10b5-1 Plans - Purpose and Design

Are you subject to Insider Trading Windows for your company stock options or restricted stock? Have you ever missed out selling at an attractive price because your window was closed? Or are you at a loss trying to figure out how to create an intelligently designed 10b5-1 trading plan? If so, this months' blog may answer many questions and help put you on the road to completing a plan...

What is a 10b5-1 Plan?

A 10b5-1 Plan is a document between an Insider (perhaps you) and a Broker which specifies under what circumstances company stock (whether options on stock or stock) can be sold. A properly established plan will allow you to sell regardless of whether or not your sale window is closed, subject to volume restrictions listed below. A plan is also an "affirmative defense" against insider trading litigation, as long as the plan is established when the insider is unaware of any "material non-public information."

Origin of the 10b5-1 Plan

Section 10b5 of the Securities Exchange Act of 1934 covers insider trading. In October of 2000, the SEC decided to amend and update the Act by specifying exactly how a corporate insider could trade their stock without violating the regulations (now 10b5-1.) The key was to establish a predetermined and systematic trading plan put in place at a time when the insider was unaware of any "material, non-public information."

Who Establishes the 10b5-1 Plan?

The Plan is between the Insider and the Broker. A Broker will need to have a dedicated 10b5-1 department to help you with plan documents, 144 filings, and a legal sign-off within the Brokerage. Obviously, the Broker manages the sale at the appropriate times. The Company files the Form 4, the S.E.C. filing related to insider trading and changes of ownership.

It is very advisable to discuss your intended plan with your company counsel and other appropriate parties. They may have important policies and/or guidelines for you to follow. Depending on your firms' policy, your Counsel may need to approve your plan and be a signatory to the plan. In other cases, they will not sign or "approve" it - it all depends on their position on this issue. Not signing or approving doesn't mean they won't allow it to go forward; just that the Company won't be part of the written agreement.

10b5-1 Plan Construction

Goals and Diversification. To start it all, think about near term goal funding. Are there some projects that, given a realistic near-term price realization, would be good to achieve? Next, think about diversification requirements (See Blog on Financial Planning). Forgetting hindsight for a moment, there is no investment that is so good to have that you should not diversify a portion of that value into something else. I saw people make grevious non-diversification decisions with tech stocks in the early 2000s, and commercial real estate in the late 2000s. Over-concentration is just more likely to end in tears. Finally, think about the overall % amount of exposure you want to have in your Company versus your other assets and build a 10b5-1 sale program from there.

Company Stock Price Considerations. Be realistic and not greedy about target stock prices. Of course everyone would like their share price to be extraordinarily high, but like the lottery it only happens to a few people. Their stories make it into the popular press, making it seem all the more likely to happen to you. Don't fall for this psychological trap. You can, however, retain some of your options or stock just in case it does go stratospheric - but I'll say it again: be realistic.

One way to think about potential stock prices is to find a price by the market capitalization of your Company (Stock Price X Shares Outstanding.) Does your target price put your market capitalization unreasonably high? Apple just hit $600 Billion. Are you close to that? If so, you might want to ratchet it down. Given a benign general market and good future events, where might your market cap go? As I mentioned before, when creating a plan and setting a price you must not have any "material, non-public information" in making your projections. Wait until you are clear, and then set the price(s).

Likely Stock Price Movement. Is it a biotech firm with a price that might move like a stomp-rocket (i.e. open far above the previous days' closing price due to a breakthrough or approval)? Is it a cyclical company that moves dependent on purchasing cycles, the business cycle, or seasonality? Or is it a steady grower with ever-increasing revenue and a likely stock price that reflects the growth? Of course it is impossible to predict the future and past performance is no indication of future performance, but it is the best you can do to put a plan in place that reflects reasonable probabilities of how your company stock price may move.

Plan Flexibility. There is a great deal of flexibility in constructing a Plan. That's both good and bad news. It allows you to customize your Plan to fit your personal circumstances, but at the same time you have factors that vary and change over time making it hard to create a finalized form out of so many moving parts. Note that the text below does not set out to describe ALL conceivable plans. There are many different ways to create a 10b5-1 sale plan. The following suggestions are ones I have found practical and more straightforward than other ideas.

Some Moving Variables:

Options vesting in greater amounts over time, typically every month.
New grants received, typically every year.

Other Factors to Consider:

Volume considerations. The amount you can sell is the GREATER of 1) 1% of the current outstanding shares of the company (This DOES NOT include unexercised warrants held by, say, 10%+ shareholders) or 2) The average weekly trading volume for the last four calendar weeks within a rolling three month time period.

How close the first sale prices are to the point where you last financed? If you are the CEO or CFO and are involved with the financing of the company (i.e. selling of shares to raise capital), putting price points too close to share price that you added new investors or encouraged others to own the stock should be avoided.

Prices sold may not be at your minimum, i.e. they may be higher, especially if the shares open higher for some reason. In other words, you may have a limit of $25 or better for 50,000 shares, but if the price opens at $35 for some reason, your proceeds will be greater. A happy circumstance, to be sure. Then let's say you vest more later, and have another sale order for 50,000 at $30. But the stock price dropped to $27 after its' run to $35. Next, it creeps up to $30 and you sell all 50,000 shares. Even though you planned and projected net amounts to sell 50k at $25 and 50k at $30, your experience was 50k at $35 and 50k at $30. The point is with 10b5-1 plans, or with any type of planning, sometimes things work out differently than projected. This can be a problem if you run up against Excise Taxes. At the very least it is something to be aware of. Regarding Excise Taxes - please consult with your tax professional for more information.

Quickness of Broker/Complexity of your Plan. Depending on how fast and organized your Broker is, getting the target price or better, especially in the case of a wildly fluctuating stock price, may not happen. If your Broker has to check all the volume considerations and/or accommodate any other restrictions you put into your plan, there is chance the sale might be missed. Keeping things as simple as possible is always a good plan practice.

Rule of thumb: In many ways designing a plan is similar to what we would do in coming up with a plan for option sales for those employees not subject to insider trading rules, only in a more formalized manner.

Valuations. When designing a plan look at sales proceeds from an after-tax perspective, not from a pure # of shares sold basis. For example, 10,000 shares sold at $50 with a cost basis of $30 and a tax rate of 40% ($8/share) will net you $12/share, or $120,000. 10,000 shares sold at $50 with a cost basis of $5/share, tax rate of 40% will net you $27/share, or $270,000. So simply ordering 10,000 shares sold at equal time increments regardless of cost basis may work, but if you have a plan to realize an targeted % of cash per sale it is unlikely to work and may not be compatible with your financial goals or circumstances.

Ways to deal with vesting and new grants in Plan design. The main problem with constantly greater amounts of vested shares over time, and new grants, is that it is hard to nail down exactly what will happen at some point in the future. How many will have vested by then? How many will have already sold by then? It's hard to say. The best way I've found to handle this is to calculate how many total shares will be vested by the end of a Plan term, and then allocate sale particulars as if it was the end of the Plan. Put language such as "sell all available shares" into all your instructions. It will be up to the Broker to confirm the amount available to sell (chances are he or she will need to contact your Stock Plan Administrator. This is an example of a complication that may delay execution.) Note that it is unlikely you will have information on future stock or option grants, so you may have to wait until your plan terminates before they can be factored in.

Actual Plan Document. The "Instructions for Programmed Plan of Transactions" (other firms may call it something else) is the meat of the Plan. It spells out which grants are involved, special considerations or restrictions, under what circumstances shares are to be sold, Disclosures, Representations, Term of the Agreement, and other instructions.

Although you can put both Buy and Sell orders into the plan, most Plans stick with Sales. Depending on your Company's Policies, you may be able to Buy shares if the window is closed, even if not in the Plan. It is the Sale that can be problematic for an Insider.

Some ways of selling:

Sell a Specific Quantity of Shares At the Market Price. It is a time-based methodology, for example Sell X number of shares be on the __st day of each week or month.
Sell At a Designated Share Price ("Limit Order"). Sells X number of shares at a limit price of ___ on Multiple Occasions. No subsequent limit order is to be entered until the preceding limit order has been executed; and not more than one limit order is to be entered per time period.
Sell At a Designated Share Price ("Limit Order"). Sells X number of shares at a limit price of ___ on a Single Occasion. This is probably the most commonly used option.

You need to specify a methodology for each group of options/shares. Of course you can break up grants into different methodologies, depending on your goals and needs.

Other items

Establishing the Plan. Your window must be open. Bear in mind that it could close very shortly after opening, given certain events, the acquisition of material, non-public information by you, or word from Counsel.

Cooling off period. Many companies will have a cooling-off period from the point the Broker's Counsel approves your plan to when your plan is live. This can range from 0 to 60 days. It will be particular to your Company. Consult with your Counsel for your company's policy.

Plan Term. This is the length of time the Plan is valid. Most range from one to two years. Plans can be canceled and re-established, but timing constraints and your lack of material, non-public information will apply.

Window Issues. You can sell shares outside of the Plan in an open window, but if your actions are not in the Plan you don't have 10b5-1 protection for those sales.

I hope there has been enough to help move you down the road to executing your own 10b5-1 Plan. Of course it is impossible to discuss every conceivable personal situation in a blog format. Here at Ascent Financial Advisors, we have a complete department that can facilitate a 10b5-1 Program for you on a customized basis. I can be reached at 303-284-8053 for further information or consultation.