How Insider Sales Can Lead Investors Astray

As global markets approach their 20 February highs, we have seen reports indicating corporate insiders—that is, companies’ CEOs and other corporate executives—are selling some of their companies’ shares from their personal holdings.^[i] In our experience, whenever this happens, it prompts financial journalists to question whether individual investors should broadly do the same, potentially on the presumption corporate executives have unique insight into the economy and/or equity markets’ prospects. In our view, however, this oversimplifies the issue, and individual investors don’t benefit from factoring insiders’ moves into their own decisions.

By some measures, the ratio of insider buying to selling is the lowest since 2000, seemingly in stark contrast to insiders’ big buying in March.^[ii] Considering this global bull market (prolonged period of generally rising equity prices) began 23 March, we have seen some commentators argue the flurry of buys illustrates insiders’ foresight.^[iii] To many, this may create the perception that corporate executives must know something most investors don’t—leading the former to now sell shares at an optimum exit point.

By virtue of their unique vantage point and their job of leading their firms through changing business cycles, we do think it is fair to say insiders are likely privy to their industries’ inner workings. We suspect this is why many commentators seemingly think insiders are especially sensitive to whether equity markets are over or undervaluing their firms. The logic might go like this: Who better to understand a company’s performance drivers than its executives? And why would they sell if they weren’t pessimistic about their own company’s or the market’s foreseeable future?

In our view, there are a lot of other reasons, as insiders aren’t too different from typical investors on several fronts. Just like anyone else who follows a financial plan, they may want to diversify overly concentrated holdings. Corporate filings indicate many have compensation plans in which shares comprise a sizable portion of their overall pay, which can lead them to build up large positions in their company’s shares. (This is typically risky, in our view, no matter how successful your company or positive your outlook is.) They may also want to access cash to make purchases or meet other financial obligations. They could also be eyeing philanthropic endeavours, real estate deals, gifting or any number of alternate uses.

Furthermore, we think their sales' timing may have less to do with finding an optimal exit point and more to do with following regulatory procedure. To comply with American insider trading rules, corporate insiders in the US must plan their share sales in advance and on a regularly scheduled basis. However, the Securities and Exchange Commission—the US’s equivalent of the Financial Conduct Authority (FCA)—allows insiders to cancel planned trades. It doesn’t seem unreasonable to us that US corporate insiders may have delayed plans to diversify or take action during the February – March bear market (meaning, fundamentally driven equity market decline of -20% or worse), not wanting to compound pressure on their shares or add to fear over their company’s health. With this seemingly less of an issue now, sales have resumed, perhaps boosted by a backlog of cancelled sales.

Fears over insider selling strike us as another example of the Pessimism of Disbelief—a term Ken Fisher coined to describe financial commentators’ seemingly constant search for reasons the equity market rally will fade soon. In our experience, whilst this mentality is common as bull markets gain their footing, it can lead individual investors to a crucial mistake. If you sell out of equities and miss a period of substantial market gains, you may forgo some of the returns that could be necessary to help you meet your long-term financial goals, depending on those goals and your personal situation. So when confronted with supposed negatives like insiders selling, we think it is important to take a step back and think critically.

For one, we don’t think markets are unaware of executives’ activities. In our view, they price all widely available information, including insider sales, which are disclosed in advance. Once those sales are announced, we think markets reflect them near instantaneously. To turn pessimistic because of transactions that are already old news to markets disregards how the latter work, in our view. Our research indicates equity markets look forward, typically to a company’s earnings prospects over the next 3 – 30 months and how reality fares against those expectations. Insider selling has little bearing on a company’s longer-term earnings outlook, in our view. Hence, we think selling because of insiders’ actions is speculating that they are doing so because they know something others don’t. It is a guess at their motivation—and, in our view, generally a poor investing thesis.

We think investors needn’t fixate on how corporate executives are managing their own financial plans. Instead, we think investors benefit most from focussing on their own plans and remembering that one of the biggest risks an investor faces is that of not reaping the market-like returns that may be necessary to reach their long-term goals.