10b5-1 Abuse (not a Christmas post)

Posted on December 26, 2021 by Florian Buschek

I have recently come across this fascinating study looking at insider sales, more specifically with10b5-1 plans. Gaming the system: Three “Red Flags” of Potential 10b5-1 Abuse. These trading plans can be used by executives to sell stock without committing insider trading (the crime). This makes sense because executives need to have a way to sell stock even though they are always in possession of insider information to some degree. Essentially a manager puts trade instructions for the future on a piece of paper and gives that to his broker. The plan is NOT public. Those can be single trade plans or multi trade plans. If you wonder why plans for a single trade might be necessary, well, read on.

Below is the breakdown of cooling-off periods after plan initiation. Do the shorter ones raise an eyebrow? Why would you file a plan to trade the same day? The longer ones make a lot of sense, no executive will know what the stock does in 6 months based on non public info in most cases.

And as the next chart shows those trades with cooling-off periods below 60 days look quite smart … who would have thought?

Coming back to the beginning about single trade plans. Do you see the problem? Good trades regardless of cooling-off period but especially good in the first 60 days.

Similar results with respect to earnings announcements. If you let executives sell ahead of earnings, guess what, earnings will be bad for the stock.

It could be that the sample was skewed to a bear market where every sale is good. But then the multi trade plans would be better and the January 2016 to May 2020 timeframe seems quite balanced as well.

So let’s face it, there is severe abuse going on especially for single trade plans and those with very short cooling-off periods. That really ought to be fixed. Luckily the SEC is looking into this. The full document is here.

Personally I think what is even more important though is disclosure. Namely making the plans public in full and disclosing trades quickly, optimally the next day. Executives should be able to sell and if they do because the stock is overvalued, well too bad for the shareholders who bought or held overvalued shares. But give me the signal from the insiders and make it all public quickly! I don’t even mind that much if they sell because they know something if only I can find out the next day. If I see a single trade sales plan with execution in days, that is all I need to know.

A common saying is “insiders sell for many reasons but only buy for one”. After the referenced piece of research things change a bit for me and I have to weigh insider sales more heavily.

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