Last week’s news that the CEO of Telsa Motors, Elon Musk, had exercised stock options with an estimated value of $100 million spread like wildfire. Picked up by the national news outlets – the news was well covered. It’s not every day that a CEO exercises $100M worth of stock options and pays cash for the taxes (yes, the company confirmed he paid cash for his taxes). This was a cash exercise with no sale involved. As I read several articles on this transaction, I realized there is still much taken for granted when an executive transacts in the company’s stock. I’ll cover highlight some of those areas in today’s blog.
The article that caught my rapid attention was Forbes’ “Elon Musk Exercising Stock Options Could Mean Tesla Will Disappoint Next Week.” Now, before I get too far down this path, I have to say I know nothing about Tesla’s inner-workings and nothing about their earnings. So anything I am saying IS pure speculation. The title of the article got me interested, though. I mean could the exercise of stock options really, single handedly foreshadow less than stellar earnings? If I had to dissect that assumption, my own thoughts went to something far more benign – I mean, what if the CEO had a 10b5-1 plan (after all, these options that were exercised were scheduled to expire in December 2016) that was merely acting on autopilot in an attempt to exercise these stock options before they expire? I have no idea whether Tesla’s CEO has a 10b5-1 plan or not. According to Tesla’s proxy statement, 3 officers do have 10b5-1 plans. And, according to the NASPP’s 2014 Domestic Stock Plan Administration Survey, co-sponsored by Deloitte, of the companies that do allow (but not require) 10b5-1 plans for insiders, 62% of CEOs of those companies were using the plans. Is it possible? Yes, it is. Do we know? No, we do not. That’s not even the point, though.
What does a 10b5-1 plan have to do with things taken for granted? These plans got some negative publicity a couple of years ago when the SEC looked into whether or not the plans, in principle, were being abused. There were some situations where it appeared that 10b5-1 transactions were well-timed around negative news – as in the company may have delayed or accelerated the timing of that news around the planned transactions. Nothing much ever happened from that speculation, and, for the most part, I’d venture to say these plans are not being abused. Rather, this type of plan works fairly well if used as intended, especially in aiding executives and other insiders to put distance between their decision making about their shares and the execution of those transactions. What worries me is that the possibility of a 10b5-1 plan’s existence still often seems to be overlooked when the media casts the spotlight onto these larger, high profile transactions. Not all of it is their fault, though. There is no present requirement for the existence of a 10b5-1 plan to be disclosed. Some companies voluntarily disclose the existence of plans and subsequently footnote their Form 4s noting transactions that occurred pursuant to a trading plan. Without disclosure, the media remains unaware that the executive may be operating under one of these plans. Does disclosure need to happen? The law firm of Morrison and Foerster summarized that consideration in an FAQ on 10b5-1 plans:
Should a Rule 10b5-1 plan be publicly announced?
A public announcement by any person of the adoption of a Rule 10b5-1 plan is not required. A company may choose to disclose the existence of certain Rule 10b5-1 plans in order to reduce the negative public perception of insider stock transactions. A company making such disclosu
re generally will disclose the existence of a plan but not the specific details. Typically, the disclosure will be for executive officers, directors, and 10%
shareholders required to file ownership forms under Section 16(a) of the Exchange Act (that is, Forms 3, 4,and 5). A company can choose whether to announce the existence of a Rule 10b5-1 plan by a press release followed by a Form 8-K or solely by a Form 8-K. The applicable Form 8-K item is Item 8.01, although Item 7.01 may be used under appropriate circumstances.
If a company decides to publicly announce the adoption of a Rule 10b5-1 plan, it is advisable to publicly announce changes to or termination of such plan as well. Under the Dodd-Frank Act, the SEC is required to implement a regulation prescribing disclosure by reporting issuers of their hedging policies. The proposed rule, if it becomes final in its current form, may result in more companies disclosing the existence of trading programs of executive officers.
While we await final hedging rules from the SEC, companies may consider proactively looking at their 10b5-1 disclosures and the potential positive potential such disclosures could have on mitigating public perception of their executive transactions. Disclosing the existence of a plan and attributing transactions related to an automatic plan in a Form 4 footnote may go miles in helping to ease some of the rampant speculation around transactions that could occur absent this information.
We won’t know anytime soon if CEO was operating under a 10b5-1 plan when he exercised his stock options, but if he did, a footnote on the Form 4 could have alleviated some of the speculation about the timing of the transaction and its relationship to earnings and other important company events.
-Jenn
Tags: 10b5-1 plan, hedging, stock option exercise
It’s been about 15 years (yikes, already?) since the SEC adopted Rule 10b5-1. For those new to the concept, a 10b5-1 plan may be best explained as a device that allows company insiders to trade in the company’s securities pursuant to a pre-arranged trading plan or instruction. The pre-arranged element is intended to help the insider avoid automatic liability for insider trading and serve as an affirmative defense to claims of insider trading. While there have been many benefits to enacting such trading plans, 10b5-1 plans have not escaped scrutiny from the SEC. I won’t cover that particular scrutiny in today’s blog, but will tackle another unintended downside: the impact of well-intentioned, pre-determined trades on a company’s stock price.
Haven’t We Seen It All?
In recent years we’ve seen the gamete of questionable situations that arise from having a 10b5-1 trading plan. Did the executive really not have material non public information at the time they created the plan? Or, on the flip side, did the executive time that press release to be just before or shortly after the trade already set to occur in his or her 10b5-1 plan? The thing these scenarios have in common are that they raise a question as to whether a specific individual should have indeed been able to trade in the company’s stock, in spite of having a 10b5-1 plan. We could cover a lot of examples of these instances. But today I want to turn to one thing I hadn’t heard of until recently, a circumstance that had nothing to do with the ethics of the trades executed under an individual’s 10b5-1 plan. It appears to be a completely, unintended consequence of the executives and company being well intentioned and yet still generating some ripples about it.
It Started With A Tweet
On February 9, 2015, CNBC’s Jim Cramer sent a memo to the board of social media darling Twitter. The essence? Stop 10b5-1 trades, because the flow of these trades (albeit pre-timed and planned) are hurting the company’s stock price. As CNBC reported, the actual memo said: “Memo to the board of directors of Twitter: Someone suggest that there be a moratorium on selling stock for a bit, maybe six months, maybe a year, to show that you believe in the company… If I were on the board I would simply say, ‘Hey guys, could you give it a break for a while because you are now telling a good narrative about user growth and engagement and you are starting to get people excited again about the company and its stock and your selling makes them feel foolish.’”
The activity that prompted the memo was a series of sales of stock by top executives at Twitter in the weeks and months prior to the memo. Although the trades were done pursuant to 10b5-1 plans, several were executed in close proximity to each other, bringing in millions of dollars to Twitter executives ($8.5 million to its CEO in January and February alone, with a similar amount to its founder and chairman, and $1.8 million to another executive). Although it may be argued that the trades were executed based on long, pre-planned directives, the quantity and dollar value of the shares liquidated seemed to be sending a message that the executives were dumping stock. Not to mention simultaneously releasing thousands of shares into the market.
So what happened? What did the Twitter board do? The company has not commented on the matter, but in a Fortune article citing exclusive information (Exclusive: Twitter execs put stock sales on ice – April 22, 2015), it appears that the memo was received and action taken. Fortune cites having multiple sources who confirm a moratorium on 10b5-1 transactions, save one insider who continues to be permitted to sell stock. Aside from the transactions of that lone insider, no other 10b5-1 transactions have occurred since February 6, 2015. It’s not clear if the company canceled plans or simply did not renew them. Whatever the details, the end results appears to be a moratorium. Since that time, Twitter’s stock price has risen approximately 25% (as of the date of the Fortune article). You be the judge. Did a halt in insider trading activity send a positive message to shareholders, resulting in an increased stock price?
Takeaways
While the Twitter scenario is the first I’ve heard of this type of moratorium, in particular initiated by a party external to the company, it certainly provides food for thought. Social media has given a voice to many – shareholders, customers, media, and others. It’s quite simple to send a message to a company, including its board of directors. And in this case it seems the message was heard. This raises the question – do other companies need to worry about how their 10b5-1 plan trades are perceived by the market? I don’t have a definitive answer on that, but I do have some suggestions.
Consider the potential timing of trades when approving 10b5-1 plans. One thing companies should consider, if they haven’t already, is how the future trades may be perceived by shareholders in the best and worst of trading scenarios. If an insider has multiple stock price targets to trigger sales, for example, and all those targets are hit in a short period of time given a rapid rise in stock price, how will those multiple trades be perceived?
Evaluate how many plans have similar triggers. Companies approach evaluating and approving proposed 10b5-1 plans differently. One thing to assess is just how many insiders have plans or propose plans with similar triggers. If five executives want to sell shares when the stock price reaches $50, this could result in a large volume of shares and transactions hitting the market all at one time. I’m not a 10b5-1 expert, but it seems there has to be a way to monitor existing plan terms and match those up against those proposed by new trading plans. If volume of shares and shareholder/market perception is a potential concern, perhaps the company can establish collective limits (as a matter of policy) as to how many shares can be sold at a given price or under a certain trigger. I may get flack for even suggesting this option, but I’m throwing it out there. Should companies, as a matter of policy, restrict the number of shares that can be sold under a trading plan, or, even a limit on shares sold cumulatively – based on the collection of all existing plans? This would certainly have helped Twitter buffer against the influx of shares into the market earlier this year.
This type of unintended aftermath of 10b5-1 trades feels like new territory. I’d love to hear from anyone who has (as a matter of policy) specific limits to prevent an influx of shares into the market, or who has ideas about best practices to help companies avoid a public call-out like Twitter received. Although they haven’t publicly admitted to any action taken, if we are to listen to the “sources” in this matter, kudos is due to Twitter’s board for handling the situation in a constructive way.
-Jenn
Tags: 10b5-1, 10b5-1 plan, insider trading, Rule 10b5-1, Twitter
I realize the title of my blog is somewhat broad – I mean, I’m guessing that highly paid CEOs have a lot in common (a nice office, fancy cars, access to private jets, world travel…). Alright, daydreaming aside, I’ll kill the suspense and answer my own question. In today’s blog I’m angling for an answer along the lines of “at least $95M each in income last year from stock compensation”.
With a rallying stock market, a legendary IPO and other favorable factors, the 10 most highly paid CEOs in 2012 (based on a recent poll by GMI Ratings – a corporate governance rating group) all earned in excess of $100M. The top two in that group earned in excess of a billion dollars. “Ah, so what?”, I thought. Then I looked a little closer and realized that that largest cash bonus in that group was $9.5M. The landslide majority of that compensation all came from stock compensation – both restricted stock and stock options.
It’s been a banner couple of years for executive pay. Once again, equity compensation appears to be squarely on top of the executive compensation pie. Of course the concerns about disproportionate gains (executives who are winning big while shareholders still are not) have surfaced, too. I’m going to avoid that discussion today, but if you’re interested in more on that topic, see Broc Romanek’s recent blog. Remember, the GMI Ratings information reflects 2012 compensation. With the stock market soaring, it seems that 2013 may even outpace 2012 in terms of realized gains on stock compensation.
When I start to see such record gains from stock compensation, and the corresponding publicity, I think about several things that stock administrators should consider:
- Prepare for trading activity. As year-end draws near and the stock market is going gangbusters, this seems to be the perfect combination for increased trading activity from executives. Even those with 10b5-1 plans may still lead to increased activity – if the 10b5-1 plan was based on a series of limit orders, those limits may execute quickly in an up market. Tax and financial advisers may also encourage executives to liquidate some of their position for one reason or another. This means there could be a surge in executives looking to trade in the coming weeks (requiring availability for pre-clearance procedures, and assurance the executive knows who to contact to execute the transaction).
- Consider whether there will be say-on-pay considerations for your upcoming proxy season. Is your company up for a say-on-pay vote this coming proxy season? With record executive compensation, there is bound to be scrutiny as to how those gains compare to shareholder returns. This opens the window to more of a microscope when the say-on-pay filter is applied. Even if you don’t get overly involved in the proxy preparation, given that a huge portion of executive compensation may have come from stock option or restricted stock transactions, you may need to be more involved in providing information for the disclosures. Now, for those who yawn at the mention of say-on-pay, let me just go tangential for a second to say that as of last week, there were 64 companies so far this year with a failed say-on-pay vote – already exceeding the 61 failures in all of 2012. So this is not an area where bygones have become bygones.
- Is it time to beef up year-end communications? Have you been considering sprucing up the old examples you use in your year-end communications? With an up stock market, I’m guessing the equity compensation windfalls may not be limited to just executives. With more employees cashing in on market gains, they are bound to be more interested in your year-end communications. Now’s the time to consider enhancing those communications with more detail and timely examples in order to proactively address employee questions. Remember, this is the first year some of those quirky taxes (like the additional medicare withholding rate) kick in, so employees may not be fully aware of how they may be or have been affected by these changes.
Who doesn’t love a good stock market rally? As keepers of the stock plans, this is what we hope for when we issue those grants and/or awards. Try to keep that in mind during those times when volume of transactions is up, and more year-end preparation is needed.
-Jennifer
Tags: 10b5-1 plan, employee communications, executive pay, restricted stock, Say-on-Pay, stock option