Corporate executives and other “insiders” are forbidden from trading on material, non-public information.

When it comes to stock options, every public filing and formal announcement from a publicly traded firm comes with a blackout period for “insiders.” So, how can executives realize their earned gains without the threat of insider trading?

The U.S. Securities and Exchange Commission (“SEC”) defines illegal insider trading as: “The buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, non-public information about the security.”

In an effort to provide guidance, the SEC enacted Rule 10b5-1 in 2000 to create a defense against insider trading if the following criteria are followed:

• Enter into a Rule 10b5-1 plan in good faith.
• Adopt a trading plan that is not within a blackout period.
• Specify the timing, price and amount of your transactions.

In December 2022, the SEC enacted additional requirements for the 10b5-1 plans.

“Over the past two decades, though, we’ve heard from courts, commenters and members of Congress that insiders have sought to benefit from the rule’s liability protections while trading securities opportunistically on the basis of material nonpublic information,” said SEC Chair Gary Gensler. “I believe today’s amendments will help fill those potential gaps.”

The new requirements alter the steps that corporate executives and “insiders” must take to fall under the 10b5-1 safe harbor, such as:

• As part of the 10b5-1 plan, executives must certify that they are not aware of any material non-public information about the issuer or its securities and that the plan is adopted in good faith.
• The good faith requirements must be extended beyond adoption through the entire duration of the plan.
• Directors and officers may not trade during the later of 90 days after plan adoption or modification or two business days after filing a Form 10-Q or Form 10-K. Insiders who are not directors or officers may trade after a 30-day period following adoption or modification.
• The 10b5-1 defense is no longer applicable if the “insider” has more than one 10b5-1 plan for the same time period.
• Issuers must make new disclosures in their reports, including names and titles of “insiders,” dates of plan adoption or termination and number of shares that are planned to be bought or sold.

Accordingly, corporate executives and “insiders” must be familiar with the above changes to the 10b5-1 plans.

How Stock Options Overtook Cash

Two decades ago, corporate executives were compensated mainly with cash and bonuses, while stock options were footnotes. But the drive to link pay and performance has increased over the years, putting equity at the forefront. According to a 2021 Associated Press study, a little more than a quarter of compensation for the typical CEO at an S&P 500 company came from salary or bonuses. At the top, cash makes up 5% of total compensation.

The shift to stock options carries more responsibility for corporate executives. Insider trading, for example, can cost up to 20 years in prison. Back in 2020, the SEC employed 1,300 staff members in its Enforcement Division and budgeted more than half a billion dollars to investigate and prosecute illegal insider trading cases.

An attorney with expertise in complex financial instruments like stock options can help you regain peace of mind about your compensation package.

(Joseph M. Pastore III is chairman of Pastore, a law firm that helps corporate and financial services clients find creative solutions to complex legal challenges. He can be reached at 203-658-8455 or jpastore@pastore.net.)

Tags: Joseph Pastore, Rule 10b5-1, Stock