SEC let insiders trade by locking in plans before they knew

Corporate executives and directors routinely need to sell company stock for entirely ordinary reasons — diversification, taxes, a mortgage, a divorce settlement — but the law bars trading "on the basis of" material nonpublic information, and a senior executive is almost never fully free of something material. Before 2000, federal appellate courts were split on whether merely possessing such information while trading was enough to create liability, or whether it had to be proven the information actually caused the trade — an unfalsifiable question of intent.

The obvious fix is to police what an insider knows at the moment of the trade: pre-clear every sale, restrict trading to a window right after earnings are released. But a senior executive knows something material almost by definition of the job, so no rule about the CONTENT of an insider's knowledge at the instant of trading could ever be airtight — there is always a later-discovered fact a plaintiff can point to and claim influenced an otherwise ordinary sale.

Moved the legal test from knowledge at trade to timing of decision: a binding plan adopted while ignorant severs the causal link, making intent provable once.

A pre-committed plan severs the causal link between later knowledge and the trade.

Proving timing at adoption is documentable, unlike proving intent at the trade.

The plan executes automatically, so the insider's later knowledge doesn't affect it.

When a decision can be biased by information you'll later get, commit to the rule before the information arrives, then let it run mechanically.

Adoption became close to universal among public-company executives, who needed a predictable way to sell stock without personally litigating their state of mind after every decline. The rule stood essentially unmodified for two decades until a Stanford Rock Center study of over 20,000 real 10b5-1 plans found a systematic subset of executives gaming the very timing gap the rule created — short "cooling-off" windows, single-trade plans, and plans launched right before earnings — producing abnormally loss-avoiding trading returns the researchers called suspect.