Investors track insider buying and selling for clues about management sentiment
Analysts and investors often review insider transactions in an effort to gain insight into management’s bullish or bearish sentiment for the company as well as the sector or industry in which that company operates. The logic for reviewing these transactions is simple. Insiders are perceived as having a working knowledge of their company and its operations, and as such are expected to be able to better predict future earnings, cash flow, and by extension, the underlying share price.
That said, because this data is scrutinized with such vigor, it is imperative that officers, directors and IROs find innovative ways to use insider filings to their advantage.
For example, a company that recently filed trade data with the SEC that contained a large volume of insider purchases might expect to see an upward tick in their share price as members of the investment community imitate the insider’s transactions and establish or add to their positions.
The company might then turn this filing/buying into a public relations catalyst by allowing the shares to have their upward run. The idea is to then wait until a later date to announce a new initiative or to issue some type of (bullish) future guidance about the company or its financial position. By metering out the positive news and maintaining a momentum of information flow, management might hope to have a bigger impact on the stock price than if all of the positive news were to be announced at once.
As a general rule of thumb, IROs and corporate secretaries should commit to having regular discussions with their senior management teams. The purpose of these discussions should be to emphasize the impact that insider buying and selling can have on open market trading activity, as well as to get managers to realize that with their actions come consequences. It is also important to ensure executives are aware of the importance of managing the timing of their transactions.
The establishment of blackout periods
In order to make certain that insiders do not violate insider-trading rules, blackout periods must be established and strictly policed. The idea behind a blackout period is that for a block of time before, during and after a material news release (such as earnings), no insider may buy or sell company stock.
Many companies tend to initiate a blackout period from the time their fiscal quarter ends to one or two days after earnings are announced. The primary benefit of establishing such a period is that, in addition to avoiding accusations of insider trading, such periods also serve to alleviate investor concerns that senior officers might in some way take advantage of material events.
Ideally, when developing a policy, the board and others involved should consider investor perception. In fact, the thought of ‘fairness’ should reign supreme. That means that blackout periods should exist even during planned ‘analyst days,’ investor conferences or other mid-level announcements so that no investor or attorney could ever claim that an insider was acting in an inappropriate manner. With that in mind, the policy should also be posted on the company website so that all investors are aware of exactly when periods to buy and sell securities exist.
The establishment of trading ‘windows’ is another way to limit accusations of wrongdoing. Windows are a period of time in which an insider may buy or sell company stock. These periods are typically constructed around events such as earnings releases or earnings guidance. Like blackout periods, windows should open and close at appropriate times so that no one might misconstrue the company’s intentions.
Windows must remain flexible and in the event of any unforeseen material event occurring they should be closed and all relevant parties, both in the company and in the shareholder community, should be advised.
Notifying the public
Publicly disseminating news of insider buying and selling (either through a press release or an 8K) is generally imprudent. Simply filing the appropriate forms with the SEC is the preferred course of action. The logic behind this is that it might draw undue concern, and investors may only look at the transaction and not the reasoning behind the transaction.
Still, there are times when a press release detailing a particular insider transaction might be warranted. For example, when a major shareholder is about to dispose of a significant number of shares in the open market or when the purchase or sale could precede another material announcement. At this point, an explanation for the transaction would be appropriate in order to avoid any misunderstandings with the investment community.
While releasing news of insider selling may seem counterintuitive putting a transaction in the proper perspective could effectively help silence an existing rumor mill and provide the company with a good venue for explaining the reasons behind the sale(s) and alleviate investor concerns that perhaps the activity is in some way a harbinger of things to come.
Improving investor perception
Companies should recommend to their boards the establishment of a 10b5-1 plan. Such a plan can be extremely useful, especially for companies where executives regularly convert their options and sell the underlying common stock.
Utilizing a 10b5-1 plan, an executive sets a specific date or price at which to effect a transaction (either a purchase or a sale), and when that event transpires, it triggers the trade. Because this is a pre-determined and systematic method of accumulating shares or disposing of them, the possession of insider information becomes irrelevant. By definition this will help to stem accusations of insider trading and front running.
Of course, there will always be those that view insider selling as a negative. So from this perspective the true hope of those that institute a systematic plan is that at least investors won’t be surprised if they see a sizable volume of insider selling being filed with the SEC on a regular and predictable basis.
According to the research firm Equilar, the number of executives taking part in 10b5-1 plans in 2005 increased 22 percent over the previous year, while the number of firms utilizing such plans increased 21 percent. In fact, according to Equilar, 35.2 percent of all S&P 500 companies had at least one executive sell shares utilizing the plan between January 2004 and March 2006. So this method of systematic buying and selling is becoming more widespread as companies seek to present themselves to the investment community in the most open and forthcoming manner possible.
The effect of insider trading on share price can vary significantly from company to company so Thomson Financial recently conducted a study to determine if insiders at a particular type of company were a better barometer of future stock price movement (perhaps because of their knowledge of the shareholder base, or nuances specific to their company) than others. Specifically, the study examines insider transactions at companies with greater than 10 percent insider ownership, and those with less than 10 percent ownership in an effort to isolate discernable patterns.
The ultimate purpose is to give companies a better idea of how potent a catalyst insider buying and selling can be in terms of stock performance. By better understanding the effect of share transactions by board members, corporate secretaries, IROs and directors themselves can avoid the potential negative reputation effects with shareholders and also stay out of the focus of regulators searching for inappropriate dealings.
