Corporate Governance

Eric Klein and Bruce Vanyo were contributors to this article.

Corporations today are under constant pressure from the media, the public, and the government to demonstrate that they have good corporate governance practices in place. The Securities and Exchange Commission is closely examining 10b5-1 trading plans of company executives. Boards of directors are increasingly involved in compliance issues. And the courts are beginning to make some decisions on stock options backdating cases. Another major issue for public companies is the enormous expense of complying with Sarbanes-Oxley.

Our panel of experts discuss these issues and provide some guidance on how to respond to these developments. They are Eric Klein and Bruce Vanyo of Katten Muchin Rosenman, Darryl Rains of Morrison & Foerster, and Jahan Raissi of Shartsis Friese. The forum was moderated by Editor Chuleenan Svetvilas.

MODERATOR: The SEC is turning attention to 10b5-1 trading plans. What is the effect of this increased scrutiny?

KLEIN: A 10b5-1 trading plan allows for stock to be sold on what we can call a preprogrammed basis, where a plan is established and the executive whose stock is to be sold doesn't have specific control over the timing of the stock sale. Instead it's done through a broker and with preestablished criteria.

What's put this onto the radar screen most recently is a study that came out of Stanford. Professor Alan Jagolinzer found that executive stock trades under the 10b5-1 plans actually performed better than executive trades that were not under the plans, and he noted a 6 percent performance increase. He looked at quite a large number of trades, a good number of companies, and that study has been cited by the SEC in various speeches.

It also doesn't help in the Qwest situation that [its former CEO Joseph] Nacchio, who was recently convicted, was found to have aggressively used 10b5-1 plans. The mechanism that's being used right now for the so-called abuse is the fact that executives have great flexibility to start up, amend, or terminate the plans and to have multiple plans, which could allow for market timing by executives.

RAISSI: The director of the enforcement division of the SEC gave a speech, and one of the themes was follow the money, which is what they are doing here. When 10b5-1 plans came into existence, the spirit was that if an executive puts a plan in place at a time when that person has no inside information and essentially puts their stock sales on automatic pilot, they are in a safe harbor for insider trading. What may have happened in some instances is that people have gamed the system a little bit to essentially cover ordinary trading, meaning making decisions about when to sell and when not to sell under the cloak of a 10b5-1 plan.

So what you have seen, anecdotally at least, are situations where people will implement a plan and have concentrated large-volume sales very quickly right before a stock goes down. In other instances, people adopt a plan, sell heavily and then terminate the plan, only to adopt another one some time thereafter. The concern is that they are selling when they want to sell, stopping the plan when they don't think it's a good time to sell, and using another plan to begin selling again. It's something that the SEC has made very clear they are going to take a look at. My guess would be they are going to find some problems in some cases but not that many.

RAINS: We shouldn't send the wrong message. 10b5-1 plans are the single best tool for reducing insider-trading risk. They are even better than the usual insider trading policy with window provisions. I'd hate for executives to avoid 10b5-1 plans because of the recent publicity and SEC activity. You shouldn't throw the baby out with the bath water.

RAISSI: These are definitely good plans. If I were an executive and I wanted to sell a large block of my company's stock, you better believe I would use one.

VANYO: The plans have been very beneficial and they've been very helpful in defending cases, as you can pretty much preclude sales that are made pursuant to 10b5-1 plans. The question is: what is the impact of the Stanford study? It's an odd study in that it finds that there seem to be trades that are unexplainable other than by gaming the system. I don't know how much data underlies it. The study also concludes that these trades are "not material." It's not clear in that context what it means. The SEC, of course, could conclude differently and find specific trades that would be material. I'm sure the SEC will be seeking all of the data the professor used, and we'll see what comes out of that.

When these plans first started, executives were very enthusiastic about them. They wanted to set something up to diversify their portfolios and not have everyone question them. But I've also seen people starting to game it and finding that when they thought the company was starting to head in the wrong direction, they would create these plans, and when the company started to pull out of that, they would abandon the plans. I've even seen situations where they would terminate one plan and change the price at which they were going to sell the stock and implement another plan, which is not really what the SEC intended by this.

So we will see changes come out of this and [Linda] Thomsen has declared that there will be a study. You may see a bunch of investigations that come out of it if the data is there in the Stanford study. You are going to have to do...