Post-Enron, Investors Seek Inside Story
Sat Mar 23, 9:57 AM ET
By Thi Nguyen
NEW YORK (Reuters) - When companies have problems,
company executives should be the first to know.
So investors looking for clues to avoid the kind of
corporate blowups that hit Enron are now scrutinizing
activities of other companies' insiders, especially when
they sell dump their own stocks.
As a result, data companies that track the share
dealings of executive are finding that their services are
in stronger demand than ever.
"Interest in insider selling has never been so high," said
Lon Gerber, director or research at Thomson
Financial/Lancer Analytics, which provides insider
trading data.
Gerber said that investors are poring through insider
dealings whenever accounting questions arise, not just
at Enron, but at Tyco International Ltd and other
companies.
"For the last two months, any time there's an
accounting irregularity, clients call us up and ask what
insiders were doing six months ago," he added.
Investors who followed the insider activity at Tyco would
have had a tip-off of trouble back in November, when top
executives reported that they sold some $100 million
worth of Tyco shares back to the company over the past
fiscal year.
Still, even after the disclosure, Tyco shares continued to
go up for more than a month. By early December, they
went into a tailspin that didn't end until late January,
after two-thirds of their value had been wiped out.
In the meantime, Tyco's problems began to surface, as
analysts and investors in January began seriously
questioning the company's accounting practices and its
plan to split into four parts.
The Tyco case shows how the insider dealings might
have provided advance warning. Now insider selling is "a
piece of evidence you want to watch," said Warren Spitz,
portfolio manager at American Express Asset
Management Group.
"When we see major surprises (in insider transactions),
we would call management and ask why they are doing
what they are doing," said Spitz. "We would take a closer
look at our assumptions on the stock. We would take a
closer look at recent 10-Qs to see if there's anything we
haven't picked up before."
The Form 10-Q is the mandatory quarterly report of
earnings and operations that must be filed by publicly
traded companies with the U.S. Securities and
Exchange Commission (news - web sites).
Some Web sites, including Yahoo and Multex Investor's
Marketguide.com, also publish records of recent insider
sales, but with some lagging and without analysis.
DRAWBACKS: THE WHEN AND WHY
But there are at least two problems for investors in
following insiders' steps: First, the regulations allow
long delays before investors are required to report
insider trades. Next, when insiders do sell, it's hard to
say why they are doing it.
"The biggest problem is loopholes in regulations that
allow management to change their economic positions in
the companies without having to let investors know in a
timely manner," said Bill Nygren, portfolio manager at
Oakmark Select Fund, a top value fund. "I would love to
see reforms on that rule."
As it stands today, companies must report insider trades
on the open market by the tenth of the next month,
meaning their sales can go unreported for up to 40 days.
But there's a big loophole, even in this relatively lax
accounting system. Since 1991, for executives who sell
stock as part of an internal company transaction -- for
example, to repay a company loan or to reallocate money
within a 401(k) -- have had the choice of not reporting
the sales until 45 days after their fiscal year-end. That
means the sales can go undetected for more than 13
months.
Enron's former chairman and chief executive Kenneth
Lay only reported last February about his sales of some
$70 million worth of Enron shares back to the company
in the prior year -- which dwarfed the $16 million in his
earlier-reported open market sales. The reports came
too late to do investors any good.
Enron stock was traded at $45-$50 when Lay sold the
shares last year. By the time he reported the trades, it
was worth 25 cents per share.
Similarly, Tyco's chief executive Dennis Kozlowski and
chief financial officer Mark H Swartzsold sold some $100
million worth of Tyco shares back to the company
without investors' knowledge for up to 13 months.
The vast majority of this kind of sales indeed seem to be
for executives' personal needs or for technical reasons of
little important to investors. But without them, Enron's
and Tyco's sales on the open market last year alone
"wouldn't have raised the red flag," Gerber said.
TIMELY INFORMATION
The rules on disclosures will likely change for the
better, at least for investors: Early this month, Congress
and regulators released a rough draft of the post-Enron
rule book for U.S. business, including proposals to
shorten the time that executives have to report their
trades. President Bush (news - web sites) even said he
would require top executives to disclose insider trades
within two days of the transaction.
"It'll be better for investors to get the information sooner rather than later," said
Gerber.
But if disclosure rules are tightened, it will still be difficult for them to know
whey insiders are selling.
Last year, in the midst of a recession and a declining market, company insiders
sold about $19 worth of stock for every $1 they bought, according to Gerber.
That could trigger a lot of selling, if investors dumped their stocks each time a
company official sold. But retail investors could learn from the pros when it
comes to reading the insider data.
Individual investors tend to put a "tremendous focus on insider selling,
especially with companies that are struggling or those with accounting issues,"
said Gerber.
In contrast, "Money managers focus more on purchases because they give much
stronger signal," he said. Insiders have little incentive to buy shares if they don't
think they'll go up, but they have many reasons to sell -- it could be to diversify
their investments or to pay for their children's education.
"When you look at selling -- It's more art than science," said Oakmark's Nygren.
"We have to look back to see if management has enough invested in the company
for them to think like owners."
For example, if executives sold big volumes of holdings but still have 90 percent
of their net worth invested in the company, that wouldn't raise the red flag for
Nygren.
Other early signals include when there are several insiders selling at the same
time, when there are only sales and no purchases for several months, or when
the level of sales is much higher than in the past, said Nygren.
"It's not black or white," said Nygren. "It's just a piece of the puzzle."
story.news.yahoo.com |
