S. Burcu Avci is an Adjunct Lecturer at Vanderbilt University, H. Nejat Seyhun is the Jerome B. and Eilene M. York Professor of Business Administration and Professor of Finance at the University of Michigan Ross School of Business, and Andrew Verstein is a Professor of Law at the UCLA School of Law. This post is based on their recent paper.
Corporate executives and directors are legally allowed to sell their shares directly back to their corporation, rather than selling them in the open market. What is most interesting and most unusual about this situation is that insiders are decision-makers on both sides of the trade. They decide to sell out of their personal account and buy into a corporate account. If they are directors, they even approve their own sales. This pits executives against their own shareholders. To the best of our ability, no one has studied what happens in these situations.
At the very least, there are potential conflicts of interest in corporate governance at the highest levels. You might expect executives to benefit themselves at the expense of their shareholders whenever there is a direct conflict. If stock prices subsequently drop, shareholders lose and insiders win. Insiders have to choose between shareholders’ interests and their personal interests, and risk violating their fiduciary duty if they sell based on adverse, material, non-public information.
Insiders’ direct sales to the corporation are stealth trades, since no sell order ever hits the market. There is no price impact or price pressure. There is no disclosure before the trade. Even the brokers are in the dark. The market only finds out, upon 16a reporting (which could be late), that a D-sale took place. Insiders report these transactions (on Form 4) to the SEC using a ‘D’ code. The corporations lump insider buybacks in with other buybacks when they report them publicly. There is usually no separate 8-K disclosure requirement. There is currently no limit on the amount insiders can sell. This means the counterparty traders will not even know they are harmed. Furthermore, they may not be able to prove they are harmed in court, since the trade does not trigger an immediate price impact.
These D-sales are much larger in volume than normal S-sales. There are multitudes of trades over $10 million or $100 million. What is to stop the insiders from taking advantage of their dual roles since they are on both sides of these large trades? READ MORE
