Occaisionally the issue of insider trading activity comes up, usually by critics of the company who like to claim that insiders are selling.
I have covered this point many times. Here is a copy of my 11/12/99 post on Raging Bull (with minor editing) on this non-issue:
Short-sellers of this stock have given this board a false impression that insiders (specifically Fred Falk) are selling their shares. In fact, the exact opposite is true. Both Falk and Putnam have established large share positions in the past four months, as noted in this table:
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In July, Fred Falk exercised options on 269,684 shares (at $0.08/share) and Robert Putnam exercised options on 109,840 shares (also at $0.08/share) Putnam also exercised options on 390,160 shares in August (again, at $0.08/share).
When a corporate officer exercises options there is an immediate withholding tax due on the difference between the option price and the then-current stock price. Many insiders sell a portion of the shares exercised in order to provide for that withholding tax. Generally, the tax due at withholding would be 20%. This is only a portion of the ultimate tax due, since the individual is liable for the full tax, at ordinary income tax rates, when the tax return in filed for that year. That full tax will be the individual's ordinary income tax rate on that difference (between current share price and exercise price.) Since the maximum individual marginal tax rate is 39.6% the corporate officer may wish to sell enough shares to provide for that amount, and take half of the proceeds for the immediate withholding tax due.
In the case of e.Digital insiders, the market price was $2.21 at exercise for Falk (7/6), while Putnam's market prices at exercise were $2.06 (7/30) and $1.73 (8/5). With an option price of $0.08, the respective gains are $2.13/share on 269,684 shares for Falk, while Putnam will be taxed on gains of $1.98/share on 109,840 shares and $1.65/share on 390,160 shares. The taxes due (at the maximum rate of 39.6%) would be $0.84/share (Falk) and $0.78/share and $0.65/share (Putnam).
I estimate that the 20% withholding tax due immediately upon exercise required the payment of $114,885 by Fred Falk and $172,249 by Robert Putnam. Note that this does not cover the full tax liability, which is about twice that amount.
To cover some of these taxes due, Putnam sold 40,000 shares at $2.23 to $2.33 on July 21, raising about $91,000. Falk sold 60,000 shares at $2.11 to $2.24 on July 23, raising about $130,000.
Keep in mind that once exercised the long-term holding period begins and the insider must then wait one year to obtain the more favorable capital gains tax rate (20%).
What are the implications of these exercises and sales? The exact opposite of what the short-sellers imply.
Since the first gain after stock option exercise (the difference between the exercise price and the share price that day) is always ordinary income, it is always best to exercise when the stock is relatively low-priced, if you intend to hold for a while. If you intend to sell immediately, then obviously you would exercise and sell your entire position, not just the portion needed to pay withholding taxes. Since neither Putnam nor Falk sold more than enough to pay the taxes due, this suggests that both believed that the stock would rise in the near future or that they are holding for the long-term tax treatment before an eventual sale.
Upon careful analysis I take the actions of both Putnam and Falk as very bullish for the stock. |
