2 Reasons All Insider Trading Isn't the Same

It's easy to see management and other insiders making trades and to assume this is important information. But all trading activity isn't created equal, just as shares that an insider holds shouldn't always be viewed in the same light as your personal holdings. Let's take a look at some insider activity at Clean Energy Fuels  (NASDAQ: CLNE  )  and Facebook  (NASDAQ: FB  ) and see what we can learn. 

Regular insider selling isn't always a bad thing
Facebook COO Sheryl Sandberg, CFO David Ebersman, and CTO Mike Schroepfer have combined to sell more than $100 million in shares over the past year. Clean Energy Fuels CEO Andrew Littlefair sold almost 100,000 shares per year over the past two years. 

What do these insiders have in common? Trading plans.

Reason No. 1: trading plans
Securities and Exchange Commission Rule 10b5 limits insider trading based on material, nonpublic information that would give insiders an advantage against those without access to that knowledge. It prevents insiders from dumping shares before bad news becomes public, or from buying shares on the cheap before a big earnings report, buyout announcement, or some other piece of news that would significantly increase the stock price. 

However, the use of trading plans, via SEC Rule 10b5-1, is a means for employees to sell and buy shares of their companies while removing any insider information from the picture. Trading plans function simply: They are set up well in advance, and they must be in place before any insider knowledge could create an unfair advantage. It's pretty easy to recognize a trading plan. If you go to Nasdaq.com's site detailing insider activity at Facebook, you see this:

Image source: Nasdaq.com.

Note how most of the transactions are listed as "Automatic Sell"? The seller is using a trading plan, not special knowledge. 

Facebook is still a young company, and like any young company, it attracted talent early on by offering up a piece of itself years before going public. When a company goes public, the net wealth of insiders goes up by the IPO value of their shares, meaning a massive tax bill as this new unlocked wealth becomes income for that year. Thus insiders tend to sell much of their shares just to pay taxes on their newfound fortunes before they can begin to think of selling to buy private islands.

Sure, Facebook is still in the early stages of its potential, and as a shareholder my view is that those sold shares would be worth a lot more in a decade. The potential from the acquisitions of WhatsApp and Instagram over the past 18 months alone offers massive channels of both growth in data -- that priceless commodity that every marketer wants access to -- and users of more than just the core Facebook social network. 

But selling for insiders is deeper than that -- for insiders, stock isn't just something to hold for the long term.

Reason No. 2: It's often compensation
Clean Energy Fuels chief Littlefair received $7.1 in total 2012 compensation. Of that, only $1.7 million was in cash, meaning that the lion's share of his income is stock-based compensation. While $1.7 million isn't a small number, it's unfair to judge any insider's decision to reap the rewards of his or her labors. Littlefair has worked at Clean Energy since co-founding the company with T. Boone Pickens in 1997, and augmenting his income via partial, scheduled selling is reasonable.

Looking for good signs in insider activity

More companies like UPS keep adding NGVs to their fleets. Source: UPS.

Littlefair actually gives us a great example of what good behavior can look like. After several years of regular selling and a compensation plan built around additional stock grants based on sustained stock performance, Littlefair demonstrated his strong belief in his company by ending his trading plan last year and purchasing 127,000 shares on the open market. In all fairness, the market hasn't responded in the interim: Since Littlefair's $1.4 million personal investment, Clean Energy shares are down 28% on a combination of analyst downgrades and slower-than-anticipated adoption of liquefied natural gas by the trucking market. Littlefair's response? Investing another $100,000 in his company's stock, picking up 11,000 more shares in recent days.

While his decision to buy more shares isn't a guarantee that the stock price will go up, it does serve as an indication that you have one insider who believes the shares are undervalued. A little analysis of the business would indicate that he could be right, as the company has increased gallons of fuel delivered no less than 10% annually for at least the past three years.

Final thoughts: Don't project and don't assume
There's a saying that goes along the lines of, "assumption is the mother of all screw-ups," so making assumptions, or reading too much into insiders' actions, won't help you invest better. To the contrary, you'll be making decisions that will impact your future, just because you took action when someone you don't know did something you don't understand for reasons you're guessing at.

Insiders are people, too, with wants and needs and goals. Some may be choosing to diversify their wealth. Some just want to buy a yacht. And that's OK, even if it means they are selling shares for less than you paid for yours. It's not like they're selling your shares.

Have questions? Thoughts? Share in the comments section below.

 

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  • Report this Comment On March 06, 2014, at 5:41 PM, JSergeant wrote:

    <i>When a company goes public, the net wealth of insiders goes up by the IPO value of their shares, meaning a massive tax bill as this new unlocked wealth becomes income for that year. Thus insiders tend to sell much of their shares just to pay taxes on their newfound fortunes before they can begin to think of selling to buy private islands.</i>

    Jason:

    Is this always true? I know it's a tricky subject. Depending on the type of option grant, they can be taxable when exercised or taxable when sold.

  • Report this Comment On March 06, 2014, at 6:29 PM, TMFVelvetHammer wrote:

    John,

    I'm not a tax (or IPO) expert, but past experience (or hindsight bias!) tells me it's always true.

    I think IPOs are typically structured so that insiders can sell partial holdings at IPO to cover taxes, if they aren't in a financial position to pay it otherwise.

  • Report this Comment On March 07, 2014, at 1:14 PM, Upside wrote:

    Littlefair seems to have forgotten that CLNE is, at its heart, a gas station company. It has no meaningful competitive barriers to entry, owns no attached convenience stores or driver lounges from which to make money, overly relies on third parties to host its equipment, and is up to its eyeballs in dilutive convertible debt. You can draw your own conclusions, but as for me I'm shorting this one down to book value.

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