The rule 10b5-1 loophole: an empirical study

This paper seeks to empirically examine the market effects of a loophole in insider trading law that allows insiders to cancel supposedly irrevocable pre-planned trades under SEC Rule 10b5-1 based on inside information. Based on an econometric analysis of a dataset of 81 NASDAQ-listed companies from 2004 to 2006, the paper concludes that: (1) the trading public attaches primary significance to the announcement of a 10b5-1 plan rather than the specified start date of that plan; (2) insiders make above-market profits using 10b5-1 plans but do not appear to arbitrarily or continually create such plans; (3) 10b5-1 plans have a significant negative effect on the liquidity of a firm’s shares, and therefore the firm’s cost of capital; and (4) insiders do not appear to increase the volatility of their own firms’ shares in order to profit by trading on the basis of material nonpublic information under the protection of the 10b5-1 safe harbor.