GUEST BLOG: [In]Securities: DOJ Rides a Horse with No Name: Rule 10b5-1 Plans Cannot be Fraudulently Misused

March 3, 2023

a Guest Blog by

DOJ Rides a Horse with No Name:
Rule 10b5-1 Plans Cannot be "Fraudulently Misused"

I swear the simplest route to good government is to impose some suitable punishment for lazy thinking and sloppy writing.

Take, for example, this Department of Justice (“DOJ”) headline yesterday: "CEO of Publicly Traded Health Care Company Charged for Insider Trading Scheme / First Insider Trading Prosecution Based Exclusively on Use of Rule 10b5-1 Trading Plans" (DOJ Release) The lead paragraph went on to say that Terren S. Peizer, the CEO and chairman of Ontrack Inc., was charged with "fraudulently us[ing] Rule 10b5-1 trading plans to trade Ontrack stock." See also "Securities Industry Commentator" at

That’s great! Except . . . it is not possible to "fraudulently use" Rule 10b5-1 trading plans!! As a predicate for securities fraud, a Rule 10b5-1 trading plan is a horse with no name.

To see why, we need to understand what Rule 10b5-1 actually is and what it does.

A Rule 10b5-1 trading plan is essentially a trading order on steroids. A trading plan is just a set of trade orders given to a broker to buy or sell securities, at specific times in the future, at specific or calculable prices. Any instruction that can be reduced to an algorithm can be built into a trading plan. A trading plan could say, for example, “Sell 1000 shares on any day between March 1 and April 30, at prices of $10 or more, but not more than 5% of the volume on any given day and none on April Fool’s day.”

As for what it does, Rule 10b5-1 is one of those few provisions in the securities laws that can help market participants avoid liability. Another one is Rule 144, which provides a “safe harbor” against charges of selling unregistered securities. Rule 10b5-1 provides an “affirmative defense” against a charge of insider trading. Forget for now the technical distinction between a safe harbor and an affirmative defense – that’s too much inside baseball. The point is that these are essentially "get-out-of-jail" cards. If you follow their requirements, you can keep the SEC’s wolves at bay.

But a “get-out-of-jail” card never becomes a “go-directly-to-jail” card. DOJ's press release suggests – more than suggests – that using a Rule 10b5-1 plan can get you into trouble. It just can’t.

A valid Rule 10b5-1 trading plan has two essential requirements. First, that you didn’t have any material inside information when you adopted it; and second, that you don’t interfere with its execution by your broker after you’ve adopted it. If you violate one of those provisions, nothing happens. Literally nothing: The trading plan has simply lost its affirmative defense, and therefore becomes as if it never existed.

But in saying that Peizer was "fraudulently using" Rule 10b5-1 trading plans, DOJ makes it sound as if that is something you can be prosecuted for. It just isn’t. Peizer was charged with selling stock while knowing in advance of an announcement that would crater its price. That is plain vanilla insider trading, which is bad enough but not worthy of the hyperbolic press release DOJ put out. The only significance of his Rule 10b5-1 trading plan, which he allegedly adopted with knowledge of the bad news, was that it had no significance.

I happen to know more about this subject than I should. For five years a decade or so ago I had a gig running the department of Smith Barney that was responsible for Rule 10b5-1 trading plans. We documented, monitored, and administered hundreds if not thousands of them, generally for ultra-high-net-worth officers and directors of publicly traded companies. The interesting thing about Rule 10b5-1 trading plans has nothing to do with anything so blatant as what Peizer is accused of having done. The truly interesting thing about them is the academic research showing that trades made in Rule 10b5-1 trading plans outperform open market trades in the same securities by about 10%. That statistical finding has never been fully explained although a number of hypotheses have been suggested. I've come to conclude two are plausible, one innocuous and one less so.

The innocuous explanation is simply that most Rule 10b5-1 trading plans have fixed limits and automatically will sell securities when those limits are reached. That suggests that the 10% profit differential is simply due to market discipline. The plan forces a sale without the seller’s interference, and in doing so cherry-picks the top of the market.

The less innocuous explanation is that even in so-called open window periods, when all facts about an issuer are supposedly in the public domain, corporate insiders have a better sense of where the company is heading than most people do. In fact, I would argue that if CEOs’ insights into their companies’ futures are not at least 10% better than everyone else's, we should question why they're paid so much. See generally

There is no solution to the first explanation, because it is not really a problem. The solution to the second explanation is fairly simple. It is to impose a so-called “cooling off” period -- prohibiting trades within the first 90 to 120 days after the plan is adopted. That time allows any potential inside information to either dissipate or be disclosed before trades actually start. The SEC’s new amendments to Rule 10b5-1 require such “cooling off” periods. See We will see in the next several years how much of the 10% profit differential vanishes as a result. I'm guessing not all of it will.

If there's any lesson from the Peizer indictment, it is that executives of public companies should not be fooled into thinking that trading in the securities of their own companies is automatically protected merely because they do it inside a Rule 10b5-1 trading plan. If you have material inside information when you set up a trading plan, as Peizer is alleged to have had, then you may prosecuted for insider trading -- and your Rule 10b5-1 trading plan will be as if it never existed.


Aegis J. Frumento

380 Lexington Avenue
New York, NY 10168
Aegis Frumento co-heads the Financial Markets Practice of Stern Tannenbaum & Bell, New York City.  He represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations).  He has decades of experience representing SEC, CFTC and FINRA regulated firms and persons in regulatory enforcement investigations, hearings and lawsuits.  Drawing on his five years managing the Executive Financial Services Department of Morgan Stanley Smith Barney, Aegis has rare depth of experience in the securities and corporate governance laws affecting senior executives of public corporations.  When not litigating, Aegis enjoys working with new and existing broker-dealers, registered investment advisers, and private equity funds, covering all legal aspects from formation to capital raising. Those clients now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises, including the use of cryptosecurities to represent equity and debt interests. 
Aegis's long and distinguished career includes having been a Managing Director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.  He graduated from Harvard College in 1976 and New York University School of Law in 1979.  Aegis is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.  He is the current Chairman of the New York City Bar Association's standing Committee on Professional Responsibility.
NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of Blog.

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