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This Week's Guidepost

Insider Trading

1. In 1934, shortly following the crash of 1929, the U.S. Congress created the Securities Exchange Commission (SEC) to protect individual investors. This commission quickly realized that corporate executives had a leg up when trading their own company’s shares. The solution fell to “disclosure” as opposed to “prevention” (banning executives from trading their own stock). This means that any trades made by company “insiders” must be made public. They defined an insider as an officer or director of a public company. It also extended to individuals or entities who owned 10% or more of the company’s shares.

2. Insiders must file a variety of forms to trade company shares. Form 3 is the initial statement of beneficial ownership for all officers. This identifies who the insiders are as viewed by the company. Form 4 reports any change in an insider’s ownership position. This includes buys, sells, or anything that causes a change. An annual statement of change in beneficial ownership is submitted on Form 5 by the company. This contains activity for exempt transactions not required on Form 4 (exempt transactions are small transactions or transfers within company plans). The important form for us is Form 4.

3. Although Form 4 is the vehicle for an insider to sell unrestricted shares, Form 144 is necessary for insiders to declare their intention to sell restricted stock. What’s the difference? Restricted stock is issued to officers as a form of compensation. Other private investors can acquire restricted stock through private placements, provided at a discount to the current market price. In either case, the stock is restricted in that it cannot be sold for one year from the transfer. To sell shares after the one-year holding period, the insider must declare intent with Form 144.

4. For purposes of the Provident Investor, insider buying is more important than selling. There are many reasons an insider (or anyone else, for that matter) would sell a stock; college tuition, mortgage payments, auto purchase, vacation expenses, etc. However, there is only one reason an insider would buy company stock; They expect the price to go up! Any benefit we derive from an understanding of insider trading will come predominantly from buying. However, because of the difference between buying and selling motivation, there are always more insider sells than buys.

5. It makes a difference which company insiders are making the buys. That is, those closer to the decision-making process will likely have a better vision of where the company is going. They stand to lose more if their predictions go awry. This “creme of the crop” insiders include the Chairman of the Board (COB), Chief Executive Officer (CEO), Chief Financial Officer (CFO), Chief Operations Officer (COO, or CO), and President (P). A Director (D) may be privy to high-level insider information. This crop of 1st-team insiders will carry more weight as we assess the importance of Insider information.

6. As we look for messages in insider data, the following are important:
   • How large was the trade (how many shares or the dollar value)?
   • How much of an insider’s holdings were included in the trade?
   • Is there a consensus by more than one insider in the company making the same trade?
   • Which officers in the company are making the trade?

7. Let’s see if we are able to use insider information in our rolling stock strategy. With the computer as our companion, it is easy to find insider information on any stock. We have used the free service Investorama in the past. We can take further advantage of this service as we seek greater insight through insider trading. Last week one of our picks was General Semiconductor Inc (SEM). This example will provide a case in point for insider trading

   Get to Insider Data with the following sequence:

   • First, get into Investorama: www.investorama.com
   • Scroll down to StockPower Search, enter the ticker SEM, and click on GO.
   • Scroll down to the category “Insider Trading,” next to last on the screen.
     
     

   • Select “Insider Scores.” This will give you a 6 month chart for SEM with standard price data at the last close.

     
     

   • On the left-side menu under “DATABASE SEARCH,” click on “BUY TRANS ONLY.”
   • This will take you to a BUY-ONLY Database Search for SEM.

8. The screen will look like this, with the insiders names and nine data columns.
   
   

9. We see six names of company Insiders with BUY transactions executed since 9/1/98. The bottom four were executed within 10 days by four different insiders (CFO, Chief Financial Office; D, Director; CEO, Chief Executive Officer; and O, Officer).

10. What do we learn? There was a consensus buy in September 1998 by four company officers (Insiders). That was big news. Two token buys were made by single insiders on February 19, 1999 and again on February 11 of this year. Is any of this important? Lets look at the price chart to see.
    
    

11. This price chart shows when the consensus buys began in mid-September. The gray pointer line is positioned on 9/11/98, the first day of the buy transactions. A dramatic 36% price increase followed over the next two months. This buy activity came after the stock had seen a serious decline from a high of about $14.00 in May to the low spot of $6.38 on September 1st. It is significant that two of the four buyers involved were among the creme of the buyer crop as mentioned earlier, the CEO (Chief Executive Officer) and the CFO (Chief Financial Officer).

12. What we saw was an activity among company officers that suggested they thought the price of their stock would increase. They did not do this for a quick return on their dollars because they were restricted from selling for one year. Whatever they saw or felt about the positive forces in their company was realized in 2 ½ to 3 months. That is an advantage we could have taken advantage of. While insider trading is considered long-term in nature, it remains a positive input to shorter-term strategies.

13. Let’s look at one more example before we discard insider selling as a strategic tool. The insider print-out for CRY is shown below (this time we selected ALL TRANS). The significance of this insider data is the consensus selling that took place on 04/03/98. The other sell transactions were singular events and the transactions marked X are for the exercise of options. But on April 4th, four insiders sold nearly half million dollars of company stock.
    
    
    
    
    
    

14. When insider sells come in a cluster, representing a consensus opinion, it bears careful scrutiny. Let’s look at the price chart for an understanding.

    
    

15. The gray pointer line is aligned on the left at the date of the insider sells, 04/03/98. Remember, these insiders cannot buy back the stock they have just sold for one year. Notice how the stock price declined steadily, not making a solid recovery until, you guessed it, one year later. Does this represent skulduggery? It doesn’t matter. There is no record that these company officers bought back in after the one-year hold. Whatever happened, it was completely legal. The reason this is pointed out in this guidepost is that insider information is readily available. Insider information may add one more dimension to your fire-wall of risk reduction. It is up to each of us how detailed we want to be and to what lengths we want to go to increase our chances of success. It is Pro-fundity’s mission to give you the tools.

    Recently (12/28/99), eminent stock market chartist and guru Don Worden (founder of TC2000) made the following comment: “Every stock has a personality. You should study a stock's personality before you attempt to come to conclusions about its technical strength or weakness... “

    To Worden’s observation we add a hearty hurrah! That is the purpose of the Rolling Analysis section. It is not to fix buy and sell triggers. It is to help us understand the personality of tickers we are considering to be rollers. This is but one unique and proprietary feature of Pro-fundity that sets it apart from other rolling stock web sites. Properly utilized, this will provide a market sense and understanding of the nature of what we call “rolling stocks,” increasing their successful use to fatten our wallets.

It is our intent to help our subscribers understand market strategies well enough to make informed decisions and understand the risks.

TC-2000 tutorials are available on the home page.

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