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Avoid Being Accused Of Insider Trading

Investor confidence in corporate management is at a low ebb. These days, questions normally reserved for corrupt politicians—what did you know and when did you know it?—are being directed at CEOs and other company insiders who have bailed out of multimillion dollar stock positions just before the share price fell off a cliff.

Still, executive compensation often includes large blocks of stock, and, as an insider, you may need to sell shares to finance big purchases, fund a child’s education, or simply pay bills. Yet you may also possess nonpublic information about events that could affect your company’s share price, and unloading stock under those circumstances could subject you to insider trading charges by the Securities and Exchange Commission, to say nothing of suits by angry shareholders.

The solution? As part of its Regulation FD (for “fair disclosure”), which took effect October 23, 2000, the SEC established rule 10b5-1, which creates an affirmative defense for executives of public companies who buy or sell stock according to a pre-set plan. The idea is that inside information can’t come into play if you commit yourself in advance to certain transactions.

Rule 10b5-1 delineates three kinds of permissible contracts: a document specifying trades that will occur at certain prices on particular dates; a plan spelling out a formula that will be followed to determine trades; or a document granting an independent third party without inside information the discretion to make trades on your behalf.

A simple plan might say that 5,000 shares would be sold May 31 at $15 a share or higher. Or you could base your plan on a formula, stipulating that 10 days after the start of each quarter you would sell enough shares to raise $25,000. Another plan might call for your advisor to dispose of 1,000 shares each quarter, but only if the share price is at least 80% of the stock’s 52-week high.

A plan might also mandate selling shares at a specified time to raise funds. According to the SEC, the “formula could provide, for example, that the employee will exercise options and sell the shares one month before each date on which her son’s college tuition is due, and link the amount of the trade to the cost of the tuition.” Or you could specify that a grant of employee stock options be exercised when the share price rises a certain amount above your exercise price.

As helpful as this rule may be, it does mean giving up some control of what happens to your stock, and you could find yourself selling shares into a slumping market, or raising money and incurring taxable capital gains at a time when you don’t need the cash after all.

Lawyers recommend that SEC filings disclose pre-set trading plans.. SEC officials remain concerned about improprieties in this area and have vowed to take a long, hard look at such plans.


This article was written by a professional financial journalist for Legend Financial Advisors, Inc.® and is not intended as legal or investment advice.

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