How the SEC can and should set the rules on insider trading
Significant and apparently timely sales of shares by senior executives Pfizer, Moderna and others have received attention. Companies were quick to defend their executives by pointing out that many of these share sales were planned in advance, according to a “10b5-1 plan.” In theory, these plans allow insiders who are not in possession of material non-public information to engage in a series of trades well in advance of developments in the market and provide a “safe harbor” against breaches. securities laws. If used as intended, these plans give company insiders a tool to trade their stocks and get cash without raising legal issues. But like any tool, these plans can be misused. Our research shows that recent examples are just the tip of the iceberg.
Most of the media attention has focused on transactions made by individual executives – little attention has been paid to the lax SEC rules that surround these plans and offer the possibility of abuse. The Securities and Exchange Commission (SEC) should reform its current policies and practices that contribute to these abuses.
First, the Commission should require disclosure that a transaction has been effected in accordance with a 10b5-1 plan. Corporate insiders must publicly disclose their transactions with the SEC on Form 4, but it is not mandatory that they disclose whether the transaction was planned in advance.
Second, the Commission should require disclosure of the plans themselves. At present, neither the public nor the Commission knows the details of all of these plans. At the very least, information on the adoption, modification, termination and number of shares covered by these plans should be compulsorily disclosed in the company’s annual file. By not disclosing these plans, companies are stealing valuable information from investors about executive action incentives. Current rules already require disclosure of whether the executive’s stock holdings are hedged or pledged. The SEC should also require disclosure if the executive’s stock holdings are scheduled to be sold. This is important information for the compensation committee of the board of directors when considering new stock options and restricted stock awards for executives.
Third, the Commission should act on President Clayton’s proposal suggestion and require a delay between when a plan is adopted and when the first transaction is executed, or a “cooling off period”. Clayton suggested a four to six month cooling off period. This constitutes a significant change in the way these plans are currently used. We analyzed data on plans from 2016 to 2019 and found that the vast majority of plans (70%) did not comply with the president’s insightful suggestion, and executives at more than 100 companies used plans that executed a trade on the same day the plan was adopted.
Fourth, the Commission should require companies to explain why they allow executives to adopt such plans in close proximity to company events. Over the past three years, more than 250 companies have cleared plans for adoption 30 days before company earnings are announced – a period during which executives are generally considered to be in possession of material non-public information and trading. is generally prohibited.
Fifth, the Commission should apply existing laws regarding filing deadlines. Corporate insiders are required to report their transactions to the SEC within two business days. However, an impressive number of transactions are reported well past the deadline. Since 2014, we see that more than 14,000 transactions covering more than $ 6 billion have been filed more than 10 days late. Late declarations are not trivial. Research indicates that reporting delays are consistently correlated with opportunism. What good are the filing deadlines if they are not respected?
Finally, the SEC should stop accepting mail (snail) deposits. Form 144 contains information on adoption dates 10b5-1. The SEC continues to allow the filing of this form by to post and does not publish forms filed by mail in its public EDGAR database. From 2017 to 2019, we find more than 89,000 forms 144 filed by mail and not published on EDGAR. Instead, the forms were kept for 90 days in the SEC reading room and then thrown away. Commercial data providers send couriers to the reading room every few days to scan forms and sell the scanned images to corporate clients. By continuing to accept mailed forms and not posting them on EDGAR, the SEC has created a two-tiered disclosure system that puts individual investors at a disadvantage and hides details of a significant number of planned share sales. of public review.
Disclosure of planned share sales is an obvious problem for public markets and shareholders. There is strong evidence that some corporate insiders are exploiting the 10b5-1 rules. Fortunately, the SEC can significantly alleviate these problems by implementing several simple regulatory and disclosure changes.
Alan Jagolinzer is a professor at the University of Cambridge. David Larcker is a professor at Stanford University and Daniel Taylor is an associate professor at the Wharton School at the University of Pennsylvania.