Everything You Need to Know about Insider Trading

by Insider Alert Research Team

Insider trading.

You might have heard the term back in 2011 when Peter Schweizer’s book, “Throw Them All Out,” first caught the attention of 60 Minutes and quickly ignited a firestorm of controversy.

In “Throw Them All Out,” Schweizer detailed numerous examples of congressional corruption, including our lawmakers’ habit of legislating themselves exclusive loopholes to profit off of the rules and regulations they shackle the rest of us with. That includes insider trading.

Let me explain…

Insider trading, at its very basic, is when somebody with special knowledge about a company decides to either buy or sell shares or security of said company. Usually this is somebody high up on the corporate ladder but, as Briefing Investor explains it, it can also include “officers and directors of companies, owners of restricted stock, and owners of more than 10% of a company’s stock.”

What’s wrong with that, you might ask?

Well, that’s where things start to get a bit more complicated.

You see, when the stock market crashed in 1929, setting off the Great Depression, a lot of blame started flying around pretty quickly as blame usually does. And while the government was in part responsible for the mess and definitely for the ensuing chaos, it didn’t want to acknowledge that blatant fact.

So, for better or worse, it began meddling in the private sector more than it already had been.

In 1934, Congress passed the Securities Exchange Act, which was promptly signed by President Franklin Delanor Roosevelt. Arguably the first of its kind – at least on the federal level – it placed strict controls on publicly traded companies with the stated intention of evening the playing field against the “fat cats” on Wall Street and in favor of main street.

Among the long list of regulations the Securities Exchange Act outlawed were:

• Using any “device, scheme, or artifice to defraud,” investors, essentially requiring companies to list all relevant information about their businesses, profits, etc. or, as Cornell University Law School explains it, anything “that investors would think was important to their decision to buy or sell the stock”
• Manipulating the market to suggest that stocks are worth more than they actually are
• Employee purchases or sales of ownership in a company without first making the public aware of the transaction, also known as insider trading

Altogether, the Act was supposed to force companies to behave more ethically and investors to act more intelligently, with the combined result of keeping the markets from crashing again. The same was true for the Sarbanes-Oxley Act of 2002, which demanded even more transparency from businesses, adding additional paperwork for them to fill out and information they had to release.

Obviously, neither have prevented very much, as evidenced by the multiple stock market crashes and recessions 1934, corporate scandals such as Enron, WorldCom and Satyam, as well as the government-connected Fannie Mae and Freddie Mac, corporate crooks such as Bernie Madoff and Jon Corzine, and Raj Rajaratnam and the other 55 people who have been charged with insider trading since 2009.

And those are just the ones who get caught!

That also isn’t to mention that company’s are really quite clever about following the letter of the law rather than the spirit much of the time. (Though it’s hard to blame them sometimes when they have to follow so many of said laws.)

As Cornell University explains:

Section 9 of the 1934 Securities Exchange Act “addresses manipulation of the stock market by traders… However, modern market manipulation is accomplished through methods that are more subtle and harder to detect… [partially because] investors must prove that the price was actually affected by the manipulation, and that the defendant acted willfully. Proving damages also involves proving the actual value, since successful claimants may recover the difference between the actual value and the price they paid.”

And the same can be said of many other aspects of insider trading law, as discussed further on.

Their Insider Pain Can Be Your Outsider Gain

Regardless of whether either the Securities Exchange Act of 1934 or the Sarbanes Oxley Act of 2002 were right or wrong, helpful or harmful, effective or ineffective, or even selfishly or selflessly motivated, they are the reality that the publicly-traded business world has to operate under in the United States.

As the aforementioned “Throw Them All Out” by Peter Schweizer pointed out, Congress doesn’t have to abide by any such rules since they loopholed themselves right out of any such responsibility or accountability, but that’s another topic for another article.

In the meantime, average investors can get ahead of the game if they only have the know-how and commitment to utilize their resources properly. (For anybody who doesn’t have the time or inclination to not only look into the following resources but follow them up and research the company as well, consider Alex Green’s Insider Alert, which does all of that work for you. For more information about the Oxford Club service, click here.)

Unless you want to get into the world of shorting stocks, forget paying that much attention to when insiders are selling. Partially that’s because there are at least a dozen good reasons for company employers or head honchos to sell what they have. And most of them are personal, having nothing to do with the company’s short-term, mid-term or long-term growth.

The chief financial officer might have a daughter going off to college, the CEO might be buying a new house, or the vice president’s young son might require a costly medical treatment. And an easy way for any of them to get the finances necessary for any of those purchases is by selling off some of their shares.

Now, if the CFO, CEO and VP are all selling at the same time, that’s reason to think twice about investing in the company. But if it’s just one or even two corporate insiders offloading some shares, more than likely, it isn’t in any danger of becoming the next Lehman Brothers.

On the other hand, there is only one reason that insiders buy, and that is that they expect their company to do well in the near future. And, let’s face it: Out of all of the analysts, investors and industry experts who like to spout their opinions at every opportunity, it’s the insiders who should know the best how their company is really doing and what it is really capable of accomplishing.

Back in 2009, Alexander Green, who edits the Insider Alert, wrote how, in 2008, he discovered that:

“David Abrams, a Director of Crown Castle International made the single-largest insider purchase in the nation. He bought 4.5 million shares at a cost of more than $60 million.

“Based in Houston, Crown Castle leases cell towers and antenna space to wireless communications companies. Most of these are in the United States, although more than 1,400 are in Australia.

• The company has more than 24,000 towers in prime markets and is actively building more to lease.
• Recent earnings, released earlier in the month, contained a few surprises.
• While earnings were in the red, revenue was still growing at 9%. And I noticed that site rental revenue, gross margins and recurring cash flow all exceeded expectations.
• Moreover, the company had lost three-quarters of its market value and was selling below book value.”

Triggered by the SEC filings that Abrams legally had to file within two days of his purchase, Alex was able to identify it as a potential growth stock worth targeting. But he didn’t stop there, taking the additional necessary step of researching the company from what it did to how and how well it did it.

Then he recommended Crown Castle International to his Insider Alert subscribers and he watched it.

Of course, the markets weren’t behaving well in 2008. At all. Yet two months later, the stock had shot up 58%. And Alex was able to lead subscribers to that significant short-term gain all because he was paying attention to what the insiders were doing.

Insider Activity Isn’t So Easy to Find

As previously mentioned, while insider trading can prove extremely lucrative, it isn’t always the easiest task to interpret or even find.

For starters, the SEC – in typical governmental fashion – doesn’t just have one generic form for insiders to fill out whenever they’re making a transaction. They have multiple ones, including:

• Form 3 filings, which officially record how much an insider owns
• Form 4 filings, which officially record any changes to what an insider owns
• Form 5 filings, which basically sum up everything recorded in Form 4 filings for the year
• Form 13D filings, which have to be filled out as soon as a shareholder owns 5% or more of a company’s shares or securities
• Form 144 filings, which officially record the POSSIBLE sale of what an insider owns (No sale actually has to be made, so someone like a CEO can just keep filing Form 144s every 90 days just in case he does want to someday sell something.)

Starting to get the picture?

And it gets even more complicated than that…

As Briefing Investor says: “Unfortunately, even if you could access all insider filings electronically as an Internet investor [which you can’t, considering that much of the data doesn’t ever have to make it onto the internet or any traditional news source either], the time requirements on these forms does not always prove helpful. Form 144s must be filed in advance of the actual sale, but it may be done as early as the morning of the sale.”

In other words: not helpful at all. The same goes for Form 4 filings, which are submitted to the SEC after any changes are made, not before or even during.

Any savvy businessperson or anybody with access to a decent legal advisor can easily get around the rules and regulations – though not the paperwork – to profit just about as nicely as he or she would if the government didn’t meddle as much as it does.

Clearly, researching insider trading with the intent of capitalizing on it can easily become a complicated and unhelpful mess for anybody who doesn’t know exactly what they’re doing or at least knows somebody who does.

But for those who can successfully navigate the complicated, convoluted world of insider trading, there’s major money to be had.

Warren Buffett Just Said “Buy!”

Warren Buffett Just Said “Buy!”

by Alexander Green, Investment U Chief Investment Strategist
Monday, November 21, 2011: Issue #1647

If you needed heart surgery, you’d try to find the most talented heart surgeon around.

If you were about to be subjected to a full audit by the IRS, you’d hire the most capable tax advisor you could find.

And if you needed investment advice? I hope you’re not one of them, but I know some folks who would read financial blogs by complete unknowns, take hot tips from friends and colleagues, or listen to a sales pitch from someone selling insurance or other financial products.

Big mistake. It makes a lot more sense to listen to the world’s smartest investors, instead. And one of the very best – if not the best – is Berkshire Hathaway Chairman Warren Buffett. (Ten thousand dollars invested in Berkshire Hathaway when Buffett took the helm in 1965 is worth well over $65 million today.)

And thanks to disclosures last week, we now know what Buffett has been doing during the last few months of crazy market activity. He’s been buying.

Specifically, Buffett has plowed $10.7 billion into IBM. He has increased his stake in Wells Fargo from 361.4 million shares to 352.3 million shares. He has boosted his Dollar General stake to 4.5 million shares from 1.5 million. And he has increased his holdings in insurer Torchmark to 4.2 million shares from 2.8 million.

There are a few interesting things to note here. The first is that while most investors have been either running to cash or nervously sitting on their hands lately, Buffett has been actively capitalizing on fresh opportunities. You should be doing the same.

Second, it’s worth mentioning that Buffett has generally avoided technology stocks like IBM. But upon reading not some super-secret briefing but rather the firm’s annual report, he learned that IBM enjoys an entrenched position providing technology services to major businesses.

Buffett likes companies with a “moat” like this and has famously said that his favorite holding period is “forever.” Indeed, he recently told The Washington Post that “IBM fits all my principles … it’s something we’d like to own indefinitely.”

Then there’s the price he paid for IBM. I often get emails from readers who are baffled that I sometimes recommend companies trading at or near their highs. Buffett bought IBM as it hit new highs – even as the broad market was cratering. Indeed, the stock has more than doubled since the depth of the 2008 recession.

Buffett’s response? He says the fact that IBM has doubled doesn’t bother him. Indeed, over the years he could have bought the firm at a tiny fraction of its current price. “What matters is what the company does in the future,” says Buffett.

There are a number of important lessons here:

1. As Buffett often points out, you should be greedy when other investors are fearful.

2. You shouldn’t be reluctant to modify your investment approach a bit (as Buffett has with one of his first significant forays into technology).

3. You shouldn’t fret about how much cheaper a stock was in the past if the business is sound and growing today.

And when it comes to investment advice, history shows it pays to listen to the best of the best. That’s one reason we’ve owned Berkshire Hathaway in our Oxford All-Star Portfolio for well over a decade.

Good investing,

Alexander Green

Growth in Net Earnings Per Share: The Only Thing That Matters

Growth in Net Earnings Per Share: The Only Thing That Matters

by Alexander Green, Investment U Chief Investment Strategist
Monday, July 25, 2011: Issue #1563

If, like many stock investors, you have struggled to make money in the current market environment, it may be because you’re not focusing on the only thing that really matters.

Perhaps you’ve been distracted by analysts who are nattering about annual GDP growth, unemployment, oil prices, the Greek crisis, or the U.S. debt limit. These things don’t tell you how to invest in the stock market. There’s something else that’s far more important. In fact, I call it “the only thing that really matters.” And I have a good example to illustrate my point.

On my way to an investment conference in Seattle last week, I caught a connecting flight in Charlotte.

As this is the peak of the tourist season, the Charlotte airport was so jam-packed it felt almost claustrophobic.

In the shopping mall area near the food court, there was a new Blackberry store that sells smartphones and other mobile devices made by Research In Motion (Nasdaq: RIMM). Yet I noticed something unusual.

There were only two people in the store. And both of them had name badges with the word “Blackberry” on it. There wasn’t a single customer inside.

Contrast this with the scene that virtually all of us have witnessed at any Apple store in the country.

They’re swarming with customers. (Most Apple stores don’t even bother answering the phone.) There are lines at the cash registers, even though mobile sales reps are ringing up customers in the aisles as well. People are crazy about iMacs, iPhones, iPads and the iTunes music store they can access with their computers and cellphones.

Given these two dramatically different retail scenes, is it really surprising that last week Apple (Nasdaq: AAPL) hit a new all-time high and Research In Motion hit a new 52-week low?

RIMM’s Blackberry device is getting thumped by both Apple’s sleek new phones and Google’s exciting new Android operating system. In the Darwinian world of capitalism, the Blackberry is getting folded, spindled and mutilated.

Reflect on this for a second. Because the important thing isn’t whether you have been bullish or bearish on the market lately, but whether you were bullish or bearish on companies like Apple and Research In Motion. No amount of economic analysis could have told you to buy Apple and shun Research In Motion. For that, you needed to do a business analysis instead. In particular, you needed to recognize that Apple’s business is on fire (earnings almost doubled from a year ago) and Research In Motion is going down in flames.

A trip to your local mall could have given you an important heads up, because robust top-line growth (sales) often leads to exceptional bottom-line results (earnings). And share prices follow earnings.

If you want to make money in the stock market, don’t jabber about world geo-political events – or follow those who do – but focus on the only thing that really matters in the stock market: growth in net earnings per share.

You can make stock investing a lot more complicated than this. But you really don’t need to.

Good investing,

Alexander Green

The Maxims of Wall Street: A Crash Course in Financial Freedom

The Maxims of Wall Street: A Crash Course in Financial Freedom

by Alexander Green, Investment U’s Chief Investment Strategist

Monday, July 11, 2011: Issue #1553

Winston Churchill once said, “It is a good thing for an uneducated man to read a book of quotations.”

This is perhaps truer today than ever. Most of us are too busy with our jobs, our families, our hobbies and other interests to read even a small fraction of the world’s great wisdom literature. That’s why Bartlett’s Familiar Quotations is a perennial seller at bookstores everywhere.

When it comes to investing, of course, we could all stand to be better educated. Wouldn’t it be great if someone collected the best thoughts of the world’s greatest investors, men like Jesse Livermore, Baron Rothschild, J.P. Morgan, Benjamin Graham, Warren Buffett, Peter Lynch, John Templeton and others?

Dr. Mark Skousen’s The Maxims of Wall Street

As a matter of fact, someone has: my good friend and Investment U colleague Dr. Mark Skousen. He has a new book out called The Maxims of Wall Street. It’s like a crash course in how to survive and profit from today’s volatile markets.

A former economist with the CIA and professor at Columbia University, Skousen has spent more than 30 years reading, teaching and lecturing about financial markets. Along the way, he has collected a treasure trove of proverbs, slogans, stories and juicy quotes.

Here are just a few of my favorites:

• “When your outgo exceeds your income, your upkeep becomes your downfall.” Rick Rule

• “A share of stock is not a lottery ticket. It’s an investment in a business.” Peter Lynch

• “The big money is not in the buying or the selling, but in the sitting.” Jesse Livermore

• “A great business at a fair price is superior to a fair business at a great price.” Charlie Munger

• “In a bear market, the winner is the man who loses the least.” Dick Russell

• “Easy money – isn’t.” Ken Fisher

• “Investors should purchase stock like they purchase groceries – not like they purchase perfume.” Benjamin Graham

• “You can’t pick cherries with your back to the tree.” J.P. Morgan

• “Never confuse genius with a bull market.” Humphrey B. Neill

• “The one investment certainty is that we are all frequently wrong.” Bill Gross

• “If you don’t profit from your investment mistakes, someone else will.” Yale Hirsch

• “Investments should be based not on optimism but arithmetic.” Benjamin Graham

• “My broker told me to buy this stock for my old age. It worked wonderfully. Within a week I was an old man.” Eddie Cantor

• “If past history was all there was to the investment game, the richest people would be librarians.” Warren Buffett

• “Investment success accrues not so much to the brilliant as to the disciplined.” William J. Bernstein

The Rules, Truths, Ways and Nevers of Investing

Dr. Skousen provides plenty of stories and commentary to go with these gems and more than 200 others. He also includes:

• Bernard Baruch’s 10 Rules of Investing

• Humphrey Neill’s 10 Ways to Lose Money On Wall Street (You may discover some you haven’t yet stumbled on yourself.)

• Larry Swedroe’s 14 Simple Truths About Investing

• Dennis Gartman’s 20 Rules of Trading

• Mark Skousen’s List of 15 Nevers

I found myself chuckling (and occasionally sighing) as I read this book. I learned so much of this investment wisdom by trial and error. Fortunately, you don’t have to.

The Indispensable Guide That is The Maxims of Wall Street

The Maxims of Wall Street is a pithy and indispensable guide. The book, which is not available through bookstores or Amazon, is a special limited leather edition with gold lettering. Only 1,000 copies were printed. Each copy is numbered and autographed by the author.

The price, including shipping and handling, is $29.95. To order please call 800.211.7661 or click here for more information.

And be thankful that – unlike me – you won’t have to learn this stuff the hard way.

Good investing,

Alexander Green