Insider Trading
What matters and what doesn't
We are asked all of the time about insider trading
and wanted to give our opinion on the subject.
We're not talking about illegal insider trading;
that is, when someone with insider (non-public)
information trades a stock based on that information.
We're talking about when an officer, director, or
other executive of a company buys or sell shares
of that company.
This is something we've had extensive experience
in. Over a decade ago, my first experience on the
institutional side of a trading floor of a major
firm dealt with insider sales as well as corporate
repurchases. We were the guys that would help these
executives jump through the hoops they needed to
so that they would be allowed to sell shares of
their company on the open market. There are quite
a few hoops at that, but most are spelled out in
SEC Rule 144 and Rule 144(k).
Rule 144 & Rule 144(k)
When you acquire restricted
securities or hold control securities, you must
find an exemption from the SEC's registration
requirements to sell them in the marketplace.
Rule 144 allows public
resale of restricted and control securities if a
number of conditions are met. This overview tells
you what you need to know about selling your restricted
or control securities. It also describes how to
have a restrictive legend removed.
Some of the restrictions on the sales include the
holding period, the number of shares that can be
sold in a specific period of time and how they can
be sold by the broker.
Restricted and Control Securities
Restricted securities are securities acquired in
unregistered, private sales from the issuer or from
an affiliate of the issuer. Investors typically
receive restricted securities through private placement
offerings, Regulation D offerings, employee stock
benefit plans, as compensation for professional
services, or in exchange for providing "seed
money" or start-up capital to the company.
Rule 144(a)(3) identifies what sales produce restricted
securities.
Control securities are those held by an affiliate
of the issuing company. An affiliate is a person,
such as a director, the CEO &
CFO, or large shareholder, in a relationship
of control with the issuer. Control means
the power to direct the management and policies
of the company in question, whether through the
ownership of voting securities, by contract, or
otherwise. If you buy securities from a controlling
person or "affiliate," you take restricted
securities, even if they were not restricted in
the affiliate's hands.
If you acquire restricted securities, you almost
always will receive a certificate stamped with a "restricted"
legend. The legend indicates that the securities
may not be resold in the marketplace unless they
are registered with the SEC or are exempt
from the registration requirements. The certificates
of control securities are usually not stamped with
a legend, but must still be sold using Rule 144/144(k)
rules and regulations.
There are plenty of technical terms and other pieces
of information regarding these types of sales, but
that's not important. As long as you understand
the general restrictions, that's all you need to
know more than 90% of investors.
Should I Sell When The CEO Does?
In a few words... probably not.
There are many, many reasons why an insider like
a CEO or a CFO will sell some of his or her shares.
Maybe he is looking to purchase a new vacation home.
Or, his son or daughter is heading off to college
and he needs some cash for tuition and other expenses.
Or, most commonly (in our experience), the stock
has made a nice run and the executive is basically
looking to diversify.
We've seen in many times where a CEO was there at
the beginning. Maybe he had plenty of money before,
but he's spent years, if not decades making the
company into what it is today. On paper, he might
have $20 million in stock, but only a couple hundred
thousand in actual cash or other investments. The
wise thing would be to sell at least a portion of
those shares to diversify, buy an annuity, insurance,
whatever. Let's say that CEO does not sell anything,
and does not plan to until well after he retires,
only when he needs it. Now, he's left the company
and still has his $20 million in stock only. The
next CEO is a crook and is caught with accounting
irregularities. The stock plummets and the company
goes into bankruptcy. The shares are now worthless.
He should have sold some, no?
We are concerned when we see an insider selling
and selling and selling. Basically, if it looks
like he's getting rid of his shares altogether.
That's a warning sign. We are also concerned when
the insider uses an idiot for a broker who files
for each and every sale made each and every day.
The insider can file ONE time (in a rolling 90 day
period) for a certain number of shares. The broker
does not need to file for every sale every day.
If he or she does, that concerns us as the insider
is not knowledgeable enough to use someone who knows
how to minimize the impact of shareholders seeing
all of these sales.
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