The myStockOptions Blog

ALERT: SEC Adopts Key Changes To 10b5-1 Plans To Prevent Insider Trading

A Rule 10b5-1 trading plan is a prearranged plan for selling and/or buying company stock under SEC Rule 10b5-1 that provides an affirmative defense against charges of insider trading if you later trade stock while you possess MNPI. Many companies now either require or strongly encourage their executives and directors to set up 10b5-1 plans. The SEC has just finalized important additional rules for 10b5-1 plans that affect those who use them, as we summarize in this article.

SEC Has Long Suspected Misuse Of Rule 10b5-1 Trading Plans

First, some background. The law prohibits you from trading stock on the basis of material nonpublic information (MNPI), i.e. information that will move the company's stock price when it is made public. You can commit insider trading accidentally as well as intentionally, even if the MNPI that you possess did not influence your decision to trade. Avoiding insider trading is a major concern for executives, directors, and employees with company stock who need to sell shares to diversify or generate cash but also frequently know MNPI. Those could be shares you purchased on the open market or from a stock option exercise, restricted stock unit (RSU) vesting, or employee stock purchase plan (ESPP).

The SEC has been building up to its new rules for 10b5-1 plans over the past several years. A growing body of evidence suggests 10b5-1 plans have occasionally been abused to commit insider trading rather than prevent it. The SEC has been scrutinizing 10b5-1 plans in the wild for some time and is bringing more enforcement actions for abuses.

For example, earlier this year the SEC announced it had settled an enforcement proceeding involving alleged insider trading by Cheetah Mobile's CEO and its former president; this case and the related SEC Order involved the misuse of a 10b5-1 plan. The SEC's statement on the matter quotes Joseph G. Sansone, Chief of the SEC Enforcement Division's Market Abuse Unit, who explains that "while trading pursuant to 10b5-1 plans can shield employees from insider-trading liability under certain circumstances, these executives' plan did not comply with the securities laws because they were in possession of material nonpublic information when they entered into it."

SEC Adopts Additional Rules For 10b5-1 Plans

In response to its findings, the SEC has taken action to tighten up the rules for 10b5-1 plans. On December 14, the agency adopted final amendments for 10b5-1 plans, a year after these additional rules were proposed.

For corporate officers, directors, and employees seeking to use 10b5-1 plans as an affirmative defense against insider-trading liability when they sell or buy company stock, these rule changes include:

1. A "cooling off" (i.e. waiting) period before trades can start after the plan's adoption or modification:

• For directors and officers, the later of (1) 90 days or (2) two business days after the disclosure in SEC Form 10-Q or 10-K of the company's financial results for the fiscal quarter in which the plan was adopted or modified (but not to exceed 120 days). The proposed rules had a 120-day cooling-off period before any trading could start after the plan's adoption or modification.
• For people other than directors and officers, 30 days. This is an important difference from the proposed rules, which did not clearly specify a cooling-off period for regular employees and managers.

2. A requirement to certify in the plan itself when adopting or modifying it that you are not aware of material nonpublic information about the company. This certification requirement is just for directors and officers.

3. No overlapping 10b5-1 plans for open-market trades. One exception would be another plan set up just to allow sales of stock (i.e. sell-to-cover) for tax withholding when restricted stock/RSUs vest.

4. A limit on single-trade plans to one per 12-month period.

These final rules are effective 60 days after publication of the adopting release in the Federal Register. Existing plans appear to be grandfathered unless modified.

Companies must also now annually disclose their insider-trading policies and procedures. For more details on the additional requirements, including the need to check a box on SEC Form 4 and Form 5 when a reported stock transaction is made under a 10b5-1 plan, see the SEC Fact Sheet on the rule changes.

The related FAQ at myStockOptions explains the background of this development, including the SEC's long-running scrutiny of 10b5-1 plans and research suggesting that abuses of 10b5-1 plans do occur, and has a growing curated list of detailed commentaries on the rule changes from law firms.

How 10b5-1 Plans Can Help You Build Wealth And Avoid Insider Trading With Your Company Stock

Executives and other key employees with equity compensation face a unique conundrum with company stock. While much of their pay is in the form of restricted stock units (RSUs) and/or stock options, they often cannot sell company shares because they possess what's called material nonpublic information (MNPI), i.e. knowledge of confidential company info that will affect the stock price when made public. In other words, they have to sell company shares to meet financial goals but also don’t want to be accused of insider trading.

Fortunately, there is a way out of this Catch-22 situation: SEC Rule 10b5-1, which provides for a Rule 10b5-1 trading plan.

Insider-Trading Risk

MNPI is confidential information about the company that will move the stock price up or down. When you know MNPI about a company, whether you’re an executive, employee, or outsider, you cannot trade in that company’s securities until the MNPI is disclosed.

When you possess MNPI, regardless of whether or not you factored that information into your buy or sell decision, you’re at risk of being charged with insider trading by the Securities and Exchange Commission (SEC) and criminal prosecutors. To make matters even more challenging, the intervals when company insiders do not possess MNPI, and can sell shares without the risk of insider trading, may be brief and infrequent.

Test your knowledge of the rules: Try our quiz on insider-trading prevention and its interactive answer key at myStockOptions.

Rule 10b5-1 To The Rescue

If you’re in this position, how can you regularly sell company stock? You can use what’s called a Rule 10b5-1 trading plan. When properly created, a 10b5-1 plan gives you a way to diversify your stock holdings, sell stock to meet goals under your financial plan, and avoid getting into trouble for insider trading.

Alert: The SEC is focusing on abuses with these plans and has proposed new rules.

myStockOptions recently held a webinar on 10b5-1 plans and other SEC rules: 10b5-1 Trading Plans & Other SEC Rules Advisors Need To Know. A panel of three experts provided key insights on both the legal framework of 10b5-1 plans and the role they can play in financial planning for company insiders.

Basics Of 10b5-1 Plans

A 10b5-1 plan is a prearranged stock-trading plan under SEC Rule 10b5-1 that provides an affirmative defense against charges of insider trading when you later sell or buy stock while you know MNPI about your company. Created when you do not know MNPI, the plan is set up in advance to make automatic, periodic sales and/or purchases of your company’s stock.

The plans need to follow the requirements, as the SEC is starting to bring enforcement actions for abuses. For example, the SEC recently announced (September 21, 2022) that it had settled an enforcement proceeding involving alleged insider trading by Cheetah Mobile’s CEO and its former president; this case and the related SEC Order involved the misuse of a Rule 10b5-1 plan.

The SEC’s statement quotes Joseph G. Sansone, Chief of the SEC Enforcement Division’s Market Abuse Unit, who explains that “while trading pursuant to 10b5-1 plans can shield employees from insider-trading liability under certain circumstances, these executives’ plan did not comply with the securities laws because they were in possession of material nonpublic information when they entered into it.”

Rule 10b5-1 trading plans have become popular since SEC Rule 10b5-1 was adopted in 2000. “Over 50% of Fortune 500 companies have at least one executive using a 10b5-1 plan,” observed webinar panelist Mike Andresino, a partner in the Boston office of the law firm ArentFox Schiff, in his opening remarks.

Mike went on to outline the basic parameters of 10b5-1 plans. “The insider who establishes the plan cannot be in possession of MNPI when the plan is established,” he asserted. “The person cannot exert any subsequent influence over the implementation of the plan and must have entered into the plan in good faith.”

There are various ways to establish a 10b5-1 plan, he noted. By far the most common is the contract method. “You enter into a binding contract to buy or sell company stock that specifies, or has a formula to determine, the number of shares, the stock price they will be sold at, and the timing. That formula doesn’t have to be precise. You don’t have to specify prices. You can refer to the market; you can refer to extrinsic events.”

Two examples:

Period-sales approach: Sell X number of shares on the first day of every month/quarter, as long as the price is above $Y 

Price-only approach: Sell X number of shares at any time during the plan when price reaches $B; sell an additional C number of shares if price gets to $D 

Importance Of 10b5-1 Plans

Rule 10b5-1 trading plans can become very important financial tools for executives, employees, and directors who know MNPI about their companies most of the time. While companies have regular open trading windows when you are permitted to trade stock, amid blackout periods when you are not allowed to trade, those window periods may not be helpful for some executives and key employees.

“In reality, for many of them, they may have inside information at any point, whether the window is open or closed,” said webinar panelist Rich Baker, the executive director of Morgan Stanley Executive Financial Services in New York. Whether the MNPI involves a product rollout, M&A, or company litigation, it can keep executives in blackout periods for quarter after quarter. “I’ve seen executives who are unable to sell company stock for two years,” Rich stated.

Ideally, Rich went on, you set up a 10b5-1 plan when you have an open trading window and do not possess MNPI. “There’s a waiting period, a ‘cooling off’ period, before you can start trading,” noted Rich. “Then trading should be allowable from a legal perspective under the plan on an ongoing basis thereafter.”

Rich explained that 10b5-1 plans can confer other benefits beyond just letting corporate insiders trade company stock in good faith and get on with their financial planning. “10b5-1 plans can reduce investor concerns. They let the company facilitate an orderly disposition for all of their executives so that they don’t have lots of optic-concerning trades going on when activity is high at the company.”

“Diversification, selling long shares, is the most commonly thought of use for 10b5-1 plans,” chimed in Mike Andresino. “You can also exercise and sell stock options under a 10b5-1 plan. In combination with restricted stock and restricted stock units, you can use 10b5-1 plans to sell shares to cover taxes at vesting even during a blackout period.”

Best Practices For 10b5-1 Plans

Mike then discussed some of the best practices for 10b5-1 plans that have arisen to help ensure they work as an affirmative defense against insider trading. “The letter of the law doesn’t have a lot of requirements, but over the years a series of practices have developed,” he observed as a prelude to covering the SEC’s proposed rules. One is the “cooling off” period. “Companies often have a period that must elapse between the adoption of the plan and the first trade that takes place under the plan. Sometimes it’s as short as two weeks. The sweet spot is generally 30, 60, or 90 days.”

Terminating the plan early can, Mike noted, put a big dent in any later claim that you entered the plan in good faith. “One thing which indicates to courts and the SEC that you may not have had good faith is adopting a plan and then, when it looks like it may be beneficial to hold the shares, you terminate the plan.” Similarly, Mike said, multiple overlapping plans can also raise questions about good faith. “Companies often impose restrictions on that.”

SEC Proposed Rules

The SEC has proposed new rules for 10b5-1 plans to combat suspected abuses, explained Rich Baker. These rules would codify many of the best practices that have arisen. The amendments add new conditions to the availability of the affirmative defense to insider-trading liability, including:

1. 120-day cooling-off period before any trading can start after the plan’s adoption or modification
2. Requirement to certify when adopting or modifying the plan that you are not aware of material nonpublic information about the company
3. No overlapping 10b5-1 trading arrangements for open-market trades
4. A limit on single-trade plans to one per 12-month period
5. Plan must be entered into and operated in good faith

The first two SEC rules would apply only to senior officers and directors, though a company could decide under its own rules to impose them on other executives and on employees. The final SEC rules are expected in the spring of 2023.

Financial Planning With 10b5-1 Plans

Webinar panelist Megan Gorman, the founder of Chequers Financial Management in San Francisco and a Forbes.com contributor, spoke about the role a 10b5-1 arrangement can play in financial planning. She presented tips and case studies on how she effectively uses and designs these plans for clients.

When putting together a plan, she explained, you should answer four questions:

1. What shares are you selling?
2. How long is the plan?
3. What is the frequency of sales?
4. What is the selling method?

“Monthly selling plans with limits are often a great approach,” she said. She noted that the optimal length of the plan is typically 12 months. “You can also structure the plan to change at different points to meet cash-flow requirements.”

Using what she calls an “elevator design” allows more shares to be sold as the company’s stock price rises, as illustrated in one of her webinar case studies. She asserted that it is also crucial to factor tax planning into your 10b5-1 arrangement, along with future vestings of restricted stock or restricted stock units.

Optics are another key consideration, Megan emphasized, especially for senior executives who can easily stumble into the media spotlight. “Just because you are allowed to do a 10b5-1 plan doesn’t mean you should,” she cautioned. “Even the most innocent actions can look nefarious on the outside.” One test Megan applies is a thought experiment: how would this stock trade look if it were reported on the front page of The Wall Street Journal?

Seek Expert Advice

Starting a Rule 10b5-1 trading plan is not a DIY activity. You need expert legal, financial, and tax advice, to follow both the SEC and your company’s rules. You want to assure you are setting up the plan properly and that it achieves what you want it to without getting you into trouble.

Before you set out, see the myStockOptions content sections on Rule 10b5-1 trading plans and insider-trading prevention. In addition, the webinar in which the experts quoted above spoke is available on demand at the myStockOptions Webinar Channel.

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myStockOptions Webinar Channel: Next Webinar

Negotiating Equity Compensation: How Advisors Can Help Clients

• October 13, 2022, 1:00pm to 2:40pm ET, 10am to 11:40am PT
• 2.0 CE credits for CFP, CPWA/CIMA, CEP, EA, and CPE
• Agenda and panelist details at the webinar registration page

Learn the best ways to evaluate and negotiate equity compensation in job offers and how to protect it at job termination. Discover how to help clients get the best deal to maximize and preserve their wealth in company shares, stock options, and restricted stock/RSUs.

This webinar will provide practical info and guidance on negotiating equity comp, how to safeguard grants when leaving a job, and big mistakes to avoid. In 100 minutes, it will feature insights from three leading financial and legal advisors, including real-world case studies. Their expertise applies to employees and executives at all types of companies, whether startups, recently public companies, or long-time public corporations.

Register now. All registered attendees get unlimited streaming access to the webinar recording for their personal viewing, along with the detailed presentation slide deck and handouts. Therefore, even if you can't attend the live webinar, please still register, as you will receive access to the recording along with the presentation and handouts.

 

Insider-Trading Prevention And Stock Plan Education: Colorful Examples Can Help Employees, Executives, And Directors Get The Message

Here's a fun piece of trivia. Way back, before myStockOptions.com, our publishing team first became involved with stock plan education while producing our Think Twice video series for employee education to prevent insider trading. Since its launch, myStockOptions.com has always had a special section of content on insider trading and other topics in SEC law, including Rule 144, Section 16, and Rule 10b5-1 trading plans. To this day, whenever we hear about new insider-trading cases that provide excellent cautionary tales for employees, executives, and directors, we like to bring them to your attention.

Highly educational insider-trading cases often involve famous people and intriguing circumstances. These qualities are notably present in a recent high-profile SEC action involving three people: professional golfer Phil Mickelson; William "Billy" Walters, a prominent sports gambler in Las Vegas; and Thomas Davis, a director on the board of Dean Foods. In addition to the SEC press release on the case, the related public statement from Andrew Ceresney, the director of the SEC's Division of Enforcement, is worth distributing in its entirety to your board members. Mr. Ceresney's message is clear:

"Board members owe their shareholders a fiduciary duty and we will pursue vigorously those who breach that trust and seek to profit from those breaches. The management and shareholders of Dean Foods placed their trust and confidence in Davis, and he repeatedly breached that trust and confidence, year after year, providing Walters with the company's most closely held information."

The SEC brought criminal charges against Mr. Davis, who has already pleaded guilty.

Some commentators think that the outcome with Mr. Mickelson, who was not charged with securities fraud, indicates that challenges may be growing for the SEC in bringing cases against tippees after United States v. Newman (see a blog commentary from the law firm Brooks, Pierce, McLendon, Humphrey & Leonard). Clarification on what is needed to show tippee liability is expected when the Supreme Court issues its opinion in Salman v. United States.

However, the case involving Phil Mickelson also shows that when the SEC finds insider trading somewhere in a chain of events, all who profited will be forced to pay back their gains, even if they did not know that the information in question was tainted. In the SEC's action, Mr. Mickelson was named as a "relief defendant," i.e an individual who must turn over ill-gotten gains arising from schemes perpetrated by others. Without admitting or denying the allegations in the SEC's complaint, Mr. Mickelson agreed to pay the full disgorgement of his trading profits, which totaled $931,738.12 plus interest of $105,291.69.

Using Rule 10b5-1 Plans To Trade Company Stock

We have recommended the use of a Rule 10b5-1 trading plan if you often know important confidential information about your company and are thus at risk of being inconveniently restricted from stock transactions because of the rules against insider trading. A properly created prearranged 10b5-1 trading plan allows you to sell stock and can serve as an affirmative defense should any insider-trading charges arise.

However, it is important to note that Rule 10b5-1 trading plans have become controversial and that best practices for them are still evolving. These plans seem to be under special scrutiny by the SEC and the Department of Justice, as notably reported by many recent articles in The Wall Street Journal (see, for example, Insider-Trading Probe Trains Lens On Boards, by Susan Pulliam, Rob Barry, and Scott Patterson, Apr. 30). The regulatory searchlight on Rule 10b5-1 plans is also discussed in recent memos from some law firms, including Dechert and Pillsbury. These memos outline best practices, as does an FAQ on myStockOptions.com.

In its blog this week, TheCorporateCounsel.net published the results of its small informal survey on some best practices (Survey Results: Rule 10b5-1 Plan Practices). Among the findings of interest:

• 31% of companies "strongly encourage" insiders to sell shares only pursuant to a Rule 10b5-1 trading plan.
• 91% of companies review and approve each insider's Rule 10b5-1 trading plan.
• 91% of companies allow sales of shares through Rule 10b5-1 trading plans during blackout periods.
• 80% of companies require a waiting period between execution of Rule 10b5-1 trading plans and time of first sale. One month was the most popular period (44%).

Regardless of what companies voluntarily do, there is a growing sense that the SEC will release proposed rules or some type of guidelines on Rule 10b5-1 trading plans. The Council of Institutional Investors continues to request that the SEC tighten up the rules. It submitted a letter in May with suggestions for amendments or SEC interpretive guidance. For additional information on 10b5-1 plans, see the special section on them at myStockOptions.com.

Back-To-School Reading: Preventing SEC And IRS Problems For Executives Selling Or Buying Company Stock

As tangy autumn breezes usher in that back-to-school feeling, we at myStockOptions.com have published a pair of exclusive new articles for executive education about stock compensation and related issues.

In a two-part series, Compliance Concerns That Executives Must Understand To Prevent SEC, IRS, And Corporate Problems, financial planner Richard Friedman of The Ayco Company explains his top 10 most important points executives must know to stay out of trouble with their equity awards. This article nicely complements the other articles and FAQs in the SEC Law section at myStockOptions.com. Part 1 focuses on compliance issues involving company stock holdings and transactions, including the topics of insider trading, Section 16, share-ownership requirements, and Rule 144. Part 2 presents several more issues, including those involving foreign financial interests, nonresident state tax returns, retirement plan funding, and company rules.

"Ways to measure and address risk have become important for Corporate America," asserts Mr. Friedman. "One of the often underappreciated moral hazards facing companies of all sizes is the risk that an executive or employee may violate corporate, tax, or securities law. As companies are subject to enhanced and often mandated disclosure, violations can lead to unwanted public attention, embarrassment, and reputational risk."

Meanwhile, compensation and benefits attorney Michael Melbinger, of Winston & Strawn in Chicago, has written an article specifically on the unique equity-award tax issues faced by non-US executives preparing to work in the United States. Foreign Executives Transferring To The United States: Tax-Planning Strategies For Equity Compensation outlines the significant tax and estate-planning opportunities—and traps—that exist for foreign executives coming to America. "If you are a foreign national who will become a resident alien in the US," writes the author, "timing is crucial in the recognition of income and the payment of deductible expenses."

At myStockOptions.com, our publication schedule runs all year. Check back often for new articles, and remember that any or all of our content is available for licensing by companies as part of their stock plan education for employees and executives.

Gupta Insider-Trading Conviction: Circumstantial Evidence Still Matters In The Age Of Wiretaps

When life mirrors art, the results are sometimes devastating. The story and trial of Rajat Gupta, the Wall Street corporate director recently convicted of insider trading, reminded us strongly of our Think Twice video series for insider-trading prevention and education. In the two vivid, professionally acted dramas of the three-part series, employees of fictional companies get into trouble not only for trading shares on confidential company information but also, like Mr. Gupta, for passing secret company news to others who financially gain from it. Mr. Gupta's conviction included a count of conspiracy for tipping off a hedge fund with confidential boardroom information about the investment bank Goldman Sachs, where he was a director. As the Think Twice videos make clear, insider tipping is as illegal as actually trading on confidential inside information.

One of the striking things about the trial of Mr. Gupta was the circumstantial evidence that led to his conviction. Circumstantial evidence was once more common in insider-trading prosecutions, before federal authorities began favoring more direct methods such as wiretapping to gather evidence against insider-trading suspects. Mr. Gupta's trial is a reminder that a sufficient accumulation of indirect evidence can still lead to prosecution and conviction on charges of insider trading and tipping. Indeed, the case may cause federal prosecutors to feel once again more confident about bringing insider-trading charges on merely circumstantial evidence.

However it is detected and prosecuted, insider trading is a serious issue for companies and their employees. Our Think Twice video series helps the many companies that use it to educate their workforce about the perils of insider trading and tipping and how to avoid making the kinds of mistakes that, whether intentional or not, can ruin lives. More educational material about insider-trading prevention, with specific reference to stock compensation, can be found in the section SEC Law at myStockOptions.com.

Insider Trading: A Daily Risk For Companies With Stock Plans

Insider trading is an almost daily problem in the US capital markets: the Financial Industry Regulatory Authority (FINRA) annually hands the SEC about 250 potential cases of insider trading—an average of one case every market day. Not surprisingly, the issue is seldom far from the news headlines. The latest outbreak of interest centers on a federal investigation into a rash of suspected and alleged insider tipping and trading at the prestigious securities firm Goldman Sachs.

As we have written before in this blog, the best remedy against insider-trading violations at any company is prevention. By its very nature, stock compensation can be on the front lines of insider-trading potential, and companies should do all they can to prevent insider trading and be prepared to demonstrate their compliance efforts. The core of this is education. At myStockOptions.com, companies and stock plan participants have a superb resource in the SEC Law section of the website. This includes not just clearly written articles and FAQs but also an interactive quiz, to test what you've learned, and an engaging podcast that you can download and listen to if you get tired of reading. Certified Equity Professionals and Certified Financial Planners can earn continuing education credit by taking the advanced course and exam on SEC law and insider trading.

One proven means of corporate compliance that companies routinely adopt is showing employees educational videos on preventing insider trading. The leading resource in this field is the Think Twice video series, which was produced by our sister company Brumberg Publications and recently celebrated its 20th anniversary. At once entertaining, informative, and sometimes downright scary, the videos make superb use of scripted dramas and SEC interviews to clearly portray the rules against insider trading, along with the harrowing ordeal of an SEC investigation and its potential consequences.

For fun trailers of all three videos in the series, see the Think Twice channel on YouTube, or watch the preview of Think Twice: The Sequel right here:

Best Fix For Insider Tipping And Trading: Prevention

As sentencing approaches for Raj Rajaratnam, the dethroned hedge-fund king convicted in May of insider trading, observers are not only wondering how severe his punishment should be but also reflecting on the SEC's redoubled enforcement campaign against insider trading. An enlightening example is The War On Insider Trading: Market-Beaters Beware by Wall Street author Roger Lowenstein, writing in The New York Times last week. "Getting a stock-market tip has always been a sort of all-American fantasy," he observes, "and despite the risk of detection, the desire for an edge seems irresistible." Indeed, it can be a daily occurrence. The author notes that the Financial Industry Regulatory Authority (FINRA) annually hands the SEC about 250 potential cases of insider trading—an average of one case every market day.

The SEC and financial regulators have increasingly sophisticated means of detecting insider trading and, by extension, the illegal tipping that often prompts it. As shown by the Rajaratnam investigation and countless other insider-trading cases, involving both big and small violations, the SEC is aggressively pursuing insider trading and tipping at all levels. Ignorance is no excuse, either. SEC and court records abound with insider-trading cases involving people who apparently didn't know that their actions were illegal.

For both individuals and companies, the best remedy is prevention. By its very nature, stock compensation can be on the front lines of insider-trading potential, and companies should do all they can to prevent insider trading and be prepared to demonstrate their compliance efforts. The core of this is education. At myStockOptions.com, companies and stock plan participants have a superb resource in the SEC Law section of the website. This includes not just clearly written articles and FAQs but also an interactive quiz, to test what you've learned, and an engaging podcast that you can download and listen to if you get tired of reading. Certified Equity Professionals and Certified Financial Planners can earn continuing education credit by taking the advanced course and exam on SEC law and insider trading.

One proven means of corporate compliance that companies routinely adopt is showing employees educational videos on preventing insider trading. The leading resource in this field is the Think Twice Video Series, which was produced by our sister company Brumberg Publications. At once entertaining, informative, and sometimes downright scary, the videos make superb use of scripted dramas and SEC interviews to clearly portray the rules against insider trading, along with the harrowing ordeal of an SEC investigation and its potential consequences.

With Options And Restricted Stock, Attempts To Delay Taxes Usually Fail

In the standard tax treatment of stock options, the exercise of the options triggers taxes. For NQSOs, ordinary income tax is paid on the value of the spread at exercise. With incentive stock options, the spread at exercise is part of the calculation for the alternative minimum tax. With restricted stock/RSUs, the date of vesting and share delivery is used to calculate taxes on the income represented by the shares you receive.

But what happens if you cannot sell shares to pay the taxes on this stock-based income? Your company may impose a blackout on trading its stock. There may be a lockup, or perhaps the shares temporarily cannot be resold because of other securities law restrictions, such as insider trading prevention or the Section 16 short-swing profit rule. Maybe the shares are not registered with the SEC, or perhaps they are subject to a noncompete clause or a clawback. It would appear unfair to have to pay taxes on stock income received through exercise or vesting if you could not sell the underlying shares at all, even just to pay the taxes.

As unfair as it seems, this is the reality presented by the US tax code, the IRS, and numerous court decisions. Taxation on the stock-based income can be delayed only by a true risk of forfeiture in the grant. In Strom v. United States (2011), the 9th Circuit Court of Appeals recently reinforced the difficulty faced by challenges to this rule. Earlier, the federal district court had supported the plaintiff's arguments that the date for the tax calculation should be delayed if a sale at exercise would trigger penalties under Section 16, but the circuit court rejected this position. By remanding the case back to the district court, the appeals court did show at least some curiosity about the taxpayer's other contention: that the merger rules on pooling accounting which applied at that time, though not now under FASB 141, are another reason for delaying the tax treatment date.

If you challenge existing tax rules, beware of getting too creative. In Notice 2004-28, the IRS indicates the danger of assuming a delay in taxation when completing a tax return. Claims that a tax treatment date is delayed or deferred could be considered "frivolous" and provoke an IRS challenge, along with civil (or even criminal) penalties. The IRS has been aggressively pursuing these cases in various courts—and continues to win them.

Know Your SEC & Insider Trading Law? Be Sure (And Stay Out Of Trouble) With Our New Course & Exam

More than two decades after the famous insider-trading convictions of Michael Milken and Ivan Boesky, insider trading has once again been splashed across the headlines over the past several years. Numerous cases, some involving bizarre schemes (and even a celebrity), have brought public attention back to the issue of illegal stock-trading on secret market-moving information about companies. This fascination recently culminated in the media frenzy over the trial and conviction of hedge-fund billionaire Raj Rajaratnam. Of great interest to many observers was not so much Mr. Rajaratnam's alleged crimes but his giant global web of informants, including consultants in the so-called expert networks that hedge funds call upon to gather information about trends in particular industries. In a Businessweek article pondering the implications of the Rajaratnam case for the future, the journalists note:

"In Boesky's day, Wall Street was a smaller, more insular world, and inside information flowed among a tighter circle of people...By the time the government’s latest case came to light with Rajaratnam's arrest in October 2009, insider trading had moved well beyond the world of merger deals and investment bankers. The cast of characters is diverse—lower-level employees, both male and female."

To help financial professionals, stock plan participants, and investors stay out of trouble with the SEC and criminal prosecutors, myStockOptions.com has developed a new course, exam, and podcast on SEC law. These materials are based on the extensive articles and FAQs in the SEC Law section of myStockOptions.com. Covered topics include SEC law basics, insider trading and tipping, Rule 10b5-1 plans, the requirements under Rule 144, and the Section 16 rules. The course and podcast complement the popular Think Twice DVD series for insider trading prevention and education that the staff of myStockOptions.com helped to develop.

While the course and exam cover several topics in SEC law, the podcast focuses mainly on insider trading. In an entertaining audio presentation, realistic hypothetical situations involving insider trading are discussed to explain the key misunderstandings about confidential information and stock trading that can get people into trouble with the SEC (even if they don't mean to break the rules).

The new course and exam on SEC law for stock plans offers 5 credits for CEPs and 3 credits for CFPs. In addition, other courses and exams in the Learning Center cover nonqualified stock options, restricted stock and RSUs, employee stock purchase plans, and financial planning for stock compensation. A link to each is available on the Learning Center page and on the home page of myStockOptions.com.

Off With Their Hedge! How The Media And Dodd-Frank Are Shaping Corporate Policies On Executive Hedging Of Company Stock

At myStockOptions.com, we see a good deal of interest in our collection of expert articles on hedging strategies for both company stock and employee stock options. As some companies know, hedging by executives can lead to PR headaches. Just last month, a front-page article in The New York Times showed some of the problems and bad publicity that can arise when executives engage in various types of hedging transactions on the stock of their own companies.

One interesting observation is that the Times article lumps all types of synthetic transactions related to company stock under the term hedging. This shows why companies should develop pragmatic policies on types of hedging that require permission and other types that are simply not allowed. For example, while selling call options on stock someone owns is not "hedging the downside risk," it can be interpreted in that way by the media, to detrimental effect. Meanwhile, of course, the strategies that truly deserve criticism are those which shelter executives from feeling the full impact of a drop in company stock price. That is really the kind of thing that should bother the media, not to mention shareholders and politicians.

The Dodd–Frank Act added Section 14(j) to the Securities Exchange Act. Section 14(j) requires companies to disclose, in the proxy materials for annual meetings, whether any employee, director, or executive is allowed to engage in any hedge against the decrease in the company's stock price. It does not matter whether the stock in question was acquired from stock compensation or not. Dodd-Frank lists specific types of hedges, such as prepaid variable forward contracts, equity swaps, collars, and exchange funds. It is not clear whether the rules the SEC develops from Dodd-Frank will cover selling covered call options on shares someone owns. In its current form, the rule is silent on whether the disclosures and policies should address an employee's ability to sell covered call options on his or her shares, a point recently made by Robert Gordon of Twenty-First Securities Corporation.

In an article he recently wrote for The Review of Securities & Commodities Regulation, consultant Mark Borges of the firm Compensia clarifies that this new law does not require companies to have a hedging policy, only to disclose whether they have one (see "The Executive Compensation Provisions Of The Dodd-Frank Act," Jan. 5, pages 1–20). However, the author believes this provision was, in practice, designed to encourage companies to develop a comprehensive hedging policy: companies that do not already have a policy are unlikely to be comfortable with revealing this and may react by adopting a policy that bans all hedging or requires hedging to be preapproved.

Allegations Of Insider Trading Yet Again Prompt The Need For More Insider Training

The SEC, the FBI, and federal prosecutors are preparing both civil and criminal charges against people involved in what is alleged to be "a culture of pervasive insider trading in US financial markets," in the words of an ominous article published by The Wall Street Journal over the weekend. The federal investigation has uncovered ways in which "expert-network firms" provide services to hedge funds and mutual funds by connecting them with current and former employees in a particular industry who are willing to pass confidential market-moving information to traders at the funds. The authorities think the results of the probe may send unprecedented shockwaves through the financial-services sector.

The federal government's renewed zeal to crack down on illegal stock trading has implications for executives and other company insiders with equity compensation. Even insiders with no intention to violate the rules can find themselves under federal investigation, or even charges, for trading company stock at the wrong moment (e.g. through a stock option exercise-and-sell transaction) or by accidentally tipping confidential market-moving information to people who could gain from it. As an FAQ on myStockOptions.com observes, this need to avoid trading on or tipping inside information continues to apply even after executives have left their former companies.

As mentioned above, one focus of the investigation involves the expert-network firms that arrange connections between fund traders and employees in an industry, who are then enticed to communicate sensitive nonpublic information to the traders. It may be easy to think that the insider-trading laws do not apply to this type of information-gathering. However, revealing sensitive confidential information about a company, even if you no longer work for it and do not trade on the information, is an insider-trading violation subject to civil and criminal charges and penalties.

For those who like a quiet life, without probes by the SEC and the Justice Department, myStockOptions.com has a comprehensive set of helpful FAQs on the rules against insider trading and tipping, with a partial focus on people with equity compensation. In addition, our fun free quiz on insider trading will let you test your knowledge to help keep you out of trouble. Recalling an investigation from the last decade, an article elsewhere in the section SEC Law has insightful tips on avoiding insider-trading violations (Prevent A Martha Stewart Moment: Insider Trading In Your Company Stock).

Need to educate your executives and employees about the dangers of insider trading and tipping? The entertaining Think Twice video series for insider-trading prevention is a valuable and memorable training tool. Hundreds of companies have licensed them to educate (and even scare) employees and executives about the importance of complying with the securities laws. The use of Think Twice as part of an overall compliance program can also help a company minimize legal blowback even if charges of insider trading are brought against an employee or executive. It seems, however, that it may be too late for some on Wall Street.