I find strong evidence of insiders selling shares prior to imminent bad earnings news through their Rule 10b5-1 trading plans. While Rule 10b5-1 selling plans may conjure images of regular selling over a sustained period of time, I find that insiders’ sales under these plans often consist of a small number of sales (the median plan consists of four sales) and commonly occur over a short period of time (the median plan lasts less than 150 days). Abnormal stock returns, earnings surprises, and abnormal earnings announcement returns are all significantly negative following plans that are short-term in nature, but not following plans that are long-term in nature. Although Rule 10b5-1 does not specify a minimum length for selling plans, finding that sales within short plans significantly outperform sales within longer plans suggests that restrictions on plan length would reduce the incidence and appearance of informed selling through Rule 10b5-1 plans.
This is a preview of subscription content, access via your institution.
Buy single article
Instant access to the full article PDF.
Tax calculation will be finalised during checkout.
Subscribe to journal
Immediate online access to all issues from 2019. Subscription will auto renew annually.
Tax calculation will be finalised during checkout.
Papers that examine this issue include: Penman (1982), Elliott et al. (1984), Givoly and Palmon (1985), Sivakumar and Waymire (1994), Noe (1999), Ke et al. (2003), Cheng and Lo (2006), Roulstone (2008), Jagolinzer (2009), and Cohen et al. (2012). Roulstone (2008) finds evidence of a relation, but describes the relation as “economically small” and decreasing over his 1980–2002 sample period. Cheng et al. (2005) find a relation between insider trading activity and the news at earnings and dividend announcements for Hong Kong industrial firms, but they do not separately analyze insider sales.
Veliotis (2010) and Henderson et al. (2012) discuss the favorable treatment that Rule 10b5-1 sales have received in legal proceedings. Jagolinzer (2009) and Sen (2008) find that Rule 10b5-1 sales are more likely than non-Rule 10b5-1 sales to occur just prior to earnings announcements (which are typically blackout periods).
Cohen et al. (2012) classify about half of all insider sales as routine using their algorithm.
The phenomenon of routine insider selling existed well before Rule 10b5-1. Cohen et al. (2012) find that their analysis of routine and non-routine selling is robust to the sample period prior to the enactment of Rule 10b5-1.
The SEC does not oversee or supervise insiders’ Rule 10b5-1 selling plans. Insiders voluntarily and typically add a footnote to their SEC Form 4 filing to indicate that their sale was under a Rule 10b5-1 plan.
Marin and Olivier (2008) also find insider selling information useful in predicting future returns. However, in their paper it is the absence of insider sales that immediately precede negative returns. Firth et al. (2011) find that insider sales are more informative than purchases for stocks listed on the Hong Kong Exchange. Results in Gangopadhyay et al. (2014) are also consistent with informative insider sales.
Cicero and Wintoki (2013) also examine insider trading patterns. Specifically, they study whether an insider’s trades occur in a sequence of months or not.
Shon and Veliotis (2013) find a relation between plan sales and prior earnings announcement news. They find that plan sales are more likely to follow positive earnings surprises and attribute this to management managing the firm’s earnings upward so that planned sales occur at higher prices.
Insiders may also pre-plan purchase transactions, but pre-planned purchases are quite rare compared to pre-planned sales. This is consistent with insiders protecting their sales transactions through Rule 10b5-1 due to the greater litigation risk for sales than purchases.
The Thomson Reuters Insiders database recently started identifying Rule 10b5-1 plan trades, but thus far they have not gone back through all SEC Form 4 filings to identify Rule 10b5-1 trades from the past.
I use 400 days instead of 365 days to allow for small timing differences from 1 year to the next. Results are robust to using 365 days.
My results may not generalize to insiders that never disclose their planned sales as planned. However, failing to disclose planned sales as planned is likely uncommon given the benefits of disclosing.
To address this concern, I repeat my analyses (untabulated) using all sales made by insiders who disclose at least one planned sale (i.e., sales not disclosed as planned are assumed to be planned, if the insider discloses at least one planned sale). My results are unaffected by this change because there is an extremely small number of unplanned sales by insiders that disclose a planned sale (i.e., the number of sales in the sample increases by about 1 %).
For robustness, I also tried a 200 days cutoff instead of 400. As expected, using a 200 days cutoff results in a decrease in the number of longer plans and a relatively larger increase in the number of shorter plans. This occurs because the probability of no other trades occurring within a time window increases as that time window is narrowed. My results (untabulated) were slightly weaker, but not materially different when I use a 200 days cutoff.
This concern is reduced by the fact that insiders sell in significantly greater quantities in their short plans which suggests that there was intent for short plans to be relatively short rather than short plans just being long plans that were prematurely cut short.
I focus on the six months following the sale to be consistent with prior literature and because the short-swing profit rule prohibits insiders form making conflicting trades (i.e., a purchase and a sale) within six months of each other.
In calculating 1MonthAbRet, 3MonthAbRet, and 6MonthAbRet, if a daily firm return is missing it is set equal to the CRSP value-weighted index for that day (i.e., no abnormal returns are generated due to missing future returns).
Because insiders are not required to disclose their plan sales, I exclude non-plan sales that occur within 15 days of a plan-sale at the same firm due to the possibility that these are planned sales. In addition, non-plan sales may imitate plan-sales by other insiders at their firm.
Fama and French (1992) find a negative relation between market capitalization and returns and a positive relation between book-to-market and returns.
Ball R, Kothari SP (1991) Security returns around earnings announcements. Account Rev 66:718–738
Bettis C, Coles J, Lemmon M (2000) Corporate policies restricting trading by insiders. J Financ Econ 57:191–220
Cheng Q, Lo K (2006) Insider trading and voluntary disclosures. J Account Res 44:815–848
Cheng LTW, Szeto RWF, Leung TW (2005) Insider trading activities before the simultaneous announcements of earnings and dividends. Rev Pac Basin Financ Mark Polic 8:279–307
Cicero D, Wintoki MB (2013) Insider trading patterns (working paper). Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2128127
Cohen DA, Dey A, Lys TZ, Sunder SV (2007) Earnings announcement premia and the limits to arbitrage. J Account Econ 43:153–180
Cohen L, Malloy C, Pomorski L (2012) Decoding inside information. J Finance 67:1009–1043
Elliott J, Morse D, Richardson G (1984) The association between insider trading and information announcements. Rand J Econ 15:521–536
Fama EF, French KR (1992) The cross-section of expected stock returns. J Finance 47:427–465
Finnerty JE (1976) Insiders and market efficiency. J Finance 31:1141–1148
Firth M, Leung TY, Rui OM (2011) Insider trading in Hong Kong: tests of stock returns and trading frequency. Rev Pac Basin Financ Mark Polic 14:505–533
Gangopadhyay P, Yook KC, Shin Y (2014) Insider trading and firm-specific return volatility. Rev Quant Finance Account 43:1–19
Givoly D, Palmon D (1985) Insider trading and the exploitation of inside information: some empirical evidence. J Bus 58:69–87
Henderson MT, Jagolinzer AD, Muller K (2012) Hiding in plain sight: Can disclosure enhance insiders’ trade returns? (working paper). Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1137928
Jaffe J (1974) Special information and insider trading. J Bus 47:410–428
Jagolinzer AD (2009) SEC Rule 10b5-1 and insiders’ strategic trade. Manage Sci 55:224–239
Jegadeesh N, Titman S (1993) Returns to buying winners and selling losers: implications for stock market efficiency. J Finance 48:65–91
Jeng L, Metrick A, Zeckhauser R (2003) Estimating the returns to insider trading: a performance-evaluation perspective. Rev Econ Stat 85:453–471
Johnson MF, Nelson KK, Pritchard AC (2007) Do the merits matter more? the impact of the private securities litigation reform act. J Law, Econ, Org 23:627–652
Ke B, Huddart S, Petroni K (2003) What insiders know about future earnings and how they use it: evidence from insider trades. J Acc Econ 35:315–346
Lakonishok J, Lee I (2001) Are insider trades informative? Rev Financial Stud 14:79–111
Lorie J, Niederhoffer V (1968) Predictive and statistical properties of insider trading. J Law Econ 11:35–53
Marin J, Olivier J (2008) The dog that did not bark: insider trading and crashes. J Finance 63:2429–2476
Meulbroek L (1992) An empirical analysis of illegal insider trading. J Finance 47:1661–1700
Muth KT (2009) With avarice aforethought: insider trading and 10b5-1 plans. U C Davis Bus L J 10:65–82
Noe CF (1999) Voluntary disclosures and insider transactions. J Account Econ 27:305–326
Penman SH (1982) Insider trading and the dissemination of firms’ forecast information. J Bus 55:479–503
Petersen MA (2008) Estimating standard errors in finance panel data sets: comparing approaches. Rev Financ Stud 22:435–480
Piotroski JD, Roulstone DT (2005) Do insiders trades reflect both contrarian beliefs and superior knowledge about future cash flow realizations? J Account Econ 39:55–81
Robbins AP (2010) The Rule 10b5-1 loophole: an empirical study. Rev Quant Finance Account 34:199–224
Roulstone DT (2003) The relation between insider-trading restrictions and executive compensation. J Account Res 41:525–551
Roulstone DT (2008) Insider trading and the information content of earnings announcements (working paper)
Rozeff M, Zaman M (1988) Market efficiency and insider trading: new evidence. J Bus 61:25–44
Sen R (2008) Are insider sales under 10b5-1 plans strategically timed? (working paper). Available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1364540
Seyhun HN (1986) Insiders’ profits, costs of trading, and market efficiency. J Financial Econ 16:189–212
Seyhun HN (2000) Investment intelligence from insider trading. MIT Press, Cambridge
Shon J, Veliotis S (2013) Insiders’ sales under Rule 10b5-1 plans and meeting or beating earnings expectations. Manage Sci 59:1988–2002
Sivakumar K, Waymire G (1994) Insider trading following material news events: evidence from earnings. Financ Manage 23:23–32
Veliotis S (2010) Rule 10b5-1 trading plans and insiders’ incentive to misrepresent. Am Bus Law J 47:313–359
I thank Ryan Ball, Philip Berger, Elizabeth Gutierrez, Sundaresh Ramnath, Jonathan Rogers, Darren Roulstone, Douglas Skinner, Andrew Van Buskirk, Stanley Veliotis, and seminar participants at the University of Chicago brown bag workshop, the 2012 South Florida Accounting Research Conference, and the 2012 Southeast Regional Meeting of the American Accounting Association for helpful comments and suggestions.
About this article
Cite this article
Milian, J.A. Insider sales based on short-term earnings information. Rev Quant Finan Acc 47, 109–128 (2016). https://doi.org/10.1007/s11156-014-0496-7
- Insider trading
- Earnings announcements
- SEC Rule 10b5-1
- Pre-planned trades