Post of the Day
July 23, 1999

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Subject: Re: insiders
Author: McMathC


Periodically people ask about insider selling and/or the fact that big shots in the company appear to have little to no ownership in the company. It often is due to the way stock option grants work. I didn't understand this issue until it happened to me, so allow me to try & explain what might be going on. Lemme give you an example using myself, using fabricated numbers (so my friends don't think I'm a multi-millionaire!):

I hold stock options in the company I work for. I was awarded these options 3 years ago, say 400,000 shares, with 100,000 vesting each year. The options are say at a price of $10.00 a share. That means after year one I can purchase 100,000 shares of stock at $10 a share, after year two I can purchase the second 100,000, and so forth. For 3 years I don't sell anything, but I take advantage of my company's Employee Stock Ownership Plan (ESOP), and purchase a small amount of shares through payroll deduction. So here's what it looks like after 3 years:

300,000 options held that I can sell
5,000 shares I hold from the ESOP

Well, at this point I am nervous about having 99.9% of my net worth tied up in my company, as much as I like it. And I want to do some work on the house, send my child to private school, buy a new car, new computer, buy some VISX stock, whatever.

So I decide to sell some options - I do what's called a "same day sale" of my options. That means that I redeem some options - say 50,000 of them. I pay the $10 a share for them, so I have to pay $500,000. Yikes! Where do I get that money? Easy: from selling these exact same shares on the same day. So I immediately sell the 50,000 shares at the current price (say $80 a share). I pocket this much dough: 50,000 shares times ($80 - $10) so that's $3,500,000 (ok, so I pay the broker $9.95 for his commission...). Well, that's before taxes, so I probably only take home 1.8 million (this kind of a sale is subject to federal and state income taxes, plus medicare, social security,etc, the same taxes that are applied to your salary, it's safe to plan on receiving only about half of what you gross).

Ok, so in the paper tomorrow, there's a big bold headline: "McMath sells 91% of stake in company! Only holds 5,000 shares!" Yes, that's true. Because I had (for a brief moment in time) 55,000 shares, and I sold 50,000 of them, leaving me with the measly 5,000 I had before I flipped the options. But the headline DOES NOT tell you that I still hold 250,000 options. I still have an enormous investment in my company, and I still want it very much to succeed.

Why don't I just buy some of the options and hold the stock? Easy - who has that kind of cash lying around? If I were to exercise the options and hold the stock I'd have to first come up with the money to pay for the options, and second, make allowance for the income taxes I would have to pay on the difference between the option price & the market price when I buy them (from our example above, I would owe taxes on the $70 a share profit I made when I purchased the shares). It's not worth it, especially if the stock has gone way up in price. It's much easier to just do a same day sale.

I hope this wasn't too obtuse, and that it helps. Now I'm not saying that all insider selling is like this, but I think that most of it is, especially when you have a company that is growing and whose stock price is appreciating like mad. Those execs think "hm, I'd better establish that trust fund now, put some aside for little Royce's education, spring for that new ferrari I've been looking at, etc." :)

The bottom line: I'm not really worried about these sales here.