Primer on 10b5-1 Plans

By Simon Tryzna, CFA, Chief Investment Officer

If you are one of the senior executives of a company, you may be subject to putting in place a 10b5-1 plan to transact your company stock, as well as you exercising and selling your options. While putting such a plan in place can be daunting, it is an incredibly powerful tool for individuals to divest out of their concentrated equity position in a way that is both appeases the capital markets and helps the individual meet their financial planning goals. In this primer, I take a look at what purpose 10b5-1 plans serve, as well as some key considerations to keep in mind when putting a plan in place.

Purpose of 10b5-1 Plans

The 10b5-1 rule was established by the SEC in 2000 to allow those that are deemed by a publicly-traded company as "insiders" to set up a trading plan for selling the stock in the company they own. An insider is someone that possesses material knowledge about what is going on at the company that investors are not privy to.

One of the biggest things that Wall Street analysts pay attention to when covering a stock is insider trading. Suppose a significant shareholder (like a C-level executive) is selling a large portion of their equity. In that case, it could be taken as a signal that they don't believe where the company is going and want to liquidate their holding before the stock price tanks. While this is a valid reason for Wall Street to take caution, there are many reasons that shareholders could be selling their stock.

A 10b5-1 plan presents a workaround solution to prevent signaling. The plan is pre-arranged, meaning that stock sales (or stock option exercises) are planned well in advance of their actual sale date. This way, any planned sales are determined prior to the shareholder being privy to any insider information. For example, say the plan was put in place in December of the previous year with planned sales every month. In March, the company realizes that their planned factory has a significant construction delay but won't have an opportunity to let analysts know that until the subsequent quarterly earnings call in May. The shareholder will still sell in March, April, and May and won't be scrutinized for trading on non-public information because those sales were planned back in December, well in advance of the factory news. These types of sales won't be why analysts issue a negative mark on the company and drive the price lower.

For the shareholder, a 10b5-1 plan presents a structured selling opportunity. Planning for a pre-determined window (6-12 months, depending on the company's insider trading policy), the shareholder can determine how many shares, at what price, and when to sell their equity. Once that's done, the shareholder does not need to worry about keeping an eye on the price, nor whether they would be breaking any insider trading rules during a sale. Lastly, companies enact blackout windows where insiders are unable to transact. Typically, there are four trading windows per year, for about 6-8 weeks after a company releases earnings. A 10b5-1 plan allows for insiders to trade outside the pre-determined windows.

Putting the plan together

On paper, a 10b5-1 plan sounds really great – and there are many benefits to it. The difficulty for the shareholder lies in determining how to best set up the sales and how to best take emotion out of it. Typically, shareholders tend to believe that their company will continue to grow, and so will its post-IPO stock price. The reality is that it may not. Factors outside the company's control (like a global pandemic) can weigh on revenues, alter planned projects, and sink the share price. Analysts, who set price targets that often greatly influence investor perception of the stock, can have a less optimistic view than management, who are incentivized to paint an optimistic picture of their company. And, lastly, there could be a broad market sell-off that wipes out market caps of all companies, irrespective of the underlying fundamentals.

The challenge, thus, is how to determine the appropriate selling instructions given the unknowns in the capital markets. Here are a couple of examples -

• Monthly sales at market price. Each month, a pre-determined number of shares are sold at whatever the market price is – i.e., each month, sell 10,000 shares at market price. The shareholder knows that a fixed number of shares will be sold over the course of the plan, irrespective of what the market is doing. The risk here is that there could be shares sold in a large quantity at an unfavorable price.
• Sales at multiple limit prices. Taking a step further, the plan could have instructions to sell more shares at higher prices. This would look like this: each month sell 5,000 shares at $25, 1,000 at $26, 1,000 at $27, and 3,000 at $30. If the stock price is at $28 on the date of the planned sale, 7,000 shares will be sold at $28. The risk here is that if the price is below $25, no shares will be sold, which could throw off any planned uses for the proceeds.
• Reduce limit price on a specified date. Building off the point above, the shareholder could write in a rule that sales the price at a significantly lower price than anticipated in the off chance that the stock doesn't sell. In the example above, the plan could have a provision to sell any unsold equity at a later date at the market price. This heavily reduces concentration risk should any shares go unsold.

Final Considerations

One of the most important things about setting up a 10b5-1 plan is not to do it in a vacuum. In other words, the shareholder must consider their overall financial situation and how their company's equity fits into their financial plan. Here are a few things shareholders should think about when putting together their 10b5-1 plan:

• Be mindful of different grants and out of which grants the shares sold come from
• If exercising options, be aware of the differences between NQs and ISOs and which options to exercise and sell first.
• Know how the rest of your portfolio looks like. Frequently, there is an increased concentration risk due to the rest of the individual's portfolio holding similar investments. For example, a shareholder whose tech company is going public has a portfolio with an overweight to the Nasdaq. Should there be a tech correction, his whole portfolio would lose significant value.
• Be mindful of the tax situation and how other investments or financial decisions impact the tax bill. If planning to use some of the proceeds to pay for taxes, make sure that the plan sells enough to cover existing tax liabilities, as well as the liabilities incurred from the stock sale.
• Know the minimum amount of time before you can re-set your 10b5-1 plan. If you can re-set your plan in 6 months, it may be prudent to do so to account for changes at the company, changes in the stock price, and, most importantly, any changes in your personal financial goals.

Lastly, if there are any financial objectives you, the shareholder, is looking to achieve with your stock proceeds (large family trip, vacation home, etc.), make sure to account for it in the plan. Keep in mind the timing of your goals and time the sales accordingly.

If you have any questions or would like some guidance on setting up your own plan, please do not hesitate to shoot me a quick note.