Insider Trading

When you hear the words "insider trading" do you immediately think of Ivan Boesky or Michael Milken? Maybe Martha Stewart? Insider trading is a phrase that has gotten a bad rap when all it needs is a bit of clarification in its application. The Securities and Exchange Commission(SEC) has made it clear that there is legal insider trading and illegal insider trading. The legal kind is the sort I want to examine today, particularly insider buys. During a weak market, heavy insider buying can pinpoint a particularly undervalued stock.

Perhaps you can decide if a sell is for reasons of diversification, to pay taxes, to pay the kids' college bills, but I can't. You can contact investor relations for some insight, but you might not always get the truth(see Enron). However, people only buy stocks because their trying to make money, but they sell for a variety of reasons.

Here are some basic definitions that will enrich our discussion.

Insider: An officer or director of a public company or an individual or entity owning 10% or more of any class of a company's stock. This group includes the chairman, vice chairman, trustees, COO, CEO, CFO, controller, directors, the president, vice presidents, the secretary, the treasurer, partners, and beneficial owners.

Form 3: Initial statement of holding by insiders.

Form 4: Reports changes to an insider's holdings; this is the most important source of information about insider activity.

Form 5: Yearly statement of holding by insiders.

Form 13F: Filed quarterly by institutional investors having assets under management exceeding $100 million and lists all equity holdings.

Form 144: Notice of intent to sell unregistered shares.

Schedule 13D: Filed by holders of 5% or more of any class of a company's outstanding shares.

Schedule 13G: Filed yearly by passive investors owning 5% or more of a company's outstanding shares.

Purchases can be either open or non-open market. An open market transaction would occur in the same way that we would purchase stocks. Non-open market transactions encompass options exercises, grants, gifts, dispositions(these are sales), and private sales.

Ownership can be either direct or indirect. Direct ownership means that the stock is registered under the insider's name. The SEC states that indirect ownership refers to "securities held by members of a person's immediate family that share the same household." Immediate family refers to children, stepchildren, grandchildren, parents, stepparents, grandparents, in-laws, and includes adoptive relationships.

The SEC further assumes that insiders have indirect ownership of shares owned by a partnership or corporation insiders are a part of, and of trusts in which they are involved.

Generally, irect transactions yield more information than indirect. However, indirect holdings can be just as instructive. For example, if a CEO was making trades for a child's trust fund, they probably wouldn't be terribly ill-timed.

In general, an open market transaction is more telling then non-open market one, and transactions by insiders with duties to the company are more significant than those of insiders without them,i.e. the trades of the CEO should carry more weight than a member of the board of directors.

Also, purchases by new insiders should be given less weight than those of long time insiders. When you first join a company or its boards, you often need to get some skin in the game as a matter of course.

Here are a couple of websites dedicated to tracking insider trading:

SecForm4
InsiderScoop
InsiderCow
EDGAR Online
MSN Money
Yahoo! Finance
Form4Oracle
Real Time Insider
InsiderScore.com
GuruFocus
J3SG.com
InsiderTransactions.com

Also, Investopedia has published some helpful articles on the topic:

Defining Illegal Insider Trading
Uncovering Insider Trading
Insider Selling Isn't Always a Bad Sign
When Insiders Buy, Should Investors Join Them?
Can Insiders Help You Make Better Trades?