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Rule 10b5-1 (Part 2)

As covered in my March 2 post, the 10b5-1 arrangement basically transfers control of a set number of shares to a third party so that they can be sold without worrying about insider trading issues. But the rule can also apply to purchases, as Northrop Grumman demonstrated last week. NOC bought $750 million of stock from Credit Suisse ($64.78 *11.58 million shares), who apparently sold short and will go into the market over the next few months to buy shares to cover its position. It’s not clear to me (IR hasn’t called me back) whether reported earnings per share can be calculated as of the date of the transaction using the smaller number of shares or whether the short has to be covered before the share count is reduced.

The basic Rule 10b5-1 advantage to NOC is that CSFB can make purchases much more often than would otherwise be the case and use up the $750 million in relatively short order. At the beginning of November, NOC executed a similar arrangement buying $500 million of stock at $55.15/share. But since CSFB had to actually go out and buy the shares that they had tendered, they wound up costing NOC $59.05 (CSFB is reimbursed for the shortfall and as far as I can tell, has no incentive to buy shares cheaply). So, there is a significant cost to the 10b5-1 arrangement, although one could argue that however you do it, purchasing large amounts of stock will always drive up the price. Going forward, investors can be pretty comfortable that the floor price for the next few months is $64.78 and likely to go higher (the stock closed at $66.95 on Friday, up $1.35).