Why 'insider' stock trades may soon be much easier to track

It's not that insider trades are secret. But under current law, these transactions can take weeks, even months, to reach the public.

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If the US Securities and Exchange Commission has its way – which now looks very likely – that will change.

Thank Enron, in large part, for triggering action. Last year, a number of questionable transactions occured.

For example, Enron Chairman Kenneth Lay quietly sold some $70 million of Enron stock last fall. But investors didn't find out about most of his manuevers until Feb. 15, 2002.

The time it took for Mr. Lay to disclose his transactions was apparently legal under SEC rules. But trading officials say the reporting process is too slow.

For example, insider trades on the open market have to be reported by the 10th day of the following month. Sometimes these trades are filed with the SEC electronically. But if they are filed longhand, they may take longer to reach the public, because the data must be typed into the system, or dug out and read by an investigator.

And when an executive sells shares back to the company, as Lay did several times last year, the sale doesn't need to be filed until 45 days after the end of the company's fiscal year.

Two-day reporting rule

But the SEC's rule change, proposed in early April, would speed up the process. Starting next year, companies rather than officers and directors would be required to report insider trades over $100,000 within two business days.

Having companies file these transactions should ensure speedy reporting, says SEC spokesman John Nester. It will help those who monitor the financial stability of selected companies, he says.

Market analysts watch insider trades, which are usually reported daily in some major newspapers, to see if they suggest "unusual activity" in a company. If a company officer suddenly bails out of his own stock, it might suggest that something is amiss.

On the other hand, the officer may merely be selling stock for tax purposes or other personal reasons.

Nejat Seyhun, a finance professor at the University of Michigan, studied more than a million insider transactions that occurred between 1975 and 1995.

He found that when insiders bought large amounts of their own firms' stock, it tended to outperform the market the following year by 8.9 percentage points.

Conversely, when insiders sold, the stock underperformed by 5.4 percentage points.

Another study, conducted by researchers at Michigan State University and Penn State University, looked at more than 4,000 firms that had accumulated a steady stream of profits.

It found that when the earnings pattern broke downward, corporate insiders had actually begun selling their own shares in large numbers "three to nine months before the break occurred," says Kathy Petroni, an accounting professor at Michigan State.

In other words, she says, the insiders appeared to be "sensing" that a downturn was on its way for their company.

350,000 trades a year

For now, insiders are continuing to buy and sell their own company's stock. Currently "around 350,000 instances of insider transactions are reported to the SEC each year," says Mr. Nester. Their combined value easily runs into the billions of dollars.

The SEC is now receiving comments on the proposed rule change, which could be approved as early as this summer.

Comments appear to be running in favor of the change. John Spears, managing director of financial firm Tweedy, Browne Co., LLC, supports the changes, but would require more details about transactions involving stock options.

This additional change, he writes, would detail how key officers view the prospects of their own firms.

But critics of the changes, such as Donald Rawlins, a vice president for AutoZone, an auto-parts company, believe that the additional reporting will really just add to information "clutter."

STAFF SOURCE: THOMPSON FINANCAL SECURITIES DATA