The Inside Scoop on Insider Trading

Key Takeaways

The inside scoop on this episode? The hosts talk to Brandon Ziegler, chief legal officer at Workiva, about insider trading and how executives might get themselves in trouble, even when they have 10b5-1 plans that are meant to help them steer clear of it. 

 

 

The Inside Scoop on Insider Trading

Steve: Hello, and welcome to Off the Books, where we're surfing the unchartered waters of accounting, finance, risk, and wherever else the waves take us. This episode is brought to you by Workiva, the risk, reporting, compliance, and winter fashion-ready platform that simplifies your complex work. Check it out at workiva.com/podcast. My name is Steve Soter, accounting enthusiast, Diet Coke aficionado, and today's host. I'm looking forward to debiting a great conversation, and I'm very glad to have you hanging in with us. I'm also very glad to have Catherine Tsai hosting with me. Catherine, can you please tell the fine folks who you are?

 

Catherine: I'm not an accountant or a Diet Coke aficionado, but I like asking questions, learning new things, and writing about it later. So I'm here to learn.

 

Steve: Well, thank you, Catherine. So today we're talking about insider trading, and no, that's not what you call it when you take the meat from your sandwich and trade it for the meat in your friend's sandwich. To find out exactly what insider trading is, we sat down with Brandon Ziegler, who is the general counsel of Workiva and is a very nice guy to boot.

 

Catherine: And side note: the SEC actually moved faster than we did. Not long after we talked to Brandon, they proposed a rule covering exactly what we asked him about.

 

Steve: That's right. We're talking to Brandon about how executives trade in the stock of their companies, and this new rule proposes some additional reporting and some waiting periods, which Brandon actually surmised would happen.

 

Catherine: All right, let's jump in.

 

Steve: Well, Brandon, welcome to Off the Books, and thank you again for joining us. So to get us started, can you tell our audience a little about yourself?

 

Brandon: Sure. And thanks for having me on the program. I've worked in the SaaS industry for almost 15 years in industries as diverse as human capital management and clinical trial software before coming to Workiva. I started as general counsel of Workiva in March of 2020, just as the pandemic shut everything down. So I've onboarded in very unusual circumstances, to say the least.

 

Catherine: Brandon, thanks for coming here today. I was hoping to ask you a little bit about 10b5-1 plans and insider trading. But just toget started, can you tell us a little bit more about what insider trading is?

 

Brandon: Insider trading is when a person buys or sells stock of a public company based on information that is not available to the public.

 

Steve: So, Brandon, it kind of begs the question. Executives and even many employees of companies are, by definition, insiders. And of course, they often get compensated by stock. So in order for that compensation to be meaningful, presumably they're going to sell it at some point. But how do they do it based on that definition of what an insider is, which again is illegal?

 

Brandon: Corporate executives are constantly exposed to material nonpublic information or sometimes referred to as MNPI for short. This can make it, as you point out, very difficult for them to sell company stock without the risk of insider trading. Or at least claims of insider trading. To help solve this problem, Congress developed the safe harbor in rule 10b5-1. Generally, rule 10b5-1 allows an insider, when they're acting in good faith and when they don't possess MNPI, to establish a plan to trade company shares with pre-established dates or formulas or other methods, as long as they're not subject to any additional influence by the insider without the risk of insider trading. But to be effective, the agreement must comply with the specific requirements of the rule, and then the rule will provide an affirmative defense against allegations of insider trading designed to show that the stock trade was not made on the basis of MNPI. If a 10b5-1 plan is properly established, the issue is no longer whether the insider had material nonpublic information at the time the stock was bought or sold. Instead, the analysis is conducted at the time the plan is established.

 

Steve: OK, so this all sounds simple enough. If I'm a company executive, I need to put one of these plans in place that dictates when to sell as long as I don't have any insider information when I put the plan in place, and I guess if I did that, then I'm OK. Catherine, is that what you heard?

 

Catherine: I think so. But aren't there plenty of people who have had company stock and sold it without one of these plans?

 

Steve: Yes, including me. As a matter of fact, I've never had a 10b5-1 plan, and I have been fortunate enough to have company stock at a handful of different places. We did have a chance to ask Brandon, and here's what he had to say about that. If I don't have one of these plans, then if I'm one of these executives or employees that have stock, I can only sell if I don't have MNPI. So maybe like right after an earnings release, I think is a pretty common time. We've told the market everything that there is to know. As employees we're now in as much in the dark, often as anybody else is. Or I create this plan that then has certain triggers like, hey, if the stock does this or if the stock does that or whatever, go ahead and sell. And I put that in at a time when I have no MNPI, but then that actually is sort of set on autopilot. It executes as the plan lays out. And then again, I've got a defense to say, hey, I put this together a long time ago, or at least at a time when I did not have information that the public didn't have. So therefore, these sells could not have been driven by any insider information. I mean, is that, Brandon, an accurate way of summarizing what you just described about a 10b5-1 plan and how it works?

 

Brandon: Yes, I think that accurately restates it.

 

Catherine: And then how does that protect investors?

 

Brandon: Well, insider trading is illegal to begin with because it gives the insider an unfair advantage in the market that allows them to profit from information about a potential up or down tick in a company's stock before other participants in the market. It puts insiders' interests above those to whom she might have a fiduciary duty, and it could allow insiders artificially influence the value of the company's stock.

 

Catherine: OK, so we're putting everybody on a level playing field there.

 

Steve: Catherine, there's a reason we're talking about all this now, and it's because it's been in the news quite a bit lately. What's been going on?

 

Catherine: Well, there have been a few headlines from time to time about questionable trades under 10b5-1 plans. But more recently, The Wall Street Journal reported on some interesting trades by the father of the CEO of Carvana. He sold tens of thousands of Carvana shares, under a 10b5-1 plan, which set out a predetermined schedule of trades so they wouldn't appear to be influenced by inside information. But then he modified his plan a few times to trade more shares, and all told, he gained something like hundreds of millions of dollars. So that doesn't seem to fit in with the spirit of what was intended with 10b5-1 plans. So I wanted Brandon's take.

 

Steve: Well, I actually interviewed for a job at Carvana a long time ago and actually wondered how that could have turned out. Meanwhile, you and I, of course, were wondering about your question for Brandon, and here's what he had to say.

 

Brandon: It's important to understand that we don't know whether any malfeasance has gone on there in this case at this point. It's early days yet. What is unusual about that scenario is, is the number of modifications that were done on a plan of that size. And right now, there are new rules around how many modifications you get or how you make modifications to a plan other than the fact that you can't make those modifications while in possession of material nonpublic information. So we'll see how what the investigation uncovers to get further guidance from the SEC about what you can and can't do about these plans. That's why there's been a lot of scrutiny around how these plans are implemented in practice, and this is in fact what Chairman Gensler is starting to focus on. Actually preceding, and current, chairs of the SEC have thought about this a lot, as well as are based upon a lot of academic research that's been done on 10b5-1 trading plans. And this is what's driving some of the controversy today and what is causing Chair Gensler to focus a little bit more on the implementation of these plans.

 

Catherine: So Steve, while we don't know all the details behind these transactions and we certainly wouldn't accuse anyone of wrongdoing, it certainly seems like there's room for someone to get aggressive with these plans. Is that what your take is, too?

 

Steve: Yeah, it certainly is. And in addition to that, it makes me wonder what the SEC is thinking about all these potential loopholes. I actually had no idea that you could do all of those things with the 10b5-1 plan. But first, dear listener, we're going to send you down a quick loophole to a commercial, and we'll be right back.

 

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Steve: Welcome back. We left off talking about what the SEC might be doing about some of the potential loopholes in 10b5-1 plans. And so we asked Brandon for his insights. So I'm delighted that you brought up Chair Gensler because that was something that we had looked at in preparation for this conversation. He's made a lot of comments about it. And of course, we're referring to the new SEC chair, Gary Gensler, who began his service in April. So Brandon, talk about that just a little bit, what he's suggesting that bad actors might be doing with these 10b5- plans.

 

Brandon: Sure. The first one around cooling off periods, you know, research shows that many plans initiate their transactions within the first two months of entering into the plan. And some in the SEC have advocated for four to six month cooling off periods. As far as the cancellation of plans, as you observed, insiders can cancel the 10b5-1 plan even if they do possess material nonpublic information that could influence the decision to cancel. So you can't get sued for not trading. And the chair thinks that cancellations while you have MNPI could be as economically significant as carrying out an actual sale or purchase in the form of loss avoidance. As you point out, some insiders can enter into and cancel multiple plans that may convey the impression that they can pick and choose among several plans that they please.

 

Steve: So again, I'm going to exaggerate here just a little bit, but it sounds like if somebody was to get really aggressive -- an executive was to get really aggressive with these 10b5-1 plans -- even if you presume that they had no material nonpublic information at the time of the plan, they could say, well, if our performance does this and it gets really, really good, here's what I think the stock could be. So maybe I'll put in a 10b5-1 plan to address that. But if the stock, you know, if our performance isn't great and the stock kind of goes down well, then maybe I'll put in another 10b5-1 plan to address that. And then based on whatever happens, I could just cancel the plan that didn't benefit me economically, and then I would be set and be in compliance with the law. Sounds like if nothing else, an SEC rule would probably address some of those things.

 

Brandon: In terms of multiple overlapping plans, the aggressive insider could game out different hypotheticals as to how the company is going to do, put all these plans into place, and then when they have better insight into what the outcome might actually be, they simply terminate the plans that are not favorable to them. Again, there is no rule prohibiting termination of plans, even while in possession of material nonpublic information. So that's exactly right. In terms of the disclosure obligation that you referred to, Steve, again, there's just this lack of transparency, lack of visibility.

 

Steve: Catherine, I found that really, really interesting what Brandon had to share, and I know that you also had a really good follow-up question for Brandon that actually led us to a pretty surprising insight that he shared with us. Before we get to the insight, could you tell the listeners about the question you had?

 

Catherine: Yeah, I was wondering if you or Brandon had ever been pressured to create a 10b5-1 plan for the wrong reasons, or if you've ever had to step in to stop someone from making a questionable trade?

 

Steve: Well, I'm glad that you brought that up because his response took a very unexpected turn. I can say our audience is going to be less than satisfied with my lack of anything juicy. But like I said, Brandon's got some great insights. Let's give it a listen.

 

Brandon: Well, it's not so much that the insider is looking to game the system in my personal experience, more that the notion to trade comes over them. And they don't always remember the mechanics of the review period, the cooling off period, or when the trading windows are open.

 

Steve: Yeah. And in my experience, so my previous professional experience didn't involve the creation of the plans, but I have been involved in some investigations where the SEC or FINRA, actually a different regulatory agency, came requesting information because they sense that there may have been a case of insider trading. And I can tell you that the level of detail that they possess is is often quite impressive in terms of the amount of information that they know. The amount of information that they request is voluminous, to say the least, and they have no sense of humor whatsoever. As you know, you would typically expect from a regulator.

 

Brandon: We routinely field requests from our customers based upon information requests given to them by FINRA to identify individuals who may have had access to our customers' prerelease financial information for the purposes of examining whether any insider trading has occurred around the customer's stock.

 

Steve: So to get this straight, what you're saying, Brandon, is that, much as was my experience that I just described of having received a request from FINRA where we provide this information, those who are Workiva customers, where they have 10-Qs, 10-Ks, earnings releases, other things that are safe and secure in our platform but have not been released to the market, those customers are coming to us saying, hey, we need to know who had this data because FINRA is asking, so we provide it to our customers, they presumably provide it to FINRA to figure out who knew about this, because FINRA, likely behind the scenes, is going to connect the dots, look at trades it examines and say, hey, you know what? This individual did this trade that seemed suspicious to us. Oh, and now it looks like they had access to prerelease information. I'm of course, connecting the dots here, and I don't mean to presume anybody's doing anything wrong, but presumably that's what FINRA could be looking for?

 

Brandon: That's exactly right.

 

Catherine: I just wanted to ask real quick -- 10b5-1 plans -- are those strictly for executives, or do they cover any other employees?

 

Brandon: Anyone can sign a 10b5-1.

 

Steve: Would you recommend that? I mean, so let's assume you're not an executive, but you know you do have some stock available to you to share. Again, it's probably got some kind of vesting schedule or whatever. If it's not significant, is the juice worth the squeeze in terms of setting up this plan, going through the administrative burden and then kind of having to see it through?

 

Brandon: No, I don't think it's worth it for most employees. I think for executive management, it's really important just given their exposure to MNPI almost all the time. But for other employees, I don't think it's worth entering into a 10b5-1 plan, except maybe in connection with an ESPP (employee stock purchase) plan they might have if they wish to trade that stock with an ESPP plan without worrying about a trading window at the time that the shares are delivered.

 

Steve: So I found that fascinating because in full transparency, I'd been a Workiva customer for quite a long time, and it never would have occurred to me that you could use the platform for what Brandon described. Of course, now it seems really obvious. But Catherine, were you surprised by what Brandon had to share?

 

Catherine: I definitely learned something new. What happens if you get caught insider trading or violating a 10b5-1 plan?

 

Brandon: Well, a whole parade of horribles can follow from insider trading like lawsuits, regulatory proceedings, imprisonment, criminal fines, civil fines, and prohibitions against serving as an officer director of a publicly traded company.

 

Steve: So you're saying it's not a good idea? Is that fair?

 

Brandon: Terrible idea.

 

Steve: Duly noted. Well, again, I found these incredibly fascinating insights, and it is actually time to wrap up this materially public and terrific conversation with Brandon Ziegler, general counsel of Workiva. Which brings us to the closing question of the day. Well, Brandon, we really appreciate you sharing these insights and to wrap up, we do have this episode's closing question of the day, and the question is if you could get access to inside information and own a controlling stake in any public company, and while we know you would never do anything wrong with that information, we're just curious if you had it what company would you choose and why?

 

Brandon: Disney. So maybe I could influence the plot of new installments in the Star Wars franchise.

 

Steve: I love it. I love it. Catherine, how about you?

 

Catherine: I had a similar response. I was going to say Netflix because I want to know what happens in the next season of everything.

 

Steve: And there's a lot of everything that is still hanging out there. There's quite a few series that need to put up or shut up. And I'm thinking, Stranger Things.

 

Catherine: Yeah.

 

Steve: Just to be totally transparent. I'm waiting on Stranger Things 4. It's only been like three years.

 

Brandon: What about you, Steve?

 

Steve: Well, for me, it's Coca-Cola, and that's for obvious reasons. Diet Coke aficionado. You know, I'd brush my teeth with this stuff, if I could, so I would love to have some kind of influence over formula changes, availability, maybe get access to a fountain here in my home office. All of the above.

 

Catherine: I thought you were going to say Crocs.

 

Steve: Probably not with the Crocs. I love Crocs. I'm wearing a pair right now.

 

Catherine: I know you are.

 

Steve: But you know, to me, you put them on your feet. You know, I kind of forget about it. Well, big thanks to Catherine Tsai and Brandon Ziegler for joining us today. And big thanks to you, dear listener, for surfing along. I'm Steve Soter, and this has been Off the Books. Please subscribe, leave a podcast review, tell your buddies if you like the show, and feel free to drop us a line at offthebooks@workiva.com. Surf's up, and we'll see you on the next wave.