NASPP Washington, DC Virginia Maryland Chapter Meeting Rule 10b5-1 Trading Plans: Update and Best Practices CHRISTINE COGNETTI Morgan Stanley Vice President 10b5-1 Plan Management July 22, 2013
Table of Contents Section 1 Overview of Rule 10b5-1 and 10b5-1 Trading Plans Section 2 10b5-1 Market Data Section 3 Media and Regulatory Scrutiny Section 4 Key Issues to Consider: Best Practices Please note that any opinions expressed by the speakers are solely their own and does not necessarily reflect those of Morgan Stanley Wealth Management or its affiliates ( Morgan Stanley ). Morgan Stanley does not render legal or tax advice. 2
SEC Rule 10b5-1 Background Adopted in 2000. Result of an acknowledgement by the SEC that senior executives and other insiders are often in possession of material non-public information ( MNPI ), and accordingly, it is difficult to trade in their company stock without raising insider trading issues. Rule 10b5-1 provides an affirmative defense from insider trading liability, even when the insider is aware of MNPI on the date of the trade, if certain requirements are met. Typically, this is done through the use of a 10b5-1 Trading Plan ( 10b5-1 Plan ) between the insider and his or her broker. 4
What Is an Affirmative Defense? An Affirmative Defense is a litigation tool. It is not an insurance policy. Allows a defendant to raise a defense Does not guarantee that he or she will win on that defense Compare to an absolute defense or a safe harbor If you prove the requirements of an absolute defense or a safe harbor, you are proven not guilty Example Rule 144: If you follow the rule, you will not even be charged with selling unregistered securities the Rule defines an exemption, and that s the end of the inquiry But under Rule 10b5-1, even if you prove you have a trading plan: You can still be sued for insider trading. You will still have to litigate an insider trading case. You could still be found liable for insider trading. 5
Key Requirements of a 10b5-1 Plan No possession of MNPI at time of adoption of the 10b5-1 Plan. Must be entered into in good faith and not in a scheme to defraud. Insider can not exert any subsequent influence over execution of the 10b5-1 Plan. The 10b5-1 Plan must: Specify amounts, prices and dates, or Provide a selling formula, or Grant discretion to the broker (not common). Should be part of Issuer s Insider Trading Policy. 6
Uses of a 10b5-1 Plan Stock Sales Facilitate the execution of a selling program free from concern about blackout periods and with an affirmative defense against allegations of insider trading Stock Option Exercise and Sale Allow for the exercise of stock options and the immediate sale of the shares received in connection with such exercise Restricted Stock Awards/Units To cover the tax liability due upon vesting of a time or performance based Restricted Stock Awards or Unit Coordinate Corporate 10b5-1 Program Selling programs established at the corporate level to facilitate the organized disposition of shares held by an entire senior management team. Benefits include potentially improved execution and ease of administration 7
Insider Trading Policy General Generally, the goal of an Insider Trading Policy is to prevent employees from engaging in transactions in a company s securities when in possession of material non-public information. Typically accomplishes this goal through: Establishing trading windows and blackout periods. Requiring pre-approval of trading activity. Prohibiting tipping of company information. Prohibiting derivative transactions in the company s securities. Communicate policy to personnel and provide training / reminders periodically. Applies to all company employees, offices and directors; also consultants and advisors in many cases. Preclearance of trades for Section 16 Insiders. Strongly recommended due to reporting requirements 8
Insider Trading Policy Trading Windows and Blackout Periods Purpose is to restrict trading during periods when risk of possessing or having access to material, non-public information is greater. Trading window is a time when employees are generally allowed to trade in the company s securities. Typically opens one or two trading days after the quarterly earnings announcement and closes before the last month of the quarter. A trading blackout period is a time when the company prohibits employees from engaging in a transaction in the company s securities (even if during an open trading window). A company may blackout a certain group of employees or all employees. General Counsel and CFO typically have input into which employees will be blacked out and how long it will last. All 10b5-1 Trading Plans should be approved by an Issuer s legal department. 9
Benefits of a 10b5-1 Plan Affirmative defense against potential claims of insider trading Access to public markets without regard to corporate blackout periods Ability to dispose of stock on a predictable and consistent basis Potential to mitigate signaling issues generally associated with sales by insiders Convenience of putting diversification on auto-pilot Discipline during volatile market fluctuations Customization of the selling plan to reflect the particular monetization needs of each individual seller Potential to facilitate the organized disposition of shares by multiple company insiders Reduce the risk associated with a concentrated equity position through diversification 10
A Common Dilemma and Potential Solution Illustrative Timeline Typical Corporate Blackout / Window Trading Program 1/1 Earnings Release 4/1 Earnings Release 7/1 Earnings Release 10/1 Earnings Release Blackout Blackout Blackout Blackout Trading Permitted During Window Periods Certain Events May Cause Trading Windows to Close 1/1 Earnings Release 4/1 Earnings Release 7/1 Earnings Release 10/1 Earnings Release Litigation Settlement Negotiations Internal Receipt of Clinical Trial Results Acquisition Negotiations Blackout Trading Prohibited during Window Periods when Key Employees or Insiders are in Possession of Material Non-public Information Trading Pursuant to a PDP 1/1 Earnings Release 4/1 Earnings Release 7/1 Earnings Release 10/1 Earnings Release PDP Implemented Litigation Settlement Negotiations Internal Receipt of Clinical Trial Results Acquisition Negotiations Trading Permitted Pursuant to Terms of Plan 11
10b5-1 Growth The Washington Service Companies With 10b5-1 Plans (as of December 31, 2012) Year Total Public Companies No. of Companies (1) with 10b5-Filings 10b5-1 Penetration (%) 2012 5,604 1,310 23 2011 6,022 1,258 21 2010 6,310 1,180 19 2009 6,457 998 15 2008 7,142 1,061 15 2007 7,597 1,343 18 2006 7,462 1,253 17 2005 7,579 1,110 15 2004 7,651 878 11 2003 (2) 7,221 468 6 2002 (2) 6,605 6 0 Source: The Washington Service tracks insider trade information filed with the Securities and Exchange Commission. The above numbers are compiled by the Washington Service from Form 4 filings in the period listed. Information contained herein was obtained from sources believed reliable but the accuracy and completeness thereof cannot be guaranteed. Information contained herein is subject to change. December 31, 2012 Notes: Reprinted with the permission of Washington Service. (301)-913-5100 www.washingtonservice.com. (1) Reflects a distinct count of companies for the year. (2) Based on companies in the S&P 500 Index as of December 31 st of each reporting year. 13
S&P 500 Companies The Washington Service Companies With 10b5-1 Plans in the S&P 500 Index (2) Year Total Companies No. of Companies (1) with 10b5-Filings 10b5-1 Penetration (%) 2012 499 259 52 2011 497 243 49 2010 491 222 45 2009 489 198 40 2008 486 183 38 2007 483 222 46 2006 475 188 40 2005 467 172 37 2004 459 125 27 Source: The Washington Service tracks insider trade information filed with the Securities and Exchange Commission. The above numbers are compiled by the Washington Service from Form 4 filings in the period listed. Information contained herein was obtained from sources believed reliable but the accuracy and completeness thereof cannot be guaranteed. Information contained herein is subject to change. December 31, 2012 Notes: Reprinted with the permission of Washington Service. (301)-913-5100 www.washingtonservice.com. (1) Reflects a distinct count of companies for the year. (2) Based on companies in the S&P 500 Index as of December 31 st of each reporting year. 14
Market Size Gross Proceeds Shares Sold Broker Rank Value ($bn) Rank (%) Rank Shares (mm) Rank (%) Morgan Stanley (1) 1 36.8 25.56 1 1,000.8 17.75 Bank of America 2 25.9 18.01 2 823.1 14.60 JPMorgan Chase & Co. 3 12.1 8.40 4 465.7 8.26 UBS AG 4 9.9 6.93 6 316.7 5.62 Goldman Sachs Group Inc. 5 9.6 6.71 5 369.5 6.55 Fidelity Investments 6 7.8 5.47 9 144.1 2.56 Allen & Co. 7 5.9 4.11 8 220.5 3.91 Credit Suisse Group 8 5.8 4.07 7 235.7 4.18 Charles Schwab Corp. 9 4.3 3.03 11 118.1 2.09 Deutsche Bank AG 10 3.5 2.47 10 138.4 2.45 Top 10 Total 122.1 84.75 3,832.6 67.96 Total 144.1 100 5,639.4 100.00 Notes: Reprinted with the permission of Washington Service. (301)-913-5100 www.washingtonservice.com. (1) Source: The Washington Service tracks insider trade information filed with the Securities and Exchange Commission. The above data is compiled by the Washington Service from Form 144 filings in the period from February 01, 2005 to December 31, 2012. Data from the period February 01, 2005 to December 31, 2009 reflects the formerly separate PDP businesses of the Global Wealth Management Group of Morgan Stanley & Co. LLC and the Smith Barney division of Citigroup Global Markets Inc. that now form Morgan Stanley Smith Barney LLC. The above data also includes transactions from Morgan Stanley & Co. LLC. Morgan Stanley Wealth Management is the trade name of Morgan Stanley Smith Barney LLC. Information contained herein was obtained from sources believed reliable but the accuracy and completeness thereof cannot be guaranteed. Information contained herein is subject to change. 15
Different Populations, Similar Results Section 16 Non-Insider Length of Plan (Days) 383 351 Shares in Plan 164K 46K Executed in Plan (%) 65K (40%) 21K (46%) Avg. Trade Size (% Options) 2012 12,937 (52%) 3,788 (62%) 2011 12,686 (57%) 4,920 (61%) 2010 11,270 (43%) 4,743 (63%) Average Commission $0.0549 / share (1) Notes: Based On a Sample of 7,093 Plans 37,114 Trade Executions (1) Commission trend has been relatively flat and consistent between S16 and Non-Insiders going back as far as 2008. 16
The Wall Street Journal Series 10b5-1 Plans not new to scrutiny; an academic study published in 2006 found that, on average, trades under 10b5-1 Plans outperformed the market by 6% after six months. The Wall Street Journal published a series of ten articles from November 2012 through April 2013 highlighting that: Statistical analysis of trading by more than 20,000 executives found that approximately 1,400 executives who traded their stock in the week before news was announced averaged 10% gains (or avoided losses of 10%) within a week of their trades, suggesting: Insiders may have adopted 10b5-1 Plans at a time when they were in possession of MNPI. Insiders may be misusing plans by terminating plans when a sale or purchase would be unfavorable. Trades outside of an established 10b5-1 Plan often raise particular concerns. Inquiries have expanded to Board Members liquidating large blocks of company stock held by their investment funds. 18
Fallout from The Wall Street Journal Series Resulted in private plaintiff s bar announcing investigations into several of the executives that were mentioned in the articles. Investigations have been launched by the SEC, U.S. Attorney General s Office, and the FBI. Prompted comments from Sen. Charles Grassley, ranking Republican of the Senate Judiciary Committee, prodding the SEC to revisit Rule 10b5-1. The Council of Institutional Investors ( CII ) issued a public letter to the SEC that argued that a number of changes should be made to Rule 10b5-1 including, requiring further disclosure, requiring a mandatory waiting period between adoption of a 10b5-1 Plan and first trade, and implementing limitations or restrictions on amendments and terminations of established plans. 19
Company Obligations in 10b5-1 Plans Company involvement: Currently there is no requirement for a company to approve 10b5-1 Plans or have policies covering 10b5-1 Plans. Several benefits from company involvement: Provides independent verification that the insider did not have MNPI at the time the insider adopted the plan and that the plan is in compliance with the company s insider trading policies. Provides a record in the event there is an inquiry into trades covered by the 10b5-1 Plan. Current Practice: Nearly all companies are involved with their insider s 10b5-1 Plan to some extent, as many brokers will require the company to acknowledge or represent certain facts about the 10b5-1 Plan. Company policies, however, may vary greatly and some companies may not address 10b5-1 Plans in their insider trading policies. Best Practice: Companies should create or amend existing policies for 10b5-1 Plans for the protection of the insider and the company, including a requirement that the plan is cleared through their legal department. Note: The best practice suggestions are based on review of public opinions and statements by industry participants and does not necessarily reflect those of Morgan Stanley. 21
Disclosure of 10b5-1 Plans Rule 10b5-1 does not require either the company or the insider to publicly disclose the adoption of a 10b5-1 Plan. Current Practice: Companies generally do not disclose, although many companies disclose the adoption of a 10b5-1 Plan by the most senior officer(s) through a Form 8-K. Upon the first trade, insiders often disclose the existence of a 10b5-1 Plan on the Form 4 filing and there is required disclosure on Form 144, when applicable, although the disclosure on each form is limited. Best Practice: In the near-term, do not see company disclosure at a 10b5-1 Plan s adoption as a developing market practice. Although, the SEC had previously considered requiring insider disclosure upon adoption of a 10b5-1 Plan and company and insider disclosure may be a future SEC requirement: Would support and could be used as evidence of the insider s good faith. Promotes transparency, may also be advantageous for investor relations to explain why the trades are taking place. Note: The best practice suggestions are based on review of public opinions and statements by industry participants and does not necessarily reflect those of Morgan Stanley. 22
The Waiting Period Rule 10b5-1 does not impose any minimum waiting period between the date that the insider adopts the 10b5-1 Plan and the date of the first trade. Waiting period supports the position that any MNPI the insider may have had at the time he or she adopted the 10b5-1 Plan has either become stale or been disclosed. Current Practice: Some waiting period, as little as a few days (although rare) to three months, could be dependent on the company policy. Best Practice: CII suggested three months, more realistic would be a couple of weeks at a minimum, but could depend on other factors, including potential possession of MNPI, length of plan or execution details (e.g., a plan established to execute market orders during a two-year period will not need as long a waiting period as a plan that will likely be completed quickly due to lower priced limit orders or a shorter term 10b5-1 Plan). Note: The best practice suggestions are based on review of public opinions and statements by industry participants and does not necessarily reflect those of Morgan Stanley. 23
Amending or Terminating an Established 105b-1 Plan Likely to cause suspicion and increase risk that the affirmative defense will not be available, especially if the amendment or termination works out favorably to the insider. Does not eliminate the affirmative defense, as long as the amendment or termination was made at a time when the insider was not in possession of MNPI and the insider was acting in good faith. SEC s Compliance and Disclosure Interpretations note that the act of terminating does not automatically result in liability under Section 10(b) and Rule 10b-5, but calls into question good faith. Current Practice: Permitted although the company or the broker may inquire about the details. Best Practice: Companies should avoid amendments or terminations to the extent possible. Company s policies may, formally or informally, address amendment or termination, including appropriate waiting periods for entering into a new plan, imposing limits on the frequency of amendments and other restrictions (e.g., only during open window periods). Note: The best practice suggestions are based on review of public opinions and statements by industry participants and does not necessarily reflect those of Morgan Stanley. 24
Trades Outside of a 10b5-1 Plan Rule 10b5-1 does not prohibit the insider from trading outside of an established 10b5-1 Plan. Clearly not protected by Rule 10b5-1. Current Practice: Permitted by some companies, several of the problematic trades highlighted in the WSJ articles and under investigation occurred outside their plans. Best Practice: Do not permit unless completely defensible in hindsight. Note: The best practice suggestions are based on review of public opinions and statements by industry participants and does not necessarily reflect those of Morgan Stanley. 25
Best Practice: Summary Companies should review their insider trading policies and ensure they address 10b5-1 Plans. Policies should include: A formal documented process when an insider adopts a plan, including approval by legal department. Appropriate waiting period. Disclosure considerations. Guidelines for amending or terminating a plan, and Trading outside a plan. Note: The best practice suggestions are based on review of public opinions and statements by industry participants and does not necessarily reflect those of Morgan Stanley. 26
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