Gaming the System: Three 'Red Flags' of Potential 10b5-1 Abuse

17 Pages Posted: 21 Jan 2021

See all articles by David F. Larcker

David F. Larcker

Stanford University - Graduate School of Business; European Corporate Governance Institute (ECGI); Stanford University - Arthur & Toni Rembe Rock Center for Corporate Governance

Bradford Lynch

University of Pennsylvania - Accounting Department

Phillip J. Quinn

University of Washington - Foster School of Business

Brian Tayan

Stanford University - Graduate School of Business

Daniel J. Taylor

The Wharton School, University of Pennsylvania

Date Written: January 19, 2021

Abstract

The SEC adopted Rule 10b5-1 to provide an affirmative defense against allegations of insider trading to executives whose jobs regularly expose them to material nonpublic information. In this Closer Look, we present evidence on the trading behavior of corporate executives using a unique dataset of over 20,000 10b5-1 plans to show that a subset of executives use these plans to engage in opportunistic, large-scale selling that appears to undermine the purpose of Rule 10b5-1. We identify three “red flags” associated with 10b5-1 abuse: 1) short cooling-off periods, 2) plans that cover a single block trade, and 3) plans that are adopted and commence trading immediately prior to earnings announcements.

We ask:
• Would simple modifications to Rule 10b5-1 prevent these abuses?
• Why doesn’t the SEC require disclosure of 10b5-1 plans and the trades made under these plans?
• Does the board or compensation committee monitor executive stock sales under 10b5-1?
• Why don’t they require best practice guidelines to reduce the potential for abuse?

Keywords: CEO compensation, CEO pay, equity compensation, insider trading, insider trading policy, 10b5-1 plans, executive stock transactions, board of directors, blackout window, general counsel approval, suspicious, abuse, red flags, cooling-off periods, block trades, earnings, corporate governance

Suggested Citation

Larcker, David F. and Lynch, Bradford and Quinn, Phillip J. and Tayan, Brian and Taylor, Daniel J., Gaming the System: Three 'Red Flags' of Potential 10b5-1 Abuse (January 19, 2021). Rock Center for Corporate Governance at Stanford University Working Paper Forthcoming, Available at SSRN: https://ssrn.com/abstract=3769567

David F. Larcker (Contact Author)

Stanford University - Graduate School of Business ( email )

Graduate School of Business
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Stanford, CA 94305-5015
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650-725-6159 (Phone)

European Corporate Governance Institute (ECGI) ( email )

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1000 Brussels
Belgium

Stanford University - Arthur & Toni Rembe Rock Center for Corporate Governance ( email )

Crown Quadrangle 559 Nathan Ab
Stanford, CA 94305-8610
United States

Bradford Lynch

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Phillip J. Quinn

University of Washington - Foster School of Business ( email )

4295 E Stevens Way NE
PACCAR Hall #468
Seattle, WA 98105
United States

Brian Tayan

Stanford University - Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Daniel J. Taylor

The Wharton School, University of Pennsylvania

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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