Is it legal for a CEO to sell shares before bad news?

What does the SEC rule say about awareness?

The rule is short. Rule 10b5-1 says that a purchase or sale is on the basis of material nonpublic information for the purposes of Section 10(b) and Rule 10b-5 if the person making it was aware of that information when the purchase or sale was made. The rule adds that the law of insider trading is otherwise defined by judicial opinions construing Rule 10b-5. In other words, the legal question is about what the seller knew at the moment of the trade, not about what happened to the share price afterwards.

That is why the timing of a sale, taken alone, settles nothing. A chief executive can sell shares in the weeks before a bad announcement and have done nothing wrong, or can sell with knowledge of something not yet public and have a legal problem. Which of the two applies is a matter for the SEC, prosecutors and courts to establish from evidence that a public filing does not contain.

What is a Rule 10b5-1 plan?

The same rule gives traders an affirmative defense. According to the SEC's fact sheet on the 2022 amendments, the defense applies where, subject to conditions, the trade was made under a binding contract, an instruction to another person to execute the trade, or a written plan adopted when the trader was not aware of material nonpublic information. In practice, an executive sets up a schedule (sell this many shares on these dates, or when the price reaches this level) while unaware of any such information, and the sales then run on the schedule.

OQRO's separate article on Rule 10b5-1 plans and insider sales explains how to recognise a planned sale in a filing.

What is a cooling-off period?

Before the 2022 amendments, a plan could in principle be adopted and used soon afterwards. The SEC's fact sheet lists the conditions added to the defense for plans adopted under the new rule:

The fact sheet also says that Forms 4 and 5 must show, by a checkbox, that a reported transaction was intended to satisfy the defense, for reports filed on or after 1 April 2023, and that companies must disclose quarterly the adoption and termination of such plans by their directors and officers.

How can you see a sale on a Form 4?

A chief executive is an officer, so a sale is reported on a Form 4 within two business days of the transaction, as the SEC investor bulletin explains. The form shows the number of shares, the price per share and a code (S for a sale on an exchange or to another person). The current Form 4 carries the Rule 10b5-1 checkbox described above, and its instructions refer to a transaction made under a contract, instruction or written plan intended to satisfy the defense.

Reading the date of the sale next to the date of any later announcement is easy. Reading the insider's state of mind from either date is not possible. For the mechanics, see how to read a Form 4, and the insider trades page lists recent filings with plan-based sales kept apart.

How can you read such a sale in a filing?

A short checklist, using only what the filings contain. First, read the date of the sale on the Form 4 and the box for Rule 10b5-1. Second, read the footnotes, where filers can explain that a sale was made under a plan. Third, for a plan adopted under the amended rule, compare the dates with the cooling-off periods in the table above: for a director or officer, trading under a new or modified plan cannot begin until the later of 90 days or two business days after the results for the quarter in which the plan was adopted, up to 120 days. A sale that falls inside that window under a plan adopted after the rule took effect is something to read carefully in the filing itself. A filing cannot settle any of these points; it gives you the dates to compare.

What this does not tell you

A Form 4 does not say why someone sold. The SEC's own bulletin states that insiders may sell company securities for any number of reasons, including liquidity and diversification. A checked plan box shows that the insider told the SEC the sale was meant to fall under a plan, not that a court has found the plan valid. A sale with no plan box checked is not a finding of anything either. Nothing in a filing shows what the person knew.

This article describes the rule as the SEC published it. It is not legal advice, and it does not suggest that any particular sale was improper.