Rule 10b5-1 Trading Plans and Insiders’ Incentive to Misrepresent
Fordham University - School of Business
December 1, 2009
American Business Law Journal, Vol. 47, No. 2, pp. 313-359, Summer 2010
Rule 10b5-1 plans provide an affirmative defense against insider trading charges if, at a time when the insider had no material inside information, the insider commits to the future trades that otherwise might then be subject to insider trading charges. The article first describes insider trading regulation under Rule 10b-5, including how trades by an insider can be the primary violation of Rule 10b-5 or instead serve as evidence of scienter in a broader Rule 10b-5 case (e.g., misrepresentation, such as distorted financial statements). The article then details Rule 10b5-1 and then considers existing case law that has substantively addressed trading under plans, and which has largely evidenced a tendency to heavily discount sales under plans as evidence of scienter. The article then reviews economics-based research and details the incentive for insider sellers, especially those now selling under a 10b5-1 plan, to misrepresent. It criticizes the extent to which the affirmative defense insulates an insider from Rule 10b-5 primary violation liability even if the insider’s information is self-created (as opposed to external information, such as learning of a failed or successful drug trial). It also recommends that parties in Rule 10b-5 cases look more closely at the scienter element given the documented incentives insiders have to prop up a stock price before a 10b5-1 plan sale whether or not the plan was initially made in good faith.
Keywords: Insider trading, earnings management
JEL Classification: M43
Date posted: May 16, 2010