Defining the Fine Line Mitigating Risk with 10b5-1 Plans Since the adoption of Rule 10b5-1 in 2000, the number of plans has grown steadily. Insiders at 51% of S&P 500 companies used 10b5-1 plans in 2015 as compared to 26% 12 years ago. 1 Given their prevalence in the marketplace, as well as the growing scrutiny of practices relating to insider trading, companies have increasingly focused on managing the use of 10b5-1 plans. Morgan Stanley and Shearman & Sterling LLP recently surveyed the public company members of the Society of Corporate Secretaries & Governance Professionals on their practices relating to 10b5-1 plans and insider trading policies. The survey results provide companies with useful benchmarking data as they design policies and procedures in an attempt to strike a balance between protecting the company and providing reasonable liquidity to insiders. What is a Rule 10b5-1 Plan? It is commonly thought of as a pre-arranged sales plan, if the plan was adopted at a time when the insider did not possess material non-public information (MNPI). These plans allow an insider to have pre-determined trades in his or her company s stock executed regardless of whether the insider had material non-public information (MNPI) about the company at the time of these trades.
The following is a discussion between Stephen Giove, a partner at the law firm of Shearman & Sterling LLP who represents public companies on a wide variety of issues (including 10b5-1 plan matters), and Christine Cognetti McCasland, an Executive Director at Morgan Stanley Wealth Management, the market leader 2 in 10b5-1 plan trading. The Role of the Company and the Board is Increasing Steve: 10b5-1 plan practices have evolved over the past 15 years. In the early days, they were looked at curiously like any new invention. However, once 10b5-1 plans began to be used by insiders at more established companies, usage started to increase significantly. About halfway through this period, 10b5-1 plans came under scrutiny, which led to a more concentrated focus on the specifics of the practices and policies surrounding these plans. That s where we are today: 10b5-1 plans are widely accepted and used, but companies and boards are increasing their management and oversight of these plans. Our survey found that 98% of companies reviewed and approved plans (or reviewed a plan template) entered into by their insiders. Additionally, 67% of boards approved their companies insider trading policies, which often include restrictions on the terms of 10b5-1 plans. Some boards were even more involved, with a small percentage approving a 10b5-1 template, trading plan restrictions, and individual plans, and/or receiving reports about 10b5-1 plan usage. Not surprisingly, 83% of companies surveyed did not mandate the use of 10b5-1 plans, although in our experience many companies strongly encourage insiders to use these plans. Interestingly though, 17% did mandate their use, up from zero several years ago. What we have seen is that once 10b5-1 plan practices become standardized at a company, adoption of plans by insiders often quickly gathers momentum. Takeaway Companies and boards level of involvement in designing, managing, and overseeing 10b5-1 plan practices is increasing, including the adoption of specific 10b5-1 plan policies. Company Approval of Plan To what extent have companies reviewed and approved 10b5-1 plans entered into by their insiders? (n=235) Board Approval of Plan Which of the following actions have companies boards taken with respect to 10b5-1 plans? (n=92) 98% 85% 13% Yes Yes, but only the template is reviewed Approved company insider trading policy Approved 10b5-1 trading restrictions Approved a company form of 10b5-1 plan 2% No Approved each insider s 10b5-1 plan Received a report of 10b5-1 plan usage Most companies (98%) report that they review and approve their insiders 10b5-1 plans to some degree. None of the above 0% 20% 40% 60% 2
Selecting a Brokerage Firm Christine: We ve seen a trend where companies are choosing a single, or captive, brokerage firm to administer plans for insiders. A captive brokerage firm helps a company streamline its internal processes. For example, a company can develop one plan template, one set of procedures, and have one source to contact for settlements and other matters. From an execution standpoint, it s probably also best to retain one brokerage firm that can centralize the transactions for all of a company s insiders on one plan management platform. Morgan Stanley is one of the few brokerage firms that employs this centralized structure it has a 14-person team exclusively dedicated to 10b5-1 plan management and trading. This separate desk structure not only guards against the perception of undue influence, but also may allow for the mitigation of the volume pressure on a company s stock price. Selection of a Brokerage Firm Have companies required their insiders to use brokerage firms pre-selected by the company? (n=217) 40% Yes 60% No, employees can use any brokerage firm 36% Yes, employees are required to use the brokerage firm pre-selected by the company 4% Yes, but employees are required to choose among multiple brokerage firms pre-selected by the company Morgan Stanley is the Market Leader in 10b5-1 Trading Plans 2 Rule 144 10b5-1 broker rankings 02/01/2005 12/31/2015 ($Bn) 60,000 Companies with a market cap of less than $10 billion are more likely than those with a higher market cap to allow employees to use their own brokerage firm (72% vs. 45%). 50,000 40,000 30,000 20,000 10,000 0 24.3% Morgan Stanley 16.1% Bank of America 8.3% 7.5% 7.3% J P Morgan Chase & Co. UBS AG Fidelity Investments Takeaway The broker selection process matters. Brokerage firms who are knowledgeable about the company s procedures and policies can significantly help it achieve its objectives, manage its population, and coordinate trading activity, while at the same time give insiders reasonable access to liquidity. 3
10 Key Questions of Plan Design These questions of design are, in many cases, interrelated and reflect the different practices, policies, and culture of each company. 1. What is an optimum plan length? Christine: A minimum plan length of at least several months can reduce the risk that insiders will use 10b5-1 plans for short-term trading purposes and, therefore, diminish the perception that a plan was not adopted in good faith. With a minimum plan length, insiders must evaluate their financial situation in terms of liquidity and diversification and commit to a selling strategy for a set period of time. On the other hand, if plans are set with too long a period, insiders may feel the need to amend or terminate them due to a change in circumstances. While our survey found the majority of companies did not impose either a maximum or a minimum term for 10b5-1 plans, those that did tended to impose a minimum plan length of six months and a maximum plan length of between one to two years. Takeaway A plan term that is too long can be problematic. A plan term that is too short can also be problematic. Length of Plans What maximum and minimum terms have companies imposed on plans entered into by their insiders? Minimum Plan Term (n=226) % 70 60 50 2. When is trading under a plan permitted? Steve: Ninety percent of companies surveyed permitted all 10b5-1 eligible employees to sell during both blackout and window periods pursuant to a plan. Nine percent of the companies surveyed provided less flexibility, as they did not permit senior executives to sell during blackout periods. Takeaway Issuers who allow their insiders to enter into a 10b5-1 plan typically are comfortable having their plans execute trades during blackout periods. Maximum Plan Term (n=225) % 70 60 50 3. How should trading plan instructions be designed? Christine: An insider should consider a number of factors when designing a plan, including the insider s financial goals, as well as the insider s risk tolerance for achieving such goals. That is, to the extent possible, the plan should reflect the insider s views as to parameters under which sales will be made. If an insider s trades are executed on a consistent basis, with similar timing each month or quarter, the plan should not only support an affirmative defense, but can also make an insider s sales start to look non-newsworthy to investors and the media. Steve: A key consideration is to design trading plan instructions that do not subsequently need an insider s input. That is, the trading instructions should be clear and unambiguous and should not be able to be influenced by events outside the plan. Insiders should also consider the potential consequences of their trading instructions. Think about the ripples that are created when a rock is thrown into a pond. For example, if a Form 4 filing insider wants to have a sale each week, the insider should consider that investors Bloomberg screens will be flashing 52 times a year. 40 30 20 10 0 None 6 Months 1 Year Other 40 30 20 10 0 None 1 Year+ 2 Year Other Takeaway Plans should remain consistent as a wealth diversification strategy and not as a one-time opportunistic trading tool. Set it and forget it. 4
4. How long are cooling-off periods? Christine: Even though the rule doesn t require a cooling-off period, the affirmative defense the insider is expecting may be called into question if there is not a waiting period between the signing of the plan and the first possible trade date under it. A 30-day cooling-off period has become very common our survey found that 41% of companies had a mandatory 30-day waiting period. Some companies even require that their insiders wait an entire window period before trading. Plan optics may warrant an extended coolingoff period. Cooling-Off Period One of the rationales for a cooling-off period is to provide a buffer period to help mitigate risk associated with trades under these plans, providing time for any MNPI to either become stale or to be disclosed. Cooling-Off Period What is the typical length of the mandatory cooling-off (or waiting) period for plans entered into by a company s insiders? (n=227) None 16% <30 days 12% 30 days 41% 45 days 2% Takeaway Issuers policies and practices continue to evolve towards longer cooling-off periods. 60 days 6% Opening of window in next quarter 11% Other 11% Companies with 75,000 or more employees and those that have a market cap over $50 billion are more likely to have a mandatory cooling-off period of 60 days. 5. Have companies permitted early termination of plans? Steve: It s well established that a plan can be terminated at any time and there is a Securities and Exchange Commission (SEC) interpretation that confirms this view. Our survey indicated that 55% of companies allowed insiders to terminate early. It s notable that 61% of those that allowed early termination required insiders to terminate only in an open window. This is a more conservative approach. Not surprisingly, 75% of the companies surveyed imposed a waiting period when adopting a new plan to replace the terminated plan. One way insiders can approach this decision is to think that they have one bite of the apple. That is, they can terminate a plan, but whether and when they can put a new plan in place and trade in that plan will depend on the facts and circumstances of the situation. Often, an insider will have to wait months before being able to enter into a new plan. In terms of trading outside of a plan after termination, insiders are encouraged to look at the totality of the circumstances and how they could be viewed in hindsight. That is, have there been prior trades under the plan; how soon after termination will a new plan be entered into; have sales been made outside of the plan; when could sales be made under the new plan; etc. Depending on the facts, there could be significant pressure as to whether the plan was entered into in good faith and whether the trades under the plan are protected. Takeaway It s very important that insiders understand the dynamics relating to early termination. This is one of the topics typically covered by Morgan Stanley in the onboarding process. Companies should carefully consider their practices in this area, as a discussion of termination goes beyond whether insiders can terminate to what termination means for the availability of the affirmative defense that the plan provides. Early Termination of Plan Have companies permitted their insiders to terminate their 10b5-1 plans, and if so, what restrictions have they imposed on such terminations? 55% Fifty-five percent of companies have permitted employees to terminate 10b5-1 plans (n=221). 5
6. Are plan amendments permitted? Christine: Generally, best practice is to set a plan and see it through to expiration without modifying or terminating it. An insider should try and take everything into consideration when setting up their 10b5-1 plan so they aren t forced to consider a modification or termination later. This would include considering financial goals and liquidity needs and then thinking through the different possibilities and outcomes. Forty percent of companies surveyed permitted insiders to amend their 10b5-1 plans. But 52% of these companies imposed restrictions on their frequency. Most companies treat plan amendments as if they were terminations, in that the original trade schedule cancels immediately upon the amendment being signed; others require the original trading schedule continue to be executed during the cooling-off period after the amendment is signed. Takeaway Considering prior to the adoption of the plan, all the possibilities that may occur over the term of a 10b5-1 plan may minimize the need to amend that plan later. Think ahead. Plan Amendments Have companies permitted insiders to amend their 10b5-1 plans and, if so, what restrictions have they imposed on such amendments and what has happened to the insider s orginal plan? 40% Permit employees to amend 10b5-1 plans (n=221) 69% 31% (n=81) It became null and void immediately from the amendment adoption date (forcing the participant to leave the market) until the first possible sale date under the amended plan It remained in effect and sales continued to be executed under the original plan until the amendment start date (not the adoption date) Over half (52%) imposed restrictions on the frequency of amendments (e.g., waiting period). Most common waiting periods were 30 days (35%) and until the opening of the next window period (28%) (n=87). 7. Should a plan have suspension provisions? Steve: This topic can be confusing. The word suspension is used to refer to two different things. The first is a decision by an insider after a plan is adopted to stop trades under the plan for a period of time. This is properly viewed as an amendment of a plan (if additional trades can still occur under the plan after the suspension period) or as a termination of a plan (if no additional trades can occur after the suspension period). The second thing that suspension may refer to is a contractual provision that would automatically suspend trading under a plan upon the occurrence of certain events. Usually these events are corporate events such as a follow-on offering or an acquisition. Takeaway If insiders incorporate suspension events into their plan, these should be clearly defined and not be within the sole control of the insider. Think through all the outcomes to understand the downstream consequences of alternative scenarios, including the impact on the trading schedule in a plan if a suspension event were to occur. 8. Can insiders have multiple, overlapping plans? Steve: Rule 10b5-1 does not prohibit an insider from having multiple, overlapping plans in place at the same time. The question is should multiple, overlapping plans be allowed in certain circumstances? If the plans involve different securities and only overlap as to time, the risk might be acceptable. However, if they overlap in terms of securities (meaning multiple plans are covering the same securities) the risk for the insider may not be acceptable. It could be argued that these plans, when viewed in aggregate, were not adopted in good faith. If someone has a plan and then gets a new option grant or needs additional liquidity, it might make more sense to adopt an overlapping 10b5-1 plan instead of modifying their current one. Care should be taken if multiple plans are permitted, to make sure one plan doesn t inadvertently impact the other plan. Multiple, Overlapping Plans Do companies permit their insiders to enter into multiple, overlapping plans? (n=211) 82% 18% YES 82% NO Multiple, overlapping plans were somewhat more prevalent in larger companies. Takeaway Multiple plans may be acceptable if such plans are not related to each other and do not impact each other. 6
9. Can an insider engage in trades outside a plan? Christine: Fifty-six percent of the companies surveyed allowed insiders with an existing 10b5-1 plan to sell outside their plan. While Rule 10b5-1 does not prohibit trades outside of the plan, these trades will not benefit from the plan s affirmative defense and may have a significant amount of risk associated with them. Trades made outside of a plan may even put trades made under a plan at greater risk and give rise to an argument that the plan was not entered into in good faith. For example, if sales outside of the plan are contractually (or via Rule 144 s volume limits) depleting the number of shares that could be sold under the plan, then such trades could be viewed as amendments to the plan at a time when the insider had MNPI. Takeaway Even if trades outside of a plan are acceptable from a legal perspective, there may be optical reasons to refrain from making sales outside of a plan. Disclosure of a Plan Have companies disclosed the adoption of 10b5-1 plans by insiders, and if so, for which insiders and where were these disclosures made? Insiders (n=66) CEO 77% Chairman 47% CFO 41% Other Executives 48% Other Board Members 32% 10. Are companies or insiders required to disclose plans? Steve: Rule 10b5-1 does not require the company or the insider to publicly disclose the adoption of a 10b5-1 plan. Of course, affiliates need to make Form 144 filings and executive officers and directors need to make Form 4 filings. Still, about one-third of companies surveyed (33%) have publicly disclosed 10b5-1 plans. Most commonly, this disclosure relates to the CEO or other important insiders or directors of the company and can be driven by investor relations considerations. When making this disclosure, companies typically consider the likelihood Disclosure Method (n=58) 8-K 55% Press Release 12% Company Website Posting 10% Earnings Conference Call 9% Other 31% that subsequent events such as the termination, amendment, or expiration of a plan may require the original disclosure to be updated. If disclosure of a plan is made, rarely are the specifics of the trading instructions or the plan itself disclosed. Takeaway Disclosure by the company is generally not required, but thoughtful consideration should be given to the circumstances under which disclosures are made, as well as the information being disclosed. The Morgan Stanley / Shearman & Sterling LLP survey of members of the Society of Corporate Secretaries and Governance Professionals revealed interesting trends in the management of 10b5-1 trading plans. If you would like to review your company s plan practices and insider trading policies, please contact Christine Cognetti McCasland of Morgan Stanley at 1-646-536-0452 or Steve Giove of Shearman & Sterling LLP at 212-848-7325. 7
1 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 periods 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. January 7, 2016. Reprinted with the permission of The Washington Service. (301) 913-5100. http://www.washingtonservice.com. 1 Based on companies in the S&P 500 Index as of December 31st of each reporting year. 2 Number of S&P 500 companies with one or more Form 4s filed during the reporting year. 3 Number of S&P 500 companies with one or more 10b5-1 trades filed during the reporting year. 2 Based on data compiled by the Washington Service from Form 144 filings in the period from 2/1/2005 to 12/31/2015. The Washington Service tracks insider trade information filed with the Securities & Exchange Commission. 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. Morgan Stanley Smith Barney LLC ( Morgan Stanley ), its affiliates and Morgan Stanley Financial Advisors or Private Wealth Advisors do not provide tax or legal advice. Clients should consult their tax advisor for matters involving taxation and tax planning and their attorney for matters involving trust and estate planning and other legal matters. These materials are solely informational based upon publicly available information believed to be reliable, and may change without notice. Morgan Stanley shall not in any way be liable for claims relating to them, and makes no express or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in, or omissions from them. Morgan Stanley and Sherman & Sterling LLP has no obligation to tell you when opinions or information in this material change. Individuals executing a 10b5-1 trading plan should keep the following important considerations in mind: (1) 10b5-1 trading plans should be approved by the compliance officer or general counsel of the individual s company. (2) A 10b5-1 trading plan may require a cessation of trading activities at times when lockups may be necessary to the company (i.e., secondary offerings, pooling transactions, etc.). (3) A 10b5-1 trading plan does not generally alter the restricted stock or other regulatory requirements (e.g., Rule 144, Section 16, Section 13) that may otherwise be applicable. (4) 10b5-1 trading plans that are modified or terminated early may weaken or cause the individual to lose the benefit of the affirmative defense. (5) Public disclosure of 10b5-1 trading plans (e.g., via press release) may be appropriate for some individuals. (6) Most companies will permit 10b5-1 trading plans to be entered into only during open window periods. (7) Morgan Stanley, as well as some issuers, imposes a mandatory waiting period between the execution of a 10b5-1 trading plan and the first sale pursuant to the plan. 2016 Morgan Stanley Smith Barney LLC. Member SIPC. CRC1477650 05/16 CS 8539961 05/16