When executives sell stock - Talk about good timing:
Execs sell before the fall
By Andrew Countryman / Chicago Tribune staff reporter March 2, 2003
In hundreds of cases since 1995, corporate leaders locked in stock gains: More than half of their sales were followed by a drop in share value.
During the stock market's intense volatility of recent years, top corporate executives routinely displayed an uncanny ability to buy low and sell high--especially before their shares sank.
A Tribune analysis of transactions by the highest-ranking executives at the 30 companies that now make up the Dow Jones industrial average shows that many were able to time their sales and purchases to nearly maximize profits--unlike many typical investors--often on stock they obtained risk-free.
None of the executives in the analysis has been accused of illegal insider trading. Yet as investors are reeling from trillions of dollars in losses and executive compensation has come under scrutiny, the Tribune's findings raise questions about the advantages that executives enjoy in trading their shares because they have access to detailed, private information about their companies.
The Tribune analyzed transactions compiled by research firm Thomson Financial of all executives who held the chief executive or chief financial officer title at the blue-chip Dow companies since early 1995, when stocks began their historic rally.
Of the nearly 500 sales through the end of last year, executives frequently managed to capitalize on a window of opportunity before their stock sank: More than half of all sales were followed by a drop of at least 10 percent in the share price within the next six months. Following one-quarter of the sales, the stock fell at least 20 percent, sometimes dropping 50 percent or more.
Even from 1995 to 1999, when the Dow posted an unprecedented string of double-digit percentage gains each year, more than two of every five sales were followed by a drop of at least 10 percent within six months.
Executives also knew when to buy, the analysis showed: Four of five open-market buys were followed by gains of 10 percent or more within six months. More than half preceded gains of more than 20 percent, with several well above 50 percent. And though the market sank over the past three years, two-thirds of open-market buys were followed by at least 10 percent gains.
Unless they exercise options, executives aren't required to reveal how much they paid for the shares they sell, so it's impossible to calculate total profits on these transactions. But the executives studied sold more than 314 million shares in the past decade, adjusted for splits, worth just under $9 billion.
During the late '90s market boom, executives at the country's more than 10,000 publicly traded companies sold stock amounting to roughly $70 billion a year, estimated Jesse Fried, a law professor at the University of California at Berkeley and an expert on insider transactions. What he calls "excess" profits on these trades from the insiders' position, above overall market performance, totaled about $5 billion a year, he calculated.
"There's a fair amount of evidence that insiders do time their trades well," said Terrance Odean, another University of California at Berkeley professor and a leading expert on investor behavior. His research into transactions by thousands of individual investors shows that they routinely trade too frequently and are poor market timers.
"How do you tell someone, `You can only trade on public information, and you're the guy who knows everything?'" Odean asked. "In many cases, they probably just sell and hope that no big negative news comes out after the sale."
Track record hardly perfect
Still, executives do make trading mistakes, selling too soon or too late and missing out on substantial amounts of money.
In the Tribune study, shares rose at least 10 percent within six months after roughly half of the executives' sales, sometimes both climbing and falling 10 percent within the six months. At chip giant Intel Corp., for example, shares rose fifteenfold from the end of 1992 through 1999, and top executives sold into plenty of rallies.
Both of Intel's chief executives, Andrew Grove and Craig Barrett, and longtime CFO Andy Bryant all sold stock during that period, only to see Intel shares more than double within six months.
But even badly timed sales can turn out to be highly profitable for CEOs: In 1996, for example, Grove sold only half the options he exercised before an Intel stock jump, yet he still netted several million dollars from the transaction.
Most of the time, though, executives' stock sales were barometers for a significant stock drop.
One example is George Fisher, who resigned as CEO of Schaumburg-based Motorola Inc. in 1993 to take the same position at Eastman Kodak Co. By the spring of 1997, he had accumulated more than 1 million Kodak shares, including vested stock options.
On May 19, citing estate-planning purposes, Fisher exercised 300,000 options at $50.47 apiece and sold them for up to $81 each--reaping more than $9 million in profit.
Less than two months later, Kodak said "price pressures" and "continued higher marketing expenses" had brought second-quarter profit in much lower than expected, and Kodak shares fell more than 12 percent in a day. They closed below $70 and continued on a long slide, taking nine months to close above $70 again.
If Fisher had sold the shares four months later, he would have been out more than $7 million.
Kodak spokesman Anthony Sanzio said the trade came during one of the company's periods in which insider transactions are permitted after earnings releases. He stressed that, even during these windows, the company's general counsel's office could prohibit a trade "if it's found that the person coming in to make the trade has information not available to the general public."
In Fisher's May 1997 trade, he said, the subsequent earnings shortfall couldn't have been predicted.
"If we had seen any of that coming, or if Mr. Fisher had information that had not been disclosed ... then the general counsel's office would not have allowed him to make that trade."
Timing can be fortuitous
Corporate insiders sell for many reasons: to diversify a portfolio, to pay off debts, to exercise expiring options or to take profits. Even when profit isn't the principal motive, sales can have fortuitous timing.
In 2000, then-General Motors Corp. CFO J. Michael Losh was nearing retirement. So on May 1, he exercised options and sold more than 78,000 shares to help rebalance his portfolio and pay off his mortgage, he said.
GM shares had closed at $93.62 in the previous session, their highest ever. Losh sold his shares for between $92.19 and $92.75.
The backdrop was an offer in which GM sought to reacquire some of its stock, giving shareholders stock in its Hughes Electronics Corp. subsidiary in exchange. The offer, announced Feb. 1 and launched April 25, included a premium to GM stockholders, who then offered many more shares than GM could accept.
On May 22, three weeks after Losh's sale, GM shares dropped more than 10 percent after the company announced it was accepting only a quarter of the shares offered, leaving thousands of shareholders unable to capitalize on the premium in the deal. The stock continued to slide, falling below $55 in mid-October--more than 40 percent below Losh's sale price.
"I would suggest that I was acting at a point in time where everybody in the world knew what I knew," Losh said. The market, he said, was well-informed about the exchange offer.
"Any insider, particularly a CEO and CFO, needs to be very thoughtful about what they do and when they do it," he said. "This is a very sensitive issue with me. ... I've made my life on my reputation and integrity."
Other sales by GM insiders have preceded substantial stock drops.
GM spokeswoman Toni Simonetti stressed that all of the sales were acceptable under SEC rules. GM has substantial blackout periods in which insiders can't trade company shares, she said, and it urges executives to consult with its general counsel before trading.
And as a cyclical company, she said, GM stock has peaks and valleys. Insiders tend to exercise options and sell shares, she said, after the stock has had a run-up.
"That's generally a good time to do it, as long as they're not otherwise restricted," she said. "I guess buy low and sell high is something we all strive to do."
Tracking `the smart money'
Executive buying or selling often influences trading by other investors.
The mere fact a top executive is selling often is interpreted as a bet against the company's near-term results, leading other investors to sell. Buying the stock is looked upon as a bullish sign. Academic researchers have found that company stocks significantly outperform the market after insiders buy and, to a lesser degree, underperform the market after insiders sell.
This means that executives are able to capitalize on market advantages that aren't available to average investors. Experts call insiders "the smart money."
In general, researchers have found that transactions are most predictive when they're by the highest-ranking executives or when several insiders at a firm are buying or selling in clumps. If many insiders are selling as the stock price is falling, they say, watch out.
"It means they are a little worried," said H. Nejat Seyhun, a University of Michigan business professor and an expert on insider transactions.
Seyhun said larger sales are more meaningful, but only up to a point. Sales of more than 10,000 shares or so don't necessarily suggest that the executive knows something you don't.
"Very, very large sales tend not to be associated with information, because they're visible," he said.
Selling is considered a less powerful predictor of subsequent stock movement because executives may be selling for a reason unrelated to the company's prospects. But they generally buy for one reason: They think shares are going to go up.
Market researchers have taken the phenomenon of well-timed trading by insiders a step further, analyzing insiders' transactions over many years to identify those with the best track records of predicting price movements, and using that data to guide their own investments.
"We've found that there are certain individuals who have a knack for getting in and out of the stock," said Lon Gerber, who monitors insider trading at Thomson Financial.
Some also have a knack for selling very close to the stock's high: The Tribune analysis showed that just over one-third of all sales were for a price that was within 20 percent of the stock's peak during the person's tenure in office, and nearly half were within 30 percent.
But those don't attract nearly the attention of a well-timed sale.
"I think that selling in advance of a decline ... bothers people more, and the government is more willing to nail people for that," said Fried, the California law professor.
But that doesn't happen often--unless the government can determine the executives knew about specific bits of bad news that hadn't been released to the public. Undisclosed knowledge about broad, general business developments simply doesn't result in insider-trading enforcement actions, Fried said.
And because improper insider trading is so difficult to prove, trades several weeks or months before even bombshell announcements are likely to be deemed acceptable.
"If it's two months before, a lot can happen in that time," said Seyhun, the Michigan business professor.
"At that level, they sort of have feelings about things--they may not have any hard information, but they have feelings," said Jim Hamilton, a senior law analyst and securities law expert at the Riverwoods-based CCH Inc. research group.
With the exception of trading before announcements of mergers or tender offers, it's extremely difficult to prosecute for insider trading after executive purchases, experts agree. This is because of a philosophy that executives shouldn't be punished for demonstrating faith in their firms.
Recently, companies have dramatically increased the use of options and other forms of equity compensation in an effort to align management and shareholder interests. Given that trend, it makes it problematic to conduct a "witch hunt," in Seyhun's words, of the circumstances surrounding every transaction.
"If we ask them to hold shares, sometimes they have to trade them," he said. "Sometimes they're going to make money, and sometimes they're going to lose money."
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Coming Monday: A look at various proposals for reform.
SBC COMMUNICATIONS INC.
Top executives dial in profits
Top officials at SBC Communications Inc. have demonstrated their skill at timely stock sales, including one just six weeks before the stock's biggest one-day drop since the crash of '87.
In the past decade, Chief Executive Edward Whitacre and the company's chief financial officers reported six stock sales to federal regulators, according to Thomson Financial, which tracks insider transactions. Three of the six, including two of Whitacre's, have come for a price within 10 percent of the stock's all-time high of $59.94.
None of the sales coincided with that January 1999 peak. Whitacre exercised just over 500,000 options in April 1999 and sold them at $55.56 apiece, or $27.8 million, netting a $19.7 million profit.
After remaining above $50 for most of 1999, however, SBC shares slumped at year's end and remained below that level for most of 2000.
They rallied in the fall, and Whitacre exercised more than 580,000 options on Nov. 8-9, 2000, selling them for between $56.95 and $57.90 a share--for a profit of $21.8 million. About two weeks earlier, then-CFO Donald Kiernan had exercised 35,500 options and sold them for $54.19 a share.
On Dec. 19, the company lowered growth projections for 2001, and shares fell 12.7 percent--their biggest one-day drop since the October 1987 washout.
After brief rallies early in 2001, SBC shares have not been above $50 for two years.
SBC spokesman Larry Solomon said the company allows insiders to trade only after a quarterly earnings release through early in the following month, when results are in for the first full month of the new quarter.
All trades, he said, must be cleared by the company's general counsel, and officials must comply with federal rules barring trades when insiders have knowledge of important non-public information.
"Based on that, it was obvious there was no knowledge of any material event" when Kiernan and Whitacre sold their shares. "For these two trades to be looked at in that light, I think, is unfair."
Solomon said no fourth-quarter results were available when Whitacre made his November trades, but the company had October and November results when it lowered 2001 guidance in December.
"Obviously, a lot can happen in a short period of time," he said.
--Andrew Countryman
INTERNATIONAL BUSINESS MACHINES CORP.
`Buy on dips' proves profitable
During the stock market's magical bull run of the late '90s, the mantra was "buy on dips."
Louis Gerstner didn't invent it, but he may have perfected it.
After becoming the chief executive of International Business Machines Corp. in April 1993, Gerstner launched an effort to revive the computer giant and remake its culture. As part of it, he embarked on a series of open-market stock purchases of IBM shares as a demonstration of faith in its future. That made him the most frequent buyer of company shares of any Dow Jones industrial average CEO in the past decade.
"Every executive had to be in the same position as a shareholder: stock up, we'll feel good; stock down, we'll feel pain [real pain--not the loss of a theoretical option gain]," Gerstner wrote in his recent book, "Who Says Elephants Can't Dance."
"I felt it was important to have my own money at risk."
And at risk it was: IBM was struggling, and success was by no means a foregone conclusion. Shares had reached nearly $44, adjusted for subsequent splits, before the 1987 stock market crash, but bottomed out at just over $10 shortly after Gerstner took office.
With that risk, it turns out, was plenty of potential profit. In his first two years in office, Gerstner bought nearly 232,000 shares at prices ranging from $10.47--pennies above the low--to $18.50, investing $3.2 million. Less than five years after the last purchase, though, IBM shares hit their all-time high of $139.19, giving him a paper profit of just over $29 million.
That surge in stock price, of course, was in no small measure due to Gerstner's efforts, and the shares he purchased were a pittance compared with the more than 9 million options he was granted by IBM.
Not all of the gains, however, were from the late '90s tech boom: After all but the first of his 12 purchases, IBM shares rose 10 percent or more in the next six months, with gains of more than 30 percent in five of the 11.
When it came to selling, Gerstner also had good timing: In six sales of IBM stock in the past decade in a Thomson Financial database of insider transactions, the stock dropped more than 15 percent within six months each time, once as much as 34 percent.
One of the biggest drops came after a sale of 400,000 shares in August 1999. A little over two months later, IBM warned that fourth-quarter and early year 2000 results would be hurt by a Y2K spending slowdown, and shares fell 15 percent. It was the stock's biggest one-day drop since the 1987 stock market crash.
IBM spokesman Joe Stunkard said Gerstner engaged in several sales as part of asset and tax planning reviews; all were preapproved by the company's legal and human resources officials, and because much of IBM's revenue is booked late in the quarter, he couldn't have known about the earnings weakness at the time of the August 1999 sale.
Stunkard also said that, consistent with Gerstner's philosophy earlier in his tenure, he kept some shares acquired on exercise during some of the sales.
"Through many of these exercises, Mr. Gerstner added to his direct ownership of IBM shares," Stunkard said.
--Andrew Countryman
Tribune examined transactions by top executives at 30 blue-chip firms
To study corporate executives' stock-trading performance, the Tribune analyzed buy and sell transactions by each chief executive and chief financial officer (or equivalent position) at companies currently in the Dow Jones industrial average. The analysis period was Jan. 1, 1995, to Dec. 31, 2002.
Transactions were obtained from a database of insider activity compiled by the Thomson Financial research firm. Option exercises were not included. Transactions were analyzed individually, and not weighted by number of shares involved.
For each transaction, stock prices were tracked to see if shares advanced or declined by 10 percent or more from the sale price at any time in the next six months. That is the length of federal regulators' rule against insiders' "short swing" profits, premised in part on the idea that company officials may be able to accurately anticipate price movements in that time frame.
The 1995-2002 period was selected to coincide with the beginning of the Dow's unprecedented run of five consecutive years of double-digit advances, to determine if stock prices fell after executive sales even during a time of broad market gains. The period also includes the recent dramatic stock market retreat, to see where executives' transactions occurred amid broader drops.
Further, the Tribune determined how close each sale was to the highest point the stock achieved during the executive's tenure in office.
To capture as many relevant transactions as possible, all buys and sells reported to the Securities and Exchange Commission by people who held the CEO or CFO position were analyzed, including some by individuals who remained high-ranking company insiders but who did not hold the position at the time of the trade. For example, several sales by Bill Gates were included. They occurred after he stepped down as CEO of Microsoft Corp. but remained chairman.
The companies examined were:
Alcoa Inc., Altria Group Inc., American Express Co., AT&T Corp., Boeing Co., Caterpillar Inc., Citigroup Inc., Coca-Cola Co., Walt Disney Co., DuPont & Co., Eastman Kodak Co., Exxon Mobil Corp., General Electric Co., General Motors Corp., Hewlett-Packard Co., Home Depot Inc., Honeywell International Inc., Intel Corp., International Business Machines Corp., International Paper Co., Johnson & Johnson, McDonald's Corp., Merck & Co., Microsoft Corp., J.P. Morgan Chase and Co., Procter & Gamble Co., SBC Communications Inc., 3M Co., United Technologies Corp. and Wal-Mart Stores Inc. |
