Every CEO Should Follow Mark Zuckerberg's Stock-Trading Example

"Mark Zuckerberg has been criticized by privacy advocates, parents critical of social media, and politicians on Capitol Hill. But in one respect, the Meta Platforms CEO is the model executive. Mr. Zuckerberg trades shares in his company each trading day, ensuring that his diversification is done randomly and avoiding any possibility that he benefits from insider information. More executives should follow his lead, and the Securities and Exchange Commission might be smart to mandate they do.

The problem starts with CEO pay. It isn't the canard that it is "excessive," but a conundrum arises because CEOs are compensated primarily with company stock. This idea -- a product of the early 1990s -- revolutionized American corporations. By aligning the interests of CEOs and shareholders, equity pay reduced the temptation to build empires and focused corporate managers on creating value for shareholders.

CEOs need to sell stock for their expenses and to diversify their portfolio. Diversification benefits not only CEOs (who are better off not having all their eggs in one basket) but also the company, since underdiversified executives value the additional shares they earn less. Selling shares is fraught, however, since CEOs possess information about the value of their shares that the broader market doesn't have. Companies take steps to minimize the risk -- such as banning executives from selling right before earnings announcements -- but these are imperfect. Numerous studies show that executives often earn abnormal returns on their stock sales.

The SEC tried to finesse the situation by promulgating Rule 10b5-1 in 2000. It permits CEOs to trade on more days, so long as they do so according to preset trading plans entered into at a time when any information advantage was minimal. The rule contains numerous loopholes, however, such as allowing executives to enter into plans and sell immediately, and allowing executives to cancel planned trades based on new inside information. A study I conducted with Alan Jagolinzer, director of the Centre for Financial Reporting & Accountability at the University of Cambridge, and Karl Muller, associate professor of accounting at Penn State University, showed that CEOs trading within preset trading plans earned more than those trading outside them. The SEC recently proposed amendments to Rule 10b5-1, including a mandatory delay of 120 days between entering into a plan and the first trade. In addition, canceling plans based on inside information would no longer be permitted if the amendments were adopted, as plans would have to be "operated" in good faith. These are good steps that will reduce abuse, but more could be done.

This brings us back to Mr. Zuckerberg. Like every CEO, he is faced with the question of how to diversify his portfolio without running afoul of insider-trading rules or exposing his company to the risk of a securities-fraud suit. His solution is clever -- trade every day. By setting a diversification goal for the year, and then dividing it by the number of trading days, he ensures that no individual trade raises insider-trading concerns. This strategy is the obverse of the investment strategy known as dollar-cost averaging -- buying shares at regular intervals. Selling every day means that some sales will be more profitable and others less so as the stock price changes, but on average the trades will offset and randomly reflect the yearly change in the stock price. By not timing the market, Mr. Zuckerberg will make less than he could by cheating, but he isn't putting Meta or himself at legal risk.

Every major corporate CEO in America should follow Mr. Zuckerberg's example. The typical big-company CEO makes enough money -- more than $24 million in 2020 -- that he shouldn't need to sell shares urgently. A CEO can set a goal for the year in dollar or percentage terms and then have those sales spread out evenly over every trading day to diversify his portfolio. No surprises, no allegations of trading in advance of information disclosure, no timing the market and no big risk of front-running.

If the SEC were serious about reducing insider trading by CEOs, it would think about requiring CEOs to trade like Mr. Zuckerberg. Another less intrusive option would be to require CEOs to randomize their trades. Under this policy they wouldn't have to trade every day, but they would be required to declare a goal for the year in terms of shares to be sold, as well as a number of days to divide the block into, and then the trading dates could be randomly assigned by a third party, such as an exchange or the Financial Industry Regulatory Authority. Diversification trades are legally required to be random, and there are clear ways to achieve this goal. More CEOs should trade like Mark Zuckerberg." [1]

1. Every CEO Should Follow Mark Zuckerberg's Stock-Trading Example
Henderson, M Todd. Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 28 Dec 2021: A.17.