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Insiders are chickening out

February 15, 2002: 5:50 p.m. ET

If a company's executives aren't buying, why should you? By Staff Writer Paul R. La Monica NEW YORK (CNN/Money) - Investors have been fascinated with insider trading since the days of Ivan Boesky and Michael Milken.

But in this new age of accounting scandals, the transaction histories of corporate insiders are being scrutinized more than ever -- basically, who knew what and when.

In most cases, insider trading is perfectly legal. Except for certain blackout periods around the release of important news, executives and directors -- the Insider -- can sell their stock whenever they want. But they must disclose trades to the SEC.

When you consider the wave of insider selling reported by Enron insiders in the months leading up to the epic collapse, it's hard not to think that they knew bad news was on the way.

And given the way insiders at other companies are behaving, there could be more bad news in coming months.

Selling before bad news breaks

Do insiders really sell if they know bad news is coming? Steven Huddart, an accounting professor at Penn State's Smeal College of Business, says yes. In a study, he found that there was a surge in insider selling at companies that reported a quarter of lower earnings growth following a string of quarterly earnings increases. Interestingly, most of the selling took place in the three to nine quarters before the bad earnings report. "Investors may be selling early to avoid the legal jeopardy of trading in advance of earnings," Huddart says.

Lon Gerber, director of research for Thomson Financial, which tracks insider trading, agrees that insiders are typically ahead of the market (though not quite as far ahead as Huddart's study suggests). He says that insider trading patterns are usually a good barometer of what a stock will do six months from the transact ion date. Unfortunately, the signals are sending scary signs.

More buying on the horizon

Since Sept. 11, there has been a steady decline in insider buying. According to Gerber, the ratio of insider-selling to buying jumped from $14.39 in November to $27.33 at the end of December.

That's the second highest insider-selling to insider-buying ratio in the 10 years that Thomson has tracked this data. Only $99 million of insider purchases were announced in December, the second lowest level in six years.

There are some anecdotal signs that insiders are getting more bullish. AOL Time Warner chairman Steve Case purchased 1 million shares of AOL, which owns, on Feb. 4. It was the first purchase by Case since AOL's merger with Time Warner closed last year. Case bought the shares at prices between $24 and $24.25 a share, just above the stock's 52-week low of $23.60.

Gerber points out that there were also notable buys in January by executives at storage hardware giant EMC and semiconductor manufacturer Atmel. He says these were significant since insider buying in technology companies is fairly rare.

He added that a purchase of shares by the general counsel of paper and timber company Georgia Pacific could be a good sign. It was the first purchase by this executive since 1996 and it comes at a time when the stock has been plagued by lingering concerns about asbestos liability.

Finally, Gerber says that it was interesting to see that the CEO of casino operator Park Place Entertainment bought shares for the first time in a year and a half. Thomson Financial is expected to report full insider trading figures for January next week.

Insider selling can be kept secret for months

Still, even if the latest data shows an increase in buying, it's hard to take some of those numbers at face value given what took place at Tyco International.

CEO Dennis Kozlowski and CFO Mark Swartz each purchased 500,000 shares of Tyco on the open market on Jan. 30. But a report in The New York Times earlier this week showed that the two executives have actually sold $500 million worth of shares back to Tyco since July 1999. Tyco's stock has plunged 54.6 percent so far this year due to concerns about accounting and several earnings warnings.

The company put out a press release to announce the purchases by Kozlowski and Swartz and the market's reaction was positive. But the selling that took place over the past few years was fairly hidden, because trades weren't made in the open market.

Any time an insider sells or buys stock on the open market, they are required to file with the SEC within ten days of the end of the month in which they made a transaction. But the rules are different for sales made to a company. In those cases, insiders don't have to file until 45 days after the end of the fiscal year that the transaction took place.

For this reason, Huddart says it might be time for the SEC to consider having insiders report transactions before they actually buy or sell.

Steven Huddart
Smeal College of Business, Penn State University, University Park, PA 16802-3603 USA
(814) 863-0048
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