“Director Jerry Fiddler unloads 500 shares of …”. I see a headline like that every month or so, and many more like it referring to other directors and officer that I know. And, I get questions. Why did you (or whoever) “unload” the stock? Is there a problem? I assume that other insiders get the same question, and I often see it discussed on stock bulletin boards – “why is the CEO/CFO/whomever selling?”. So, I decided to answer the question for me, personally, and hope that the answer extrapolates to other insiders as well.
No, there’s not a problem. In fact, if there was a problem that I knew about and you didn’t, I couldn’t sell the stock. (More on that later.) I sell the stock for the simple reason that I need the money. I don’t have a job that pays me a salary. As an angel investor, I put money into very young companies, where it stays for a long time – usually years. When that company becomes public, it’s time to take some of the money out, providing money to live on, and also money to do my next investment. Capital wants to move. Even if that weren’t the case (and, after all, not all insiders are professional investors, and some do draw salaries) it’s only prudent financial management to diversify. When a company becomes successful and goes public, many of the early shareholders find that a huge percentage of their personal assets are in one, single stock. It makes sense to move some of that investment to other assets, perhaps including a house.
So, the question becomes not whether to sell stock, but how and when to sell it.
As an insider (all directors, most officers, and many others within a company are considered insiders) I am extremely restricted in when I can buy or sell stock. Every quarter, we are “blacked out” from some period (usually 15 days but sometimes longer) before the end of each quarter until two days after we announce the quarter results. Since the announcement is usually about a month after the quarter ends, thats at least 6 weeks out of every 13 week quarter that we can’t buy or sell stock. We also can’t trade the stock during the other 7 weeks if we have any material information that’s not yet public. That could be a pending big deal, acquisition, or whatever. There was one period of time when I was at Wind River that I couldn’t trade the stock for two full years, because there was always something happening and therefore a trading window never opened.
That’s why the SEC, in its infinite wisdom, created 10b5-1 plans. A 10b5-1 plan lays out a schedule of stock trades, almost always sales. It must be created in an open trading window (not near the end of a quarter, no material inside info, …), approved by corporate counsel, and then filed with an agent (usually an investment bank) that will administer the plan and execute the trades. Once created, I no longer have any control over the plan. Therefore, it is irrelevant whether I’m blacked out, and the plan can trade on its schedule regardless of blackout windows.
The plan can be as simple or complex as desired. It could say, simply, sell 1000 shares (or $1000 worth of shares) on the 15th day of every month, or every third month. It could say sell 1000 shares every month if the price is over X, another 500 shares if it’s over Y, another 500 shares if it’s over Z. A plan like is often cumulative, where if the stock had been below X for three months, when it moves north of X the three months worth of trades are executed. Although plans are not made public, it’s usually pretty easy to see that an insider has a 10b5-1 plan in place because they’re usually quite regular. If you see someone make a sale of 500 shares on the 12th of every month, it’s a pretty good bet that there’s a plan. If you see an insider make a large sale when a stock reaches a new high, especially a round number, it’s very possible that there was a plan in place with a breakpoint at that price and the cumulative sale has occured.
The sales can be weekly, monthly, quarterly, every 10 days, or whatever. Shorter periods lead to lots of announcements of the form “Director Unloads 2 Gazillion Shares”, which just don’t look great. (Insiders must file a form with the SEC whenever we buy or sell, which becomes public info.) Longer periods mean the sales are larger. More importantly, long periods can lead to the appearance of managing the company (announcements, etc.) to affect the stock price at those times, which is a very bad thing. I usually opt for monthly.
Another question I often get is why I don’t buy shares when the stock is down. The problem is that the SEC imposes “short swing” restrictions and penalties. If an insider executes a sell and a buy within six months of each other, the SEC will impose a fine of all the profit for the transactions. Of course, buying more shares of a company that I already own a lot of also flies in the face of diversification, and the ability to invest that cash in other companies. Despite that (and the inevitable argument from my financial advisor), I still do it occasionally when the stock is irresistibly low.
So, what is the moral of this missive? First, insider sales are usually no big deal, especially if they seem like they’re being done under a plan. Second, an insider buy can be a very big deal, because the insider is making the buy despite the short swing restriction that means he can’t sell any stock for at least six months. It doesn’t mean that the insider knows anything specific that you don’t, because if he did he or she couldn’t buy the stock. It does, though, show real confidence in the company from somebody who know it well. There’s an old saying – “There are a thousand reasons to sell, but only one reason to buy.”