In prior posts I have established I sell RSUs and ESPP immediately upon vesting. However in my case there is a bit more to these questions then that. You see I am considered an insider by my company. What is an insider you ask? The SEC defines insiders as those who are significant shareholders, directors, or have access to non public information. Now let’s be clear, I am not a director of my company. Also if you’ve been reading up to this point you know I am not a significant shareholder. That means I have access to non public information about my company.
What Does It Mean to be an Insider?
The ramification of being an insider is I can only legally sell my company stock at certain times of year. These times tend to be 2 days following announcement of our quarterly earnings and lasting about a month. After that we are in periods of time where I know more about our future earnings projections then the public. As such I am prohibited from trading.
RSU and ESPP Vesting do not line up with Trading Periods
That being said my RSUs and ESPPs often vest at the beginning of the calendar month, long before quarterly earnings. That means all things being as they are I would be forced to hold my RSUs from the point of vesting until after our earnings announcement. An earnings announcement can have a major impact on the value of a company’s stock. Depending on any given announcement this could put significant amounts of my stock related income value at risk. Without this restriction I could just go in the day they show up in my account and hit sell, incurring no risk. Needless to say I need a way to mitigate this risk.
What is Insider Trading?
Insider trading is defined as selling or buying of stock using information that is not publicly available. The thought process is that by trading with non public information individuals are thus harming those who do not have this information. Non Public information could be related to a companies current financial situation, like a company on the verge of bankruptcy. It could also be predictive in nature, for example the release of a new product to market that could significantly impact the company’s future financials.
Why Insider Trading Rules?
The purpose of these insider rules is to keep people from trading on non public information. Doing so can allow people with such information to unfairly profit at the expense of other investors that lack said information. Selling before a loss or buying before a big gain to capture a bigger portion of the investment pie. Insider trading is illegal, whether you get information from working directly with numbers through your employer or hear about it from your neighbor down the street. Insider Trading is not something to play around with unless you want to end up in jail. Receiving or giving said information is illegal. Even the perception of insider trading could lead to massive fines, headaches, and investigations.
105b-1 Trading Plan
The thing is the government provides a way around that perception for Insiders like myself. Insiders can setup what is called a 105b-1 plan. This is a ahead of time trading plan for your stock holdings. The theory is the time lag removes the ability to time trading based on recent non public information. So, I instruct my broker to sell my vested stock immediately upon vesting months or even years ahead of time. In some ways this is beneficial to me, I’ve found my broker sells the stock closer to the exercise date then I otherwise could.
In any case I always include a limit defining the lowest amount I’m willing to take for my shares to avoid the risk of a flash crash. When someone else is automatically selling by definition you have no control over that day’s sales. It’s best to put in some protective measures. (in fact, it’s probably best to always use limit orders when buying or selling stock regardless). When the stock hits my account my brokers promptly sell them. The funds are then dropped directly into my bank account. From there we utilize the funds towards things like next year’s ROTH contributions.
An Aside, Loopholes in Insider Trading Laws
Despite being off topic I can’t help but mention one of the true injustices in the world before I get off my insider explanation. You’ll notice something significant missing from my definition of insider trading. While a purchase or sale of a stock with insider information can result in criminal prosecution, technically the courts have ruled that cancelling a trade does not constitute an illegal act. Originally the SEC itself stated canceling a plan would not be pursued. After some pressure they have backed off that position somewhat depending on their finding of the person’s intent. In any case an immoral person could cancel their plan if they note upcoming bad news. I have higher moral fiber then that, but its important to realize that even with these limitations some unscrupulous individuals can utilize loopholes to their advantage.
Evidence Shows Insider Trading Laws are not Effective
One would think such plans would limit the ability of executives to game their insider knowledge for personal gains. However the statistical evidence does not back up that conclusion. Evidence shows that executives tend to make consistent profits using trading plans despite the implied protections. This statistical evidence shows insider trading is neither rare nor controlled. In 2006 a study found on average trades under 10b5-1 plans outperformed the market by about 6% after six months. Even if they are not canceling plans they could be gaming the system in other ways. For example another way around said plans is timing the release of news around planned trading dates.
So if Insider Trading is Common Why Should You Still Invest?
Insider trading plays a big part in short term day to day moves, if we trust the statistical evidence. Beyond Insider Trading some have raised concerns of the unfair advantage high speed trading gives. But in both cases there is a commonality. We’re talking about short term quick changes to the market. If you buy and hold for the long term these moves largely do not matter. After all if you are not triggering the selling of an index fund due to short term noise then it does not really matter how quickly others can respond to said noise. In a way insider trading is just another justification for long term buy and hold index investing.
Are you an insider of a Public Corporation? Were you aware of Insider Trading Rules?