Insider Trading

“The problem is that if you are a senior executive at a public company, you are constantly learning things that could be material to its stock price. If you are a top executive, everything that you do is material to the business; if it wasn’t material to the business, someone else would do it.” – Matt Levine, Bloomberg Opinion

The above is a quote from a piece published on March 8, 2023, by Matt Levine (https://www.bloomberg.com/opinion/articles/2023-03-08/the-good-hedge-funds-always-get-paid?leadSource=uverify%20wall).

Pro tip: Read Matt Levine’s commentary, which comes out on an almost daily basis, he really has a good take on how financial markets really work. In it, he sets out a number of legal and less legal (and ethical) ways to structure the activity of executives trading in their own company’s shares.

I don’t think Matt came out against insiders transacting – as long as they were doing it in accordance with the rules, as well as ethically. But it seems a vocal proportion of investors seem to be of the view that “all share trading by company executives is insider trading” and, as such, should be completely prohibited.

It just so happens that later on in March, there were a few significant events that caused losses to investors.

In the USA, their 16th largest bank, Silicon Valley Bank (SVB) failed, leading to a few other bank failures, and wiping out over $60 billion in market value in the sector.

In South Africa, a market darling amongst the go-go crowd – Transaction Capital (TCP) – came out with a profit warning. As a result, the share accelerated its decline and has now lost over 80% of its value over the past year, equal to almost R30 billion.

Apart from significant losses to shareholders, what did both of these events have in common? Very simply – management told shareholders bad news was coming and gave them fair warning to adjust their exposure appropriately. 

The interesting aspect of management’s chosen communication channel was that it could not be found in their financial reporting. If you study both SVB and TCP’s financials that were available before the respective share price meltdown you would find no sign of trouble. Rather, the signs were contained in announcements related to significant sales of shares by management.

In the case of SVB, executives and directors cashed out $84 million worth of stock over the past two years, and in early February 2023, both the Chief Executive Officer (CEO) and Chief Financial Officer (CFO) sold shares. All these transactions were announced publicly.

Over at TCP, the CEO sold R50 million of shares in December 2022, barely three months ago. This was also officially announced, albeit on 19 December, at which time most investors were slapping on the suntan lotion at their favourite beach, not watching stock market announcements.

Some investors seem to be upset that management “got away” with selling such big chunks of shares. They seem to believe that the executives should go down with the ship, like the heroic captains of a bygone era, and should not be allowed to trade in the shares of their company at all.

I have a different view. 

Make no mistake – despite what many promotional executives will have you believe, that their business is always showing positive growth – business is messy, and is always subject to the vicissitudes of the marketplace. Good and bad. Investors scour financial reports for any signs of a change of fortune, believing it will help them in forecasting the prospects of the business under review. The bad news is that analysing these reports for signs of future distress (or prosperity, as the case may be) is a waste of time – the reported financial accounts pertain to that which has already happened.

Yes, understanding the accounts can lead to a good understanding of the business, and helps with understanding the economics driving the value creation (or lack thereof). But they are useless when it comes to the here and now, the immediate competitive dynamics that the business is experiencing. Trying to divine these from the accounts is like trying to drive home, using only the rearview mirror.

More useful is the information conveyed through the buying and selling of shares by management. To alert investors, this can serve as actionable information.

Whether executives should have been allowed to sell their shares is a moot point. Those that agitate for a change in the rules to block executives from transacting in the stock of their companies are effectively agitating to close down an important source of information for investors. A source of information that is both more timeous and more accurate than that found in their quarterly or semi-annual financial reporting. 

As such, I am strongly in favour of allowing executives to transact. It leads to more efficient price discovery, which after all, is the purpose of the market! In fact, if it is actually true that senior executives are at all times in possession of insider knowledge, I would go so far as to say let them trade at all times. Why have a closed period at all? As long as the trades are disclosed properly and timeously (and I would probably want to tighten up on these measures) I say it’s all good.

If you were left holding the bag in Silicon Valley Bank or in Transaction Capital you simply weren’t listening to management.

As they say in the classics: “Don’t do what I say, do what I do”