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Insider Selling: Does it Matter?

by | Oct 22, 2021 | Market Signals & Indicators

Short-answer…No; Long Answer…No

You see it so often across social media as people post insider sales at top performing stocks as a “warning signal” yet there is no empirical evidence that this information holds any value. As we have long described, insider buying is a solid signal as insiders only buy for one reason, they think the stock is undervalued and will go up. Insider sales can happen for a multitude of reasons of which most do not relate to any kind of outlook the Executive has for the business/stock.

However, to stay focused this write-up is in regards to a specific type of insider sale, 10b5-1 plans. After Snap (SNAP) shares got crushed on earnings you started to see all these posts about insider sales in the name in days leading up to the report, yet they conveniently do not show the same insiders have been regularly selling shares the whole way up and ahead of some massive blowout earnings reports as well. In this case the sales were days before the report and continue to follow the regular schedule making it not suspicious whatsoever.

Blackout Periods

While not mandated under law, the use of blackout periods is a nearly universal component of the insider trading compliance programs of most publicly held companies. The SEC requires public companies to create an environment in which employees are discouraged from insider trading; companies that fail to do this can be held liable for any insider trades by their employees. Over time, trading blackout periods have emerged as one concrete way companies can demonstrate that they discourage insider trading. Quarterly blackout periods coincide with the end of fiscal quarters and are lifted shortly after earnings are released. Eighty percent of companies close their trading window 11 days or more before the end of their fiscal quarter. Almost half (48%) of companies allow trading to recommence two trading or calendar days after earnings are announced. Another 30% open the trading window even sooner—one trading or calendar day after earnings are announced.

10b5-1 Plans

Rule 10b5-1 plans provide an affirmative defense for companies and those presumed to be “insiders” (i.e., directors and officers) transacting in the relevant company’s securities. These plans have become relatively commonplace, but from time to time, they have attracted attention, usually in response to media coverage of enforcement action by the SEC or reports of suspicious activity. The instances of public scrutiny have demonstrated the unraveling of perceived abusive plan practices such as establishing multiple plans, making excessive modifications to plans or limiting plan duration. Recently, the SEC has increased its enforcement activity for violations of Section 16 reporting obligations, which demonstrates a renewed focus on insider trading activity, landscape that Rule 10b5-1 plans also occupy.

Rule 10b5-1 plans are passive investment schemes (plan holders relinquish direct control over transactions), which provide a mechanism for companies and corporate insiders to purchase and sell securities of such company when they have MNPI, by providing an affirmative defense to insider trading. Although attention generally is focused on the selling aspect, the plans also can cover purchases of securities. Furthermore, the protections of Rule 10b5-1 are not limited to publicly-traded stocks. Private equity funds and other investment managers can benefit from Rule 10b5-1, such as by using a Rule 10b5-1 plan to make future acquisitions or dispositions of company equity or debt without violating insider trading restrictions. [2] Distressed debt investors also may use Rule 10b5-1 plans to make future acquisitions or dispositions of company debt.

I stumbled upon this William Blair PDF online regarding 10b5-1 plans which provides solid insight:

10B1 Trades

Snap (SNAP) SEC documents note “Our directors and officers may adopt written plans, known as Rule 10b5-1 plans, in which they will contract with a broker to buy or sell shares of our Class A common stock, Class B common stock, or Class C common stock on a periodic basis. Under a Rule 10b5-1 plan, a broker executes trades under parameters established by the director or officer when entering into the plan, without further direction from them. The director or officer may amend a Rule 10b5-1 plan in some circumstances and may terminate a plan at any time. Our directors and executive officers may also buy or sell additional shares outside of a Rule 10b5-1 plan when they do not possess of material nonpublic information, subject to compliance with the terms of our insider trading policy. The sale of any shares under such plan would be subject to the lock-up agreement that the director or officer has entered into with the underwriters.”

Conclusion

People on social media playing Monday Morning Quarterback to insider sales rarely understand any of which was detailed above and are just always looking to start a conspiracy. It ranks up there for the dumbest thing I consistently see on the platform right along with “The Fed is why the market is so strong” and “The move higher lacks volume.” There are about a dozen other common misnomers but I will save those for another time.

References

4 Trends in Trading Blackout Periods – NASPP

A Guide To Rule 10b5-1 Plans – Harvard Law