Reprint permission from the December 3, 2001 issue of Crain's Chicago Business.
The Securities and Exchange Commission's Regulation FD (for "fair disclosure") was widely heralded when it was announced last year.
The regulation bans senior officials of public companies from disclosing "material information" to financial analysts and big investors before making it public.
But Rule 10b5-1, issued at the same time, virtually escaped media attention. Now, it's clear that the rule, which is intended to make sense of a tricky and onerous insider trading law, does more harm than good.
The Securities and Exchange Commission (SEC) adopted Rule 10b5-1 after two federal Appeals Courts rejected an arcane SEC policy that prevented insiders from selling company stock while "possessing" material, non-public information, whether or not it was "used." To many, that's a distinction without a difference.
But the SEC was lobbied hard to allow executives to sell their companies' shares without legal peril.
Rule 10b5-1 permits insiders to sell their companies' shares under a pre-arranged, written trading plan. By doing so, an executive who isn't aware of material, non-public information when he sets up his plan won't be breaking the law if he happens to have inside information when he later sells stock under the plan.
While the rule was in the talking stage, its critics found it too tough. Some argued that the SEC had no business redefining the crime of insider trading. That's a congressional function, they insisted.
Others thought the rule went too far by denying an executive the opportunity to defend himself against an insider trading charge by asserting that market-sensitive information simply wasn't used in his decision to sell.
The truth is that Rule 10b5-1 is just bad law. It doesn't prohibit trading outside an approved plan. Out-of-plan sales merely lose the automatic protection of the safe harbor.
Nor does it prevent insiders from modifying or even terminating a trading plan. And the plan can last as long as the executive decides. So, investors have absolutely no guarantee that insiders won't secretly sell their shares before a company's major news hits the wire services.
All kinds of questionable insider-selling practices are already raising suspicion.
SEC filings reveal that Glen Meakem, chairman and CEO of FreeMarkets Inc., sold 170,000 shares of the business-to-business software maker under a Rule 10b5-1 trading plan earlier this year for about $3 million. The trading period ended just five days before the company lowered earnings guidance for the year. It's fair to assume that if the rule had not been adopted, he might have thought twice before selling so much stock in advance of an earnings report.
And then there's the case of Jeffrey Bezos, Amazon.com Inc.'s CEO and the owner of about 32% of the company's outstanding shares. He was roundly criticized earlier this year for selling $12 million of the stock after Amazon received a preview copy of an influential analyst's report questioning Amazon's going-concern status. Seeking refuge from the press and the regulators, Mr. Bezos quickly established a Rule 10b5-1 plan and declared his intent to sell another 300,000 shares of Amazon stock.
There is no evidence that Messrs. Meakem or Bezos did anything at all wrong. But James Crowe sets a better example. Mr. Crowe, CEO of Level 3 Communications Inc., told his shareholders in advance that he intended to sell small blocks of his company's stock over time, and why. And when conditions changed, he also told them he was abandoning his sales plans and wouldn't sell any more stock until he let his fellow shareholders know.
The SEC should follow Mr. Crowe's lead and require insiders to disclose the specifics of their selling plans to company stockholders before they're implemented. Once sales intentions are fully disclosed upfront, investors won't need to wonder about insiders' motives after the fact.
Marc J. Lane is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law. He can be reached at [email protected].
Copyright © 2001 by Crain Communications Inc.