The Next Backdating Scandal?

When Joseph Nacchio, former CEO of Qwest Communications International, is sentenced in July for insider trading, he could get life. His time served may be less, but still, at age 57, Nacchio will probably spend most of his remaining years behind bars.

Central to his conviction were two trades Nacchio made within established Rule 10b5-1 plans. These plans, which were approved by the Securities and Exchange Commission in 2000, allow executives to establish regular intervals for selling stock. Until recently, such sales were thought to be protected from litigation as long as executives did not have insider information at the initial setup. New research, however, calls that thinking into question.

Alan Jagolinzer, an assistant professor at Stanford University's Graduate School of Business, analyzed the trading patterns of executives enrolled in 10b5- 1 plans over a five-year period. He found that the plans tended to sell after good news and ahead of bad news. The upshot: a trading profit 6 percent better than that of uninformed investors.

On average, Jagolinzer says, there is "evidence of 10b5-1 sale transactions and subsequent underperformance of the stock." Does this mean executives are manipulating 10b5-1? "My paper can only identify an empirical pattern," he says.

Jesse Fried, a law professor at the University of California, Berkeley, goes further: "Jagolinzer's paper shows that many executives continue to sell stock on inside informationÂÂ…[and] often choose to do so through 10b5-1 plans." Stanford law professor Joseph Grundfest adds that the paper "gives the SEC reasons to ask tough questions."

Those questions are being asked. "Recent studies suggest that the rule is being abused," said Linda Chatman Thomsen, SEC enforcement director, in a recent speech. "We're looking at this — hard. We want to make sure that people are not doing here what they were doing with stock options."