When it comes to wealth management, corporate executives who receive at least some of their compensation in the form of equity—stock options, restricted stock units (RSUs) or performance share units (PSUs) —face unique challenges.
There are two key issues involved in any effort to manage equity compensation. Executives, who generally have detailed inside knowledge of company operations and strategy, must manage the sale of these assets within the framework of insider trading rules set up by the U.S. Securities and Exchange Commission (SEC). In addition, as discussed earlier in this series, corporate executives need to carefully consider how to manage these assets within the framework of their own wealth management goals.
The good news is that executives can leverage the procedures for stock sales by insiders contained in SEC Rule 10b5-1 to manage both of these issues. First, Rule 10b5-1 can provide an affirmative defense to insider trading, if one is ever required.
Second, the stock trading plans necessary to have this Rule 10b5-1 protection can also be leveraged to create a disciplined approach for executives who want to sell some or all of their company stock and diversify their assets. When structured properly, 10b5-1 plans can act as a strategic tool for gaining greater control over equity compensation.
Equity grants represent earnings for corporate executives, which adds to the complexity of how they are perceived and managed. Equity grants do not have an initial buy side associated with a typical stock transaction.
Because executives do not purchase these shares, they may not always manage this part of their wealth as objectively as the rest of their portfolio. Without a detailed plan for holding or selling these shares over time, executives risk accumulating a concentrated position in company stock that can greatly increase the level of risk in their portfolio.
When executives do decide to sell company stock, another set of issues arises. Executives are often restricted on when they are permitted to transact in company stock. Put simply, executives cannot trade in their company's stock when in possession of material nonpublic information (MNPI). There are laws, regulations, and compliance programs designed to prevent this by imposing quarterly restrictions on insider trading leading up to earnings releases, and impromptu blackout periods before announcements that could impact company stock price, such as a pending merger or acquisition or other material announcements.
The SEC’s Rule 10b5-1 is designed to provide an affirmative defense against allegations of insider trading by allowing executives to establish pre-approved advance trading plans for the systematic execution of company stock trades. To create a compliant 10b5-1 trading plan, the executive involved must enter the plan in good faith and cannot have access to MNPI when the plan is formalized.
Executives do have some leeway when structuring 10b5-1 trading plans. For example, the plan can identify when to sell specific stock grants and at what predetermined prices. Once in place, 10b5-1 trading plans automatically trigger stock sales without additional action by the shareholder and irrespective of future blackout periods or corporate pre-clearance. In other words, the plan will be executed automatically behind the scenes.
Multiple advisors at Blue Chip Partners hold the Chartered Market Technician (CMT) designation – a credential held by few in the private wealth management community. This allows our team to provide individual stock analysis, which can be particularly valuable when an insider is considering selling a portion of their concentrated position. Potential transactions can include trading directly held shares, or equity compensation in the form of vested Restricted Stock Units (RSUs), Performance Share Units (PSUs) and stock options.
Expressions of opinion are as of this date and are subject to change without notice. The information provided does not constitute tax, legal, accounting, or other professional advice and is without warranty as to the accuracy or completeness of the information. Any information provided is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation to buy, hold or sell any security. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. There are limitations associated with the use of any method of securities analysis. Indices are included for informational purposes only; investors cannot invest directly in any index. Every investor's situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Past performance does not guarantee future results. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that any statements, opinions or forecasts provided herein will prove to be correct.