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New York Times, September 1, 2002

Money and Business/Financial Desk; Section 3 STRATEGIES

Insider Trades Point to a Rising Market (Eventually)


09/01/2002 The New York Times Page 8, Column 1 c. 2002 New York Times Company


FOR the first time in many months, corporate insiders have stopped selling their companies' stock at above-normal rates. Because insiders' behavior is a good leading indicator for stocks, better days may be ahead for the market.

But don't count on that improvement immediately. Recent research has found that the lag time may be quite long.

The research focused on the buying or selling of a company's stock by its officers, directors or largest shareholders. In most cases, such insider trading is legal; it becomes illegal only when it is done with private knowledge of a specific event that is likely to greatly affect the stock price -- like an impending investigation by the Securities and Exchange Commission or a Chapter 11 bankruptcy filing. The law is quite complex, however, so to avoid even the appearance of impropriety, insiders often avoid any trading within several weeks of a significant event.

Researchers are able to study trends in insider buying and selling because securities laws also require insiders to inform the S.E.C. any time they buy or sell their companies' stock. In the past, they had to do so within 10 days of the end of the month in which the transactions took place -- though last week the S.E.C. shortened this time frame to two business days.

In large part because many executives receive substantial amounts of stock as part of their compensation, insiders typically sell more of their companies' stock than they buy -- about twice as much, in fact.

Beginning last December, however, the ratio of sales to purchases rose significantly above this historical level, according to the Vickers Stock Research Corporation, which gathers and analyzes the insider transaction data from the S.E.C. At one point in the spring, the sell-buy ratio over the trailing eight weeks was nearly three to one.

The eight-week ratio began declining in mid-July, however, and now stands at 1.25, suggesting that insiders are selling at well under than their historical average rate. The ratio is likely to continue falling, according to Vickers, because insiders have sold at an even slower pace in recent weeks. The ratio is below one, for example, for all August insider transactions that have been reported so far to the S.E.C.

New research sheds light on how long it may take for insider trading patterns to cause a change in the overall direction of stocks. It was conducted by three accounting professors -- Bin Ke and Steven Huddart of Pennsylvania State University and Kathy Petroni of Michigan State -- and is circulating in academic circles as a working paper (

To measure the lag time, the researchers focused on companies that report lower earnings after many consecutive quarters of profit increases. Not surprisingly, these companies' stocks plummeted when their bad earnings were eventually reported. Of course, insiders would have an incentive to sell when they first had an inkling that their companies' fortunes might take a turn for the worse. In fact, the researchers found higher-than-average selling by corporate insiders began as early as nine quarters before such earnings reports.

The researchers also found that insiders generally wrapped up their abnormally high selling at least three quarters before the release of a negative earnings report. That might be because insiders wanted to avoid the potential penalties of selling in the weeks just before bad news was made public, the researchers speculate.

The study offers a road map for interpreting the abnormally high amount of insider selling from December to July. If that selling conforms to the historical pattern, the bad news anticipated by these insiders will not become public knowledge, and thus fully reflected in stock prices, until sometime in 2003 at the earliest.

In other words, the bear market may have further to go.

Graph: ''Early Warning?'' A new study has found that stock sales by corporate insiders start increasing more than two years before negative news about the company is made public. Insider selling relative to historical average Graph shows the stock sales by corporate insiders before and after negative news made public. QUARTERS BEFORE NEGATIVE NEWS (Sources: Bin Ke and Steven Huddart of Pennsylvania State University and Kathy Petroni of Michigan State University)

Copyright © 2000 Dow Jones & Company, Inc. All Rights Reserved.

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