Mark Zuckerberg has been criticized by privacy advocates, critical social media parents and Capitol Hill politicians. But in one respect, the CEO of Meta Platforms is the model executive. Mr. Zuckerberg trades his company’s shares every trading day, ensuring that his diversification is random and avoiding any possibility of him benefiting from inside information. More executives should follow his lead, and the Securities and Exchange Commission might be smart to force them to do so.
The problem begins with the compensation of the CEO. It is not the duck that it is “excessive”, but a conundrum arises because CEOs are mainly remunerated by shares of the company. This idea, a product of the early 1990s, revolutionized American businesses. By aligning the interests of CEOs and shareholders, equity compensation has reduced the temptation to build empires and focused business leaders on creating shareholder value.
CEOs need to sell stocks for their expenses and diversify their portfolios. Diversification not only benefits CEOs (who have an interest in not having all of their eggs in one basket) but also the business, as under-diversified leaders value less the extra stocks they earn. Selling stocks is onerous, however, because CEOs have information about the value of their stocks that the broader market does not have. Companies are taking steps to minimize risk, such as prohibiting executives from selling right before earnings are announced, but these are flawed. Numerous studies show that executives often get abnormal returns on their sales of stocks.
The SEC attempted to change the situation by enacting Rule 10b5-1 in 2000. It allows CEOs to trade for more days, provided they do so according to pre-defined trading plans made at a time when any advantage is overdue. information was minimal. There are many loopholes in the rule, however, such as allowing executives to close plans and sell immediately, and allowing executives to reverse planned transactions based on new inside information. A study I conducted with Alan Jagolinzer, director of the Center for Financial Reporting & Accountability at Cambridge University, and Karl Muller, associate professor of accounting at Penn State University, showed that CEOs trading under predefined trading plans earned more than those trading outside them. The SEC recently proposed changes to rule 10b5-1, including a mandatory 120-day period between entering into a plan and the first trade. In addition, cancellation of plans on the basis of inside information would no longer be allowed if the changes were adopted, as plans would have to be âexecutedâ in good faith. These are good measures that will reduce abuse, but more could be done.
This brings us back to Mr. Zuckerberg. Like any CEO, he faces the question of how to diversify his portfolio without breaking insider trading rules or putting his company at risk of a securities fraud lawsuit. His solution is clever: trade every day. By setting a diversification target for the year, then dividing it by the number of trading days, it ensures that no individual transaction raises insider trading issues. This strategy is the reverse of the investment strategy known as buying stocks at regular intervals. Selling every day means that some sales will be more profitable and others less as the stock price changes, but on average trades will clear and randomly reflect the annual change in the stock price. By not timing the market, Mr. Zuckerberg will earn less than he could by cheating, but he is not putting Meta or himself in legal danger.
Every large company CEO in America should follow Mr. Zuckerberg’s lead. The typical CEO of a large corporation earns enough money – over $ 24 million in 2020 – not to need to urgently sell stocks. A CEO can set a goal for the year in dollars or as a percentage and then spread those sales evenly over each trading day to diversify their portfolio. No surprises, no trading allegations before information is released, no market timing and no big front-running risk.
If the SEC were serious about reducing CEO insider trading, it would consider forcing CEOs to trade like Mr. Zuckerberg. Another less intrusive option would be to force CEOs to randomize their transactions. Under this policy, they would not have to trade every day, but would be required to declare a target for the year in terms of shares to sell, as well as a number of days to divide the block, and then The trading dates could be randomly assigned by a third party, such as a stock exchange or the financial industry regulator. Diversification transactions are legally required to be random, and there are clear ways to achieve this goal. More CEOs should trade like Mark Zuckerberg.
Mr. Henderson is Professor of Law at the University of Chicago.
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Published in the print edition of December 28, 2021.