I read an interesting article in BusinessWeek issue dated March 8, 2010 entitled Hiding Behind Their Hedges: How Some Executives Are Selling Their Companies Short; by Jane Sasseen.
The main points of the Sasseen article can be summarized as follows:
a) Executive management especially those paid with stock options can hedge the price of the stock by a zero-cost collar or a prepaid variable forward contract. (Defined at http://www.optionsforoptions.com/withstock/collar.html and http://en.wikipedia.org/wiki/Variable_prepaid_forward_contract)
b) Company executives that use these hedging vehicles seem to have a direct correlation to stock price down turn in the months that follow the hedge.
c) Disclosure of this activity is hard to monitor
From the standpoint of any of the C-suite (CFO, CEO, CTO, CIT) executives, I don’t blame them for actually wanting to turn a stock option into cold hard cash. Isn’t the intent of stock compensation to add an incentive to the executive to bring the company’s stock price higher? I suppose if a person is aware that it will be difficult to accomplish (for reasons beyond your control), it makes sense that you would want to hedge your losses and maximize your gains.
If the correlation stated in item b above is correct, then it would be nice if the average investor could obtain this type of information. It might then be easier to determine if a company’s stock should be shorted or not. I poured through Form 3, 4 and 5 filings about beneficial ownership at sec.gov for executives I knew had created hedge instruments. I couldn’t fully grasp if the executives had created a hedge vehicle or not from the filings. Technically what they are doing is not illegal. Furthermore, unless a transaction actually occurs it is not reportable. Why would the SEC want to know about a complex option theory if it hadn’t come to fruition?
Since this information is not readily available as an investment research tool, it is extremely important to diligently obtain as much knowledge as you can on the company. Vast amounts of pertinent information can be found in the company’s annual report! Annual reports are required by the SEC for a very good reason. It is called “disclosure”.
As the December fiscal year end reports become available, it is extremely important that every investor make it a point to read through a company’s annual report. Read and understand the Management’s Discussion and Analysis and the key executive officer letter. Then act on what you glean!
Check out http://publicregister.com and http://publicregisteronline.com for a complete list of annual reports for publicly held companies.
Tags: 3BL, annual reports, transaparency
May 29, 2010 at 1:58 am |
This is a very worrying sign for a shareholder. There is a massive conflict of interest here.
March 16, 2011 at 1:45 pm |
The question here is what are the key words in the Forms 3,4,5 upon which the studies cited in the Bloomberg BW article are relying? I have been searching through these forms and can’t figure this out. At the same time, many companies are prohibiting such hedging from either their directors/officers or all employees.