On the ADVFN message boards, I received a question regarding insider trading in a few stocks on the Magic Formula Investing list. After thinking about the question for a while, I realized I did not have a good answer.
I usually take a quick look at insider trading activity when I’m interested in a stock, but I have never really based a decision solely on insider activity. I find that insider trading reports rarely provide a clear signal that is predictive of a stock’s future price.
This past week, I was reading the May 15, 2006 edition of Fortune and I spotted a quote that has shaken my whole notion of insider trading reporting. In “No More Mr. Nice Guy” by Bethany McLean and Peter Elkind, I learned about the following trick that Kenneth Lay of Enron pulled to disguise his insider sales of Enron stock:
“During 2001 [Lay] repeatedly drew down an Enron line of credit in order to answer margin calls from banks and repaid it by selling almost $80 million of stock back to the company. Yet because such sales don’t technically have to be disclosed until year-end, anyone looking at publicly available information would have thought that Lay’s stock ownership was slightly increasing (as a compelling slide put up by Hueston showed), when in fact he was unloading almost two-thirds of his Enron shares.”
I was shocked at how easy it was to legally circumvent SEC rules as an insider. I am amazed that there was such a large loophole in the regulations that allowed insiders to sell shares in their company and avoid reporting “forced sales” in a timely fashion. I guess I really shouldn’t be surprised, but it was news to me. I guess this is another reason not to take reported insider transactions too seriously.
The use of forced sales of stock to avoid timely reporting of insider transactions has raised several question for me. Have these regulations been changed as a result of the Enron scandal or is it still possible to hide insider sales by using margin calls to force sales of stock? How widespread has the practice of planning forced sales to dispose of insider shares? Can anyone point to any current insider selling shenanigans? I would like get a better handle on this issue. I knew that it was very hard to prosecute insider trading, but I had no idea how easy it was to do something similar in a creative but legal fashion.
When I actually do examine insider transactions, I have found two websites that have been helpful. I usually do a quick search on NetSteering, and more recently, I have also used the new comer Form 4 Oracle to look up insider activity. What other tools do you use to track insider transactions?