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What is a 10b5-1 plan?

“Is a 10b5-1 plan a type of qualified retirement plan?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Kansas is representative of a common inquiry related to trading securities.

Highlights of the Discussion

No, it is not a “qualified plan” in the sense of a 401(k) or profit sharing plan, which meets requirements for favorable tax treatment under Internal Revenue Code 401(a). A 10b5-1 plan is a buy/sell agreement for securities that meets the requirements of the Securities Exchange Commission’s Rule 10b5-1 related to “insider trading.”

Legal insider trading occurs when corporate insiders—officers, directors, and employees—buy and sell stock in their own companies and report their trades to the SEC. Illegal insider trading refers to an insider using material, nonpublic information to buy or sell securities to his or her  advantage.  A 10b5-1 plan is a written contract between an insider and his or her broker to buy or sell company stock at a time when the insider is not in possession of any restricted information related to the stock. A 10b5-1 plan is a way for insiders to trade company securities and minimize legal exposure by giving them an affirmative legal defense. An affirmative defense is not a safe harbor nor will it protect a person from allegations of wrongdoing. It allows a person to refute allegations of wrongdoing.

In order for a 10b5-1 plan to serve as a defense against charges of insider trading, it must meet the following criteria:

  1. Entered into in good faith without intent to abuse Rule 10b5-1;
  2. Adopted when the individual trading the security was not aware of any material, nonpublic information;
  3. The terms of the plan contains a pre-set formula for determining the amount, price and date of transactions;
  4. The individual subsequently cannot affect criterion #3 once it is in place;
  5. The purchase or sale of the security was made according to the plan.

Anyone can adopt a 10b5-1 plan, although it is generally used by large stock holders, directors and officers of the company. A company’s internal trading policies should address 10b5-1 plans, if they are offered.

EXAMPLE

Erin, an executive at Enrun Corporation, executes a written, one-year contract between herself and her broker that instructs the broker to sell 10,000 shares of Enrun on the first trading day of each month and twice as many shares (20,000) if the price has increased by 5% since the prior sale date. On the surface, this contract, generally, would meet the requirements to be a 10b5-1 plan.

Conclusion

A properly executed 10b5-1 plan can stand as an affirmative defense against allegations of insider trading for someone who is in a position to have material, nonpublic information. Extreme care should be used when establishing and using such plans as they are not infallible, however. Consult a legal expert.

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