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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.
Should I Buy When The CEO Does?
In a
word - almost always!
There are literally a hundred reasons why an insider would sell
shares. However, there's only ONE reason why he or she would buy
his own company's shares. The stock is undervalued and the
insider believes it will go up. Who knows better than the CEO or
CFO? Nobody!
We
do hate to see an insider buy a couple of hundred shares here or
there. That doesn't inspire confidence. However, if we see an
insider buying thousands of dollars worth of the stock, several
times, and continues to do so -- we love that and will make us
take another look at a company.
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