Compensating Executives by Insider Trading? And it is Legal.

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With much spot light focused on insider trading and excessive executive compensation received at times of recession, investment programs under Rule 10b5-1 receive little attention.

Investment plans under Rule 10b5-1 were established to prevent insider trading and protect the securities markets but instead have been used to enhance executive compensation.   Like options, which in theory were supposed to tie management pay to stock performance, reality has altered 10b5-1 programs into a practice that makes it impossible for the recipients to not benefit no matter how the company fares.

A 10b5-1 is a written plan that sets certain times of the year, or certain target prices, when corporate executives intend to buy or sell shares of their own company stock.  Executives who use such plans can trade even if actual trades are made at a time when the individual may be aware of material, non-public information.  And if they face suspicious trading accusations, having followed such pre- determined plan is an affirmative defense against insider trading.

In concept, the 10b5-1 program should help executives avoid trading on non-public information and benefit market by adding liquidity, providing direction to other investors, and demonstrating confidence in the firm from those that know its operations the best when purchases are made.

However, in practice, this has become yet another form of executive compensation that has a lot in common with insider trading.   Executives at publicly traded companies can utilize insider information to profit by trading through the 10b5-1 program. Insiders do not have to disclose any information to the public or the SEC about the pre-set aspects of the plan, any changes, or any cancellations.   Trades do not have to be disclosed for 48 hours, leading to the craft of “sell and tell.”

So, if an executive is aware of poor or positive earnings coming, trades can be executed in the 10b5-1 plan to profit.   As there is no legal requirement for the disclosure of the plan or any changes, there is no way to know if the executive benefited from insider information as the trades could have been planned well in advance and just happened to be the right transaction to yield profits (sure).

Obviously, it harms the market and other shareholders, rather than protecting the company as it was intended.   Executives often in possession of inside information to sell at a higher price, manipulate market and force the other shareholders to pay more than they would have otherwise.   Shareholders also suffer a lack of information about insider buying and selling can be considered material to the investors, which greatly diminishes shareholder value.

As the solution, Congress and the SEC need to take action.   While this was needed years ago due to the abuses, new laws will hopefully restore the 10b5-1 plan to its original intent to allow insiders to buy and sell company stock without abusing insider information and abusing the rest of the investing public.

 

 

Anna Timone (195 Posts)


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