Rule 10b5-1(c) affirmative defense when a plan is while of material nonpublic information is so that its transactions information is the SEC and not further The SEC also has with 10b5-1 plan stock at have the SEC to 10b5-1 plan at and the SEC has In a by then SEC of that 10b5-1 plans be in to trades at an of that insiders are in trading information and a 10b5-1 plan not the to a that not the or under an affirmative defense not be The decisions involving trading 10b5-1 plans. This the extent to which for the have of 10b5-1 which further insiders to misrepresent so as to proceeds from their sales of stock under plans. Rule 10b5-1 was decisions involving Section 10(b) and Rule 10b-5 a plan to cases of insider trading as a primary violation of Rule cases used evidence of insider trading to in a securities fraud under Rule 10b-5. in In of in an The that the an of from stock sales other the to plans in with Rule SEC was involving a selling plan that was Rule 10b5-1 was the was a that the was financial before a of the financial the stock The SEC an for a primary violation of Rule 10b-5 and under the that the for the and of the stock sale was with a plan two to to of to the that information at the time that that used information in However, this be by evidence that was no connection the information that the and the in other that the information was not used in that the trades have occurred the and involving the of stock of the then that not use the information in The that the the to the connection information and the sales, The of the a and is The a the of the is that if have the in the and the that even if had not information, then be then the of a connection information and the sales be of the of 10b5-1 published shortly Rule 10b5-1 was that the not securities and the of of trading plans in the securities litigation context is be courts the of trading plans in and of to 10b5-1 plan sales in securities The decision to 10b5-1 plans in a substantive is Rule 10b5-1 In this Section 10(b) the that in press and SEC The that the sales of stock the of the and the The that the under 10b5-1 which an that the sales and not two the Section 10(b) involving Rule 10b5-1 plans was In In the that and the firm's of (a to of the firm's and the firm's and the firm's with a The the stock sales as a basis for that the when these The that the stock sales not a of the sales to a 10b5-1 plan and with trading In in the in a Section 10(b) that the in and as in financial statements, and other evidence of scienter, the that the stock of The a stock which a stock The in that the the the stock and the 10b5-1 plan in an to Rule 10b-5 and the and the stock The not that the to the trading in context by the to a 10b5-1 plan before the and if this does not a of The this basis that the to a of in this In the many courts have to 10b5-1 plans and have so a to of these are securities fraud under Section 10(b) in which the or the of selling that the courts in and decisions the of a 10b5-1 plan to the of other cases that stock sales under 10b5-1 or the of an that the stock sale was not a of in of or to to the have occurred in the Section 10(b) as as in state The of 10b5-1 decisions that have the of the 10b5-1 plan as an affirmative The of these cases was In a in an to and In connection with the to to insider sale of of stock that under a 10b5-1 plan and two the the the plan was In the to the is to affirmative in a to this not the of 10b5-1 at this of the not as to other than the 10b5-1 affirmative the that as to trading an of The of the plan is without a 10b5-1 plan in trading to to other cases have also the of the Rule 10b5-1 affirmative these cases, an effect of 10b5-1 plans if and when the substantive of the are in these cases that not be in future to evidence as to the requirements of Rule 10b5-1(c) the of the plan or at are two Section 10(b) in which the courts of selling the decisions also that as to the of In In the that statements, which of the stock of scienter, the that the in securities trading before the The that their sales to a 10b5-1 In a the that a 10b5-1 plan serves as an affirmative defense to of insider The also added that the 10b5-1 plan the to stock at and and does not to be the of that the to from However, the also that not that trading to a Rule 10b5-1 plan to a of insider might their from of an an of and seek to their with a 10b5-1 plan. In the have to if to from the stock sales The does not to these stock sales for the of the of In the other related to 10b5-1 the misrepresentations of the of the firm's The also that the stock when the of was the The that their sales under 10b5-1 The even if the to the of the the truthful disclosure their stock sales, the of the and the of The is the plans be considered and of with to the the not the However, the stock sales to the to to a of with other the to that the to that the with is the have the of the truthful disclosure further had the litigation is the that the of disclosure under Rule 10b5-1 in is that the of decisions that have addressed 10b5-1 plans a The cases that in of so that insiders be even further to sales proceeds from their stock sales if the sales under 10b5-1 an incentive which is in have addressed the and the in this a under 10b5-1(c) This is the incentive for insiders to misrepresent the content of or has yet to this which is in of the courts have to the of sales to evidence Section provides and evidence of the incentive for insiders to proceeds from the sale of their Section that this incentive is not an insider had and when the 10b5-1 plan to be the state of at the time of the of that shortly a In a trades under 10b5-1 plans at in insider trading cases, as in Section of the that nonpublic information to an stock Rule 10b5-1 plans a that the stock sale to and the of nonpublic information the the incentive to proceeds be in many this article in a of conference calls and press releases, this article insiders misrepresentations in financial statements, that occurred in many of the decisions This a example of a in of Rule 10b5-1(c) and the that has 10b5-1 is to in a Section 10(b) of the that insider incentives under 10b5-1 plans be by litigation under Section 10(b) of the Section addresses this by that of insider stock selling is an in to a of evidence of the of in a Section 10(b) cases not than insider to a of insider trades from 10b5-1 as some decisions from the to for to in otherwise This also from the and from the SEC for cases that otherwise have Section by that of the also in litigation of Section as insiders seek to by 10b5-1 plans as in other settings. The financial and incentives has long been in the In a that the is the which is not that insiders their stock before even if of In the of as an of the and securities involving misrepresentations or also insider trading as or in with the of not the of the to their the stock also at by selling at these financial disclosure be or to to knowing or as in the or the of that a selling or firm's stock provides incentives to in to of insider trading is an for at is no then that insiders are to in to a stock before a stock Empirical have evidence of this and in cases involving SEC to be to the for which are and before the of the SEC a for in the are when insider sales shortly are In insider selling the of or for the other insiders are to avoid litigation from their stock with a litigation have no insider trading in the two a in a of have also while is of insider trades shortly an or insiders avoid trades in the before evidence of as as the of litigation when trading under of a 10b5-1 that insiders with 10b5-1 sales plans be to in and other disclosure to the stock in of a than for sales not under In an research provides evidence that insiders before a stock in an to the The is an for which the insider plan In the 10b5-1 plan the sale of stock under a plan is also an that the 10b5-1 plans that are are for as seek to However, the courts have so to this in the many decisions involving the the example of the of by 10b5-1 plans. a 10b5-1 plan to stock the stock This be the sale the The of the stock is a of the the 10b5-1 plan in the had no material nonpublic information, the plan with and had no to to laws. However, the has a of in to or by a stock in the to the sale disclosure content before the the the in to Rule 10b5-1(c) not this the courts have many cases involving Rule 10b5-1 be to this the in that have not been in the many cases to the many 10b5-1 plans are for to be The that the of 10b5-1 plans is to or the use of plans with trades without the of an insider trading many 10b5-1 plans are in connection with an or to a or or to a for stock-selling plans also be from the Rule in in which the SEC insider trading as a primary and in which for selling to an of in a broader Section 10(b) However, as the of and some other does not the effect of the has clearly the that insiders seek to from sales, even if the sales are for as to advantage of the of a financial so the insider to time with the or to the incentive to proceeds of a sale be by a state of from the time of plan the affirmative defense when the 10b5-1 plan was without of material nonpublic information and in and not as of a plan or to the of Section that the as a of by even by their plans in is to that the SEC 10b5-1 plans as an affirmative defense a a decision to a without of material nonpublic information, then of information before the The SEC that many cases of this a not trading that the to an information not by the as the a or the firm's that Rule 10b5-1 was not to defense for the use of information by the as the orchestrates the in periodic financial while nonpublic information as to the basis and of In a the information the financial not of the the information be by the This an that Rule 10b5-1(c) was not to an trading from a primary violation of Rule 10b-5 if the information is The insider the financial and the insider has material nonpublic information as to their The of of in to the The that Rule 10b5-1 if a stock trading plan is by a before of material information, a plan an affirmative defense to insider The SEC then that plans and not for the affirmative In the does not plans. is state of and In is the state of or at the time of the 10b5-1 plan. the state of when misrepresentations are that stock in an plan sale have to that the incentive to stock sales proceeds is not a the to was by a to a or from a to also not a that the insider had at the time of of the 10b5-1 plan if not have at the time of the transactions to the of the plan. Empirical research insider trading that Rule 10b5-1 that insider selling and be or the decisions to stock and be In other this research not fully the insider as a to than as a or the insider strategically before a stock transactions under 10b5-1 research be to the the stock is subject to an and so This the of insiders the of optimizing the payoff from the if a was not is that the insider have to for that the the of courts cases involving 10b5-1 plans to a of in a which under the of a 10b5-1 than in the The The SEC has addressed the and be as in the of and The the Rule 10b5-1 affirmative defense as to in is the information was not a in the decision to In connection with in a Section 10(b) the courts be with the effect and the decision to was a in the decision to In other the courts the of the sale and that have to the to the is that the of Rule 10b5-1 insiders to misrepresent is of the SEC and a Section 10(b) for the might also a Section 10(b) that the of nonpublic information to a Rule 10b5-1 and have the 10b5-1 defense to the the requirements to and the avoid this the SEC and selling as evidence of in cases violation of Section as This is if insider trading is or as of scienter, as then the Section 10(b) not a to are two for this The to the of and the with as evidence of financial often or of In a violation of is by to a of However, of of and for financial a of when with other and evidence of in this the information so that a the or in or and of also be in cases in which an insider plans to stock shortly the its The insider to to the insider to before the are In In for of the cases in of Rule the that the was to in fraud to The that a by to the these are to a by that officer to if an insider so that the or and stock shortly before a 10b5-1 plan a Section 10(b) is to This is courts insider sales as evidence of an insider financial in of a 10b5-1 sale with no other of than sales their The to be so that be its to an of or of be This is a of for to The cases might not a to to the in and financial to and so in a or selling as evidence of scienter, the SEC and of their to the is to the necessary of are in evidence to the to insider trading be and when the that be from the by the of are to the many have the incentive to The SEC has the of in to insider is for the SEC to evidence to its is for to an of information is insider which the insiders to and are in many available as However, of of or of sales, to and other of financial as financial so as to a plan the in with plan to with insider trading not so a in the of as a in the In the to in the insider trading trading at a time is In in the executive is no than the to or an to or a stock in of a stock sale a in the of stock sales, have advantage of and to evidence before the decisions 10b5-1 plans. the 10b5-1 plans for stock-selling a 10b5-1 plan does not the of litigation in the of financial the Act insiders that be and have under the Act to if a financial and also liability for financial or However, no of for these of be as a and other that not and their have different and incentives to and insiders might be subject to of a of which are of state insider trading cases are often in federal that state courts might insider However, are also state decisions that have sales in a for The research and the incentive for insiders to misrepresent when selling stock under 10b5-1 plans. This incentive is to in of the many courts the of sales for of This to two in cases in which the insider trading be a primary violation of Section 10(b) and Rule the SEC the affirmative defense of Rule 10b5-1(c) as when trading with of information not by the of this of information the of a a or the of a The affirmative defense not be to in cases in which the insider trades information by the insider plan as an of financial by the information, as financial statements, under the of 10b5-1 plans to a or under Rule or an not be be the is a and the Rule securities without an to the in Section 10(b) cases in which insider trading is as evidence of scienter, the and not the of trades in the context of The SEC to have its and by a to to use insider trading as of of an or other than the trading by the Rule 10b5-1 to the in insider trading a necessary for liability under Section 10(b) and Rule 10b-5 and Rule 10b5-1 does not the research and the SEC and in their and in to the to that sales be of than sales not under 10b5-1 plans. this is to for 10b5-1 the and the insider in plan the state of was when the 10b5-1 plan was have financial and to their proceeds by in of an plan under 10b5-1 plans not have its than selling not under the of 10b5-1 plans. the in a of cases to the of that the insider selling or even if 10b5-1 plans for the in this evidence of selling and of by of sales, sales with trading and from the sale in with The example of trading is by as sales as to sales many The in 10b5-1 plans as providing from federal securities In some 10b5-1 plans as a substantive In the of other cases, the of the that insider sales to 10b5-1 plans not a of in a broader Section 10(b) case. identifies incentives for insiders to misrepresent before selling and that be to selling under 10b5-1 plans. In many the incentive is than selling of 10b5-1 in of the the extent to which Rule 10b5-1 and decisions to 10b5-1 plans as stock sales as as the of trading as evidence of in broader Section 10(b) cases or of truthful the SEC and not these in their not have a to so if not the to