The Beginner's Guide to Understanding Company Insider Transactions

In 2003, Martha Stewart received a tip from Peter Bacanovic (stockbroker) that ImClone, a biopharmaceutical company, would fail to receive FDA approval.

Stewart proceeded to sell $230,000 shares of ImClone on December 27, 2001, one day before the FDA decision was announced. The next day, the stock dropped 16% and Stewart avoided a loss of $45,673.

Stewart spent five months in jail and paid a $30,000 fine.

Everyone knows what Martha Stewart did was illegal. But what about this?

Silicon Valley Bank (SIVB) was a regional bank in the San Francisco Bay Area that serviced much of the tech industry.

SIVB went bankrupt on March 10, 2023. The stock dropped from $267 on March 8 to $0.40 on March 28.

Greg Becker was the CEO of SIVB, and on February 27, he sold $3.5 million of SIVB stock.

What separates Martha from Greg?

Let's find out.

Insider Trading vs. Insider Transactions

Insider trading is when someone with non-public, material information about a company trades that company's stock or other securities.

Say your friend who works at Apple tells you iPhone sales are off the charts and Apple will beat quarterly earnings. You then trade Apple stock before this information becomes public. This is illegal, and you might end up in jail like Martha.

An insider transaction is when a company insider (officer, director, or 10%+ share owner) makes a trade and reports it to the Securities and Exchange Commission (SEC). This transaction is legal as long as the company insider is not trading on non-public, material information about the company.

But wait, how is that possible? Won't the CEO of a company (Greg, we're looking at you!) always have some non-public, material information?

We think so. That's why we created StockOcean. We believe insiders will always have an informational edge over outside investors. And we want to make it easy for you, the ordinary investor, to track and disseminate company insider transactions.

Here's how it works.

What is a Form 4?

Every company insider is required to file a Form 4 within two business days of executing their trade. This form includes the insider's name, title, trade date, type of trade, average price, and other information. Here's the Form 4 SIVB’s Greg Becker filed before the aforementioned $3.5 million trade.

In August 2000, the SEC established something called a "10b5-1 plan." This allows company insiders to buy or sell shares under a predetermined structure to avoid accusations of insider trading.

For example, a CEO can say, I will sell 1,000 shares of stock on the second Wednesday of every month next year.

By doing this, the CEO can absolve himself of insider trading accusations because the plan was "pre-arranged." Greg Becker's sale on February 27 complied with his Rule 10b5-1 trading plan. See the footnotes of his Form 4.

So Greg is in the clear right? Not so fast.

Smart executives have found ways to capitalize on their insider knowledge while complying with the SEC's rules. For example, by enacting a 10b5-1 plan a week in advance, or enacting multiple 10b5-1 plans and canceling unfavorable trades at the last minute, they can still trade on insider knowledge before it’s public. (More on this in a future blog post.)

If we read Greg's 10b5-1 trading plan, it says it went into effect on January 26, 2023 - just a little over a month before the complete collapse of his business.

Did Greg have any material non-public information prior to enacting his 10b5-1 plan? Time will tell, but so far, it looks like he's in the clear.

More importantly: if you were invested in Silicon Valley Bank, would you have liked to know that Greg sold $3.5 million worth of stock on February 27, 2023?

Common Types of Insider Transactions

Company insiders can engage in a variety of transactions, each with their own implications. Common ones include:

1. Open Market Purchases: When insiders buy company stocks on the open market -- often signifies confidence in the company's future growth prospects.

2. Open Market Sale: When insiders sell company stocks on the open market -- provides liquidity for insiders but does not necessarily indicate negative sentiment.

3. Options Exercise: When insiders exercise stock options granted as part of compensation -- can signal their belief in the company's long-term potential if they hold.

In Greg's case, he exercised stock options and immediately sold them in the open market. There are dozens of other transaction types that you can read about on the SEC's website here.

Insider Transactions to Inform Investment Choices

According to an old Wall Street adage: 

CEOs have bills to pay and mouths to feed. However, when they buy a stock, they are (almost always) acting on a belief that the price will go up.

When multiple insiders buy company stock, this is an even stronger signal known as a Cluster Buy.

People have studied what type of insiders have the best performance. Generally, they have found that the CFO performs best, followed by the CEO.

This makes sense, given the CFO and CEO have intimate details of the company's financials and past and future performance. Board members, on the other hand, might only meet once a quarter.

You can filter by the type of insider when screening for transactions on StockOcean.

Risks of Copying Insider Transactions

I don't recommend copying company insider transactions. While it may be tempting to copy a CEO's or CFO's trades, remember that everyone has different risk tolerances, hedges, and hold periods.

Instead, I recommend using insider trades, cluster buys, and cluster sells as signals to do a deep-dive into specific companies.

I also recommend tracking insider buying and selling for each stock in your portfolio. Don't be caught off guard.

You can turn on e-mail alerts for free at StockOcean by typing in a ticker and pressing "Add Alert."

If you're a public company employee and receive stock compensation, be vigilant and track your executive team's trades. Keep them honest, and don't let them pull a fast one on you.

Parting Words

Leveraging company insider transactions as a part of your investing tool kit can be very powerful. At StockOcean, we track the most interesting weekly trades and our track record is public here. Follow along and subscribe to our blog for future resources and articles.