• Reasons for selling are often inscrutable
• Focus should be on insider purchases
So-called directors’ dealings or insider transactions are always used when managers trade in shares or related derivatives of their company or the parent company. The group of insiders includes all persons who are entrusted with certain management tasks within the group. This includes, for example, the members of a supervisory, management or administrative body as well as shareholders and other persons with constant access to insider information.
A term with an aftertaste
When most people hear about insider selling, the first thing that springs to mind is the Ivan F. Boesky financial scandal in the 1980s and the Oliver Stone film character Gordon Gekko that was inspired by it Wall Street. In reality, however, very few insider purchases or sales are as spectacular or even illegal.
If managers sell blocks of their own employer’s shares on a large scale, this is often taken as a sell signal by private investors. While this assumption is not fundamentally wrong, it is also not as clear-cut as many think. “The reasoning is that executives have an insider’s view of their company and know how the company is doing,” says Franz-Josef Leven from Deutsches Aktieninstitut in relation to the interpretation of insider transactions.
Insider transactions can have many reasons
However, it is almost impossible for private investors to evaluate an insider purchase or sale or to find out the right motives. Because the directors’ dealings often have no connection with the prevailing valuation of the share. As a consequence, share purchases can already be stipulated in the respective executive’s employment contract, for example. “There are many companies that oblige their supervisory boards to invest part of their remuneration in shares in their own company to demonstrate commitment,” says DWS Managing Director Marc Tüngler. “An acquisition here has no meaning whatsoever with regard to the operative development in the company,” says the investment advisor Adrian Roestel from Munich.
Insider sales can happen for a variety of reasons, but not every sale is a bad sign for shareholders. When selling shares from employee bonus programs, for example, manager salaries are broken down into a fixed and a variable part. If explicit corporate goals have been achieved, the executives receive additional shares or stock options. However, as a variable component of wages, these shares are often converted back into cash and accordingly sold on the stock exchange.
Especially in the case of smaller and still relatively young companies, the management level can also make sales in order to spread the risk. Because for founders or former owners who have tied up most of their assets in their own company, it can make sense to sell shares in order to diversify their own portfolio. In addition, there are also many prominent insiders who sell their own company holdings according to a strictly defined plan in order to generate fresh liquidity on a regular basis. The reasons for an insider sale can therefore also be of a private nature. “Maybe the manager wants to build a house or buy his daughter a car,” says Franz-Josef Leven.
Clear sell signals for investors
In addition to many reasons for selling that have nothing to do with the operative business of the company, there are of course also reasons that are very much related to the course of business. For example, it can happen that insiders consider their own shares to be overvalued or assume that business will develop negatively and say goodbye to their shares for this reason. Such a motive would also be a clear sell signal for private investors.
Another case where insider selling is a troublesome sign is when the company’s management announces a large-scale stock buyback program and management takes advantage of the stock market price increases, which are usually felt immediately after such positive news liquidate own shares. “When executives offload significant amounts of stock after announcing a buyback, they often profit from short-term price fluctuations at the expense of long-term investors,” SEC Commissioner Robert Jackson said of this highly questionable practice.
Management needs skin in the game
The large number of possible reasons for an insider sale are nevertheless inscrutable for the private investor. For this reason, DWS Managing Director Tüngler also believes: “The notification of a purchase or sale alone should not be the impulse for the investor to act”. That said, long-term investors should focus on insider buying rather than insider selling, because when a CEO, founder, or board member invests in their own company systematically, it’s a great vote of confidence. Last but not least, fund manager Nick Clay of London-based Newton Investment shares this view, saying: “We definitely want management to have skin in the game and be willing to use their own money to buy shares”.
Pierre Bonnet / finanzen.net
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