After $NLFX & CEO Reed Hastings received a Wells notice from the SEC regarding his Facebook post, I’m sure most people today are focusing on the SEC’s “Reg FD”. (For a good summary and read see @kiddynamiteblog‘s post here –  ”Netflix, Social Media, and Regulation Fair Disclosure“.)

I decided to vent a little bit about another SEC Rule – 10b5-1.

If I were an executive of a publicly traded company, no matter on how great I thought the prospects of the company was, I would diversify my holdings. You don’t want to have all your financial capital tied to one company, especially if your human capital (future employment earnings) is relying on that same firm (See Lehman, Enron etc).

It typically doesn’t bother me much when I see “insider selling” of a company which I own equity in. Why would I expect executives to keep all their money tied up in one company?

When executive sell is a whole other story. Most executives are privy to insider information. To this point the SEC created the rule 10b5-1. Basically, it allows an executive, which enters a prearranged selling program, to sell even if he is privy to insider information on the date of the sale. Since it was a predetermined & irrevocable sale, it is not considered a sale based on this insider information.

Let’s take look at Pandora ($P). The company released horrible numbers this week. Executives obviously knew about it the days leading up to it, but because the following executives sold under 10b5-1 plans, they were able to sell at much higher prices.

On 12/3/12,

• John Trumble (Chief Revenue Officer) exercised and sold 25,000 shares at $8.9029.
• Thomas Conrad (CTO) exercised and sold 38,096 shares at $8.9034.
• Steven Cakebread (CFO) exercised and sold 40,000 shares at $8.903.

The cost of exercising these shares was $0.16 for Messrs. Trumble & Conrad, and $0.71 for Mr. Cakebread. All the options had over 6 years till expiration, and while Mr. Conrad has another 39,800 shares, Messrs. Trumble & Cakebread were left with none.

The $8.90 selling price is over 12% higher than where the stock currently trades (just a few days later).

Having said all that, the sales were legal, and I don’t blame the executives for selling one bit - especially since they went into this agreement months ago.

I do however have an issue with the fact that – although they officially have to be irrevocable - if the trades do get canceled, the executives can not be charged with insider trading, because they didn’t execute a trade!

Imagine for a minute $P was going to come out with great numbers & guidance. Shouldn’t canceling the above trades based on that information be considered illegal?

Either way, if I owned any $P shares, I would sell it anyway I could too.

- MicroFundy