What is a Rule 10b5-1 Trading Plan?

Rule 10b5-1 is a rule established by the US Securities and Exchange Commission (SEC) that enables corporate ‘insiders’ to make pre-arranged trades while following insider trading laws. Insiders in the US consist of officers and directors of a company as well as any shareholders that own 10% or more of the company's voting shares.

In this guide, we look at the basics of Rule 10b5-1 trading plans. We also explain what they mean for those integrating insider transaction data into their investment research.

Rule 10b5-1 Trading Plan: Definition

A Rule 10b5-1 trading plan is a pre-arranged plan set up by a corporate insider to sell (or buy) company stock.

Rule 10b5-1 trading plans specify the number of shares to be sold (or bought) as well as price and date parameters, and/or have a formula or algorithm that triggers the trade and the number of shares involved.

Insiders have significant flexibility when it comes to establishing these trading plans. For example, an insider could set up a plan to sell a certain number of shares at the start of every month. Or, they could establish a plan to sell a certain number of shares when the company’s share price reaches a specific level.

Why Insiders Use Rule 10b5-1 Trading Plans

Rule 10b5-1 trading plans are most commonly used by insiders to sell stock at regular intervals while ensuring that they are compliant with insider trading laws. By setting up trading plans in advance, insiders can avoid accusations of illegal insider trading.

When established properly, these plans provide corporate insiders with a way to diversify their interest in company stock while managing the market’s reaction to the insider selling activity.

An example of a corporate insider who uses a Rule 10b5-1 trading plan to sell stock is Facebook CEO Mark Zuckerberg. Zuckerberg regularly sells Facebook stock. However, his sales are almost always pre-arranged through a trading plan.

How Are 10b5-1 Trading Plans Established?

To establish a 10b5-1 trading plan an insider must:

Enter into the plan before becoming aware of material non-public information (MNPI)
Specify the amounts, prices and dates for the securities to be sold (or purchased) or detail a written formula for determining such parameters
Delegate all trading discretion and decisions to a person who does not possess MNPI

All purchases and sales under the plan must then be made in accordance with the terms of the plan.

Why It’s Important To Identify 10b5-1 Trades When Analyzing Insider Transactions

If an investor is using insider transaction data as part of their investment research process, it’s vital that they identify automated 10b5-1 trades and separate these from standard trades.

The reason this is important is that automated trades tend to have much less informational value than standard open-market trades. Often, automated trades are pre-arranged years in advance.

A good example here is some insider selling from Mark Zuckerberg in 2018. In the second quarter of 2018, Zuckerberg sold 13 million Facebook shares – double what he sold in the first quarter of 2018 and approximately 10 times the number he sold in the fourth quarter of 2017. Some investors were concerned about this selling activity due to the fact that it was around the time of the Cambridge Analytica data-mining scandal.

However, a look at Zuckerberg’s SEC Form 4 filings revealed that the trades were all pre-arranged. In September 2017, Facebook had announced that Zuckerberg would sell between 35 million and 75 million shares in the following 18 months, through a 10b5-1 selling plan. Zuckerberg’s trading plan most likely had different selling trigger prices meaning the higher Facebook’s share price rose, the more shares were sold.

How Can Investors Know If An Insider Is Using A 10b5-1 Trading Plan?

Rule 10b5-1 trading plans don’t tend to be made public. This means that investors often only find out that insiders have sold stock via a trading plan after the sale.

The easiest way to identify if a transaction has been made via a trading plan is to examine the SEC Form 4 filing.

If the sale has been made through a trading plan, it will mention this in a footnote.

In the case of Mark Zuckerberg’s sales below, footnote 2 states: ‘The sales reported were effected by CZI pursuant to its Rule 10b5-1 trading plan.’

Rule 10b5-1 Trading Plans: Summary

Rule 10b5-1 trading plans are pre-approved selling mechanisms that enable insiders to sell (or buy) company stock at regular intervals, without being accused of illegal insider trading.

When analyzing insider transaction activity, it’s important to identify automated trades and separate these from standard trades. In general, pre-arranged trades have much less informational value than regular trades.