New York — It's no secret that Wall Street's dirty laundry has been piling up. And the Securities and Exchange Commission is busy sorting through the insider-trading mess. But there is a ``clean'' form of insider trading. And investors can ride the coattails of such trades.
It's legal for corporate executives to buy and sell stock in their own company - provided the investment decision isn't based on important confidential information.
Common sense says ``corporate insiders'' have an inherent analytical, if not informational, advantage over most investors. Indeed, academic studies over the past 20 years show corporate insiders consistently beat the market averages.
But the Securities Exchange Act of 1934 requires corporate insiders (defined as company directors, officers, and major shareholders) to report all trades. The report must be filed with the Securities and Exchange Commission by the 10th day of the month following the transaction.
So the average investor can at least trade on the heels of corporate insiders. While it's not a sure-fire strategy, money managers find it a useful selection screen. Occasionally it can pay off handsomely.
Take Texfi Industries, a Rock Mount, N.C., textilemaker. Texfi stock traded between $3 and $6 last year, says Bob Gabele of FCI-Invest/Net, a computer data-base service that tracks SEC insider filings.
Then, in January, a Texfi director bought 75,000 shares at 5. And the chairman picked up more than 5,000 shares at 5. That information popped up on Mr. Gabele's screen in mid-February. By then, Texfi was on the rise. The Texfi director purchased 38,600 more shares at an average price of just over 7. In March, Texfi hit $12 a share.
Texfi officials say two acquisitions made late last year boosted the latest quarterly earnings (reported at the end of February) dramatically. Had an investor been quick to follow the Texfi insiders, he could have made a cool 50 percent gain in less than two months.
That illustrates the potential of the insider game. But in practice, the past two years have produced poor showings for several insider investment services.
The recommendations of The Insiders, a Fort Lauderdale, Fla., newsletter, rose only 20.2 percent in 1985 and 6.4 percent last year.
The Standard & Poor's 500 index was up 31.7 percent in 1985 and 18.6 percent in '86. And the Portland, Ore.-based Insider Indicator fared only slightly better, according to Hulbert Financial Digest, a Washington, D.C., newsletter tracking service.
The almost two-year-old Insider Reports mutual fund is also struggling. During the last 12 months (ending March 31), the fund fell 1.4 percent while the average growth fund rose 18.22 percent, according to Lipper Analytical Services.
Defenders of the technique contend that the system works best in the secondary stocks, which have until recently lagged behind the broader market. Or perhaps the information has become so widespread that this strategy is losing its effectiveness.
Or perhaps the technique needs more refining. Richard A. Horowitz of the Dallas-based Insider Edge, an advisory service exclusively for money managers, says most insider data sold to individual investors lack the kind of sophisticated analysis to make them worthwhile.
For instance, insider selling has been ``heavy'' in Du Pont and Westinghouse. On the face of it, that might be a cautionary sign. But based on Mr. Horowitz's stock-by-stock historical data base of insider selling, current levels are entirely ``normal.''
If tracking insiders still intrigues you as an investment strategy, there are a number of things to keep in mind.
News of trading by insiders may be old by the time you get it. Until recently, insiders have been rather lax about reporting. However, the SEC ``is going after insiders that consistently file late,'' says Gabele. And the federal crackdown on Wall Street seems to have triggered a marked increase in ``amendments,'' or corrections to previous filings, says Gabele.
If the data are old, then the stock may have moved too high to make them worthwhile. The Insider Reports mutual fund won't buy if the stock has jumped more than 25 percent over the insider's purchase price.
But Michael Reid of Insider Indicator says waiting for pricing strength may be a better strategy. ``Insiders tend to be too early, they [often unsuccessfully] bottom fish.''
The most relevant buy signal tends to be heavy, consistent buying by insiders. The more insiders who are buying the merrier. Advisers typically don't recommend a stock until three or four inside purchases have been made over a span of six to nine months.
But watch for disinformation. New directors or officers may buy a few hundred shares just to signal their commitment to the company. Likewise, some insiders buy out of bravado when the company is actually foundering. It's rare, but the goal is to manipulate the press and shareholders into thinking the situation is improving.
Studies show that insider selling has less predictive value than buying. Corporate officers may need cash for a myriad of reasons: another business venture, a new home, or Susie's college tuition. If the company went public recently, officers have to wait six months before they can sell any stock. Prospects may still be rosy, but if it's the first opportunity in years for founders to recoup their investment, selling can be heavy.
Typically, the insider newsletters and data-base services do some analysis for you. They sift through the SEC filings, get explanations from company officials, and make recommendations.
For example, The Insiders weighs the titles and numbers of buyers vs. sellers, size and timing of trades, type of transaction (options, gifts, open market), and price. Then it assigns a rating of 1 to 10, 10 being the strongest buy signal.
Currently, the heaviest insider buying is in regional banks and thrifts, real estate investment trusts, and gas utilities. Insiders have been big sellers at computer hardware and software companies.
FCI-Invest/Net is exploring the correlation between takeovers and executives exercising their options to buy stock. ``We've noticed that just before several takeovers, there's been a mushrooming of insiders exercising their options,'' says Gabele.
Is all this insider trading really legal? It would be difficult for regulators to get at what motivates an executive to buy or sell a particular stock - his confidential knowledge or his public knowledge. ``It's the finest line out there,'' Gabele comments.
``The CEO will always know certain things you and I can't know about a company,'' agrees Gary Naftalis, a securities lawyer at Kramer, Levin, Nessen, Kamin & Frankel in New York.
But he adds, ``What the CEO knows when he trades may not qualify as ``material information' - something significant such as an earnings report or a tender offer.''
Some facts and a fund for investing with insiders NEWSLETTERS The Insiders Includes recommendations, rankings by stocks and by industry, and market timing index. Published twice monthly by The Institute for Econometric Research, 3471 N. Federal Highway, Fort Lauderdale, FL 33306. 800-327-6720. Annual subscription $100. Single copy $5.
Consensus of Insiders Includes recommendations, model portfolio, top 20 stocks with most insider activity, market timing. Published weekly. For free back issues, write: P.O. Box 24349, Fort Lauderdale, FL 33307. (305) 563-6827. Annual subscription $199. Market timing only, $100. Trial subscription (six weeks) $20.
The Insider Indicator Includes commentary along with buy and sell signals on exchange-listed and over-the-counter stocks. Also broad market signals. Provides quarterly and annual historical index (going back 2 years) of individual stock signals. Published twice monthly. Write: 2230 N.E. Brazee Street Portland, OR 97212. (503) 281-8626. Annual subscription $145. Trial subscription (including 10 back issues): $45 for 3 months.
The Insider Chronicle Lists insider trades, unregistered stock issued (144 letter stock filings), and major shareholders (13D filings). Some analysis. Published weekly, with quarterly summary. For free copy, write: P.O. Box 272977, Boca Raton, FL 33427. (305) 394-3404. Annual subscription: $350.
Vickers Weekly Insider Report Ratings on 1,300 stocks, top ten buyers and sellers, buy/sell ratios, analysis. Recently added a model portfolio. Vickers Stock Research Corp., P.O. Box 59, Brookside, NJ 07926. (201) 539-1336 Annual subscription: $137. Trial subscription (3 months): $40. REPORTS Insider Trading Reports Prints historical report (going back one or two years) of insider trading activity in company specified by customer. Grinde Group Ltd., Route 198, Woodstock Valley, CT 06282 (203) 974-2223. Report for one company, one year: $13.45. Two years: $19.20. After initial purchase, will send monthly reports on specific stocks for $1.65 per month. Also provides annual reports. Call 1-800-4-ANNUALS.
Insider Trading Monitor Insider trades appear within hours of filing with SEC. Industry rankings, most active stocks. Access via personal computer and modem. For information write: FCI-Invest/Net, 99 Northwest 183rd Street, Suite 237, N. Miami, FL 33169. (305) 652-1721 Cost: $10 per minute. Also available through Dow Jones News/Retrieval.
The Official Summary of Security Transactions and Holdings Monthly publication of insider trades reported to SEC (tabulated by FCI-Invest/Net). Annual subscription $59. Single issue $6. Superintendent of Documents, Government Printing Office, Washington, DC 20402. (202) 783-3238. MUTUAL FUND The Insider Reports Fund Two-year-old mutual fund. For prospectus write: SRS Advisors Inc. 120 Broadway, New York, NY 10271. (212) 349-2372. Minimum initial investment: $2,500.