(Excerpted from Stanford GBS News)
High-profile legal cases, alleging misconduct by executives at Countrywide Savings (CFC), Novatel (NVTL), and Qwest (Q), may be prompting the Securities and Exchange Commission to rethink rules that permit scheduled trading by insiders. One catalyst for this second look is research by Alan Jagolinzer, an accounting professor at the Stanford Graduate School of Business, whose work indicates that prearranged trades allowed under the so-called “Safe Harbor Rule” may be less innocent than they appear.
Rule 10b5-1, adopted in 2000, allows corporate executives to make prearranged trades at specified prices or dates in the future. The idea, explained Linda Chatman Thomsen, director of enforcement for the SEC, was to give executives a safe harbor to proceed with these prearranged trades and”give executives regular opportunities to liquidate their stock holdings—to pay their kids’ college tuition, for example—without risk of inadvertently facing an insider trading inquiry.”
But citing Jagolinzer’s work in a published, Washington, D.C., speech, Thomsen said:”Recent academic studies suggest that the Rule is being abused. The academic data shows that executives who trade within a 10b5-1 plan outperform their peers who trade outside of such a plan … ; it ought to be the case that plan participants should be no more successful on average than those who trade outside a plan.
The difference seems to be that executives with plans sell more frequently and more strategically ahead of announcements of bad news. This raises the possibility that plans are being abused in various ways to facilitate trading based on inside information. We’re looking at this—hard. - SEC’s Linda Chatman Thomsen
Although Jagolinzer’s paper,”SEC Rule 10b5-1 and Insiders’ Strategic Trade,” was recently published in the February 2009 issue of Management Science, his preliminary work was completed earlier, and the researcher briefed the SEC on his findings in December 2006, four months before Thomsen’s speech.
The”harder look” prompted in part by Jagolinzer’s research may already be changing the behavior of insiders. Last year, usage of these plans declined, possibly because of SEC scrutiny, according to a Reuters news agency report, which attributed the information to Equilar, a research firm. Stock market declines may also have prompted participants to suspend activity as the year drew to a close, Equilar said.
What’s more, the SEC recently released new interpretive guidance that outlines how insiders are expected to comply with Rule 10b5-1 trading plans. A spokesman for the SEC said the commission will not comment further on its use of Jagolinzer’s research.