Falling for False Insider Signals

Matthew Carr By Matthew Carr, Emerging Trends Strategist

Market Trends

The markets can be a scary place out there. Particularly for small investors.

To be honest: It sucks. It sucks bad.

There’s volatility, crisis upon crisis, and then scores of information to pore over.

We all know that the internet has made that last one considerably worse for investors. The prevalence of bad information, or misinterpretations of signals, is downright frustrating. And can be obnoxiously irritating.

My biggest pet peeve is bad info on insider activity… I’m not talking illegal stuff, which has put even the home ec queen Martha Stewart in prison. But legal moves that are filed with the Securities and Exchange Commission (SEC) and made available to the public.

Insider activity – the legal kind – is considered the ultimate signal that something major is going on. And it’s completely understandable… These people are corporate insiders, they’re supposedly in the know.

So, there are a lot of mainstream publications and blogs out there that offer their take on “insider moves” and how everyone who reads the article is going to get rich.

Problem is: The vast majority of those articles are crap. Meaningless drivel. Worthless.

And I’m going to show you why…

Three Mind-Blowing Days in April

Here’s the first – and most important – rule of investing based on insider activity: Don’t follow a loser.

It’s that simple.

If a writer is pouring poison in your ear that an insider has bought a bunch of shares in a company and that it’s a bullish signal… Take a second to look the insider up and see how he’s done.

Let’s do our own due diligence…

A little more than a year ago, there was an “insider” move that a number of financial outlets covered. And I about had an aneurysm from it because it made me so, so very angry…

In April 2011, a lot of noise was being made that there was major insider buying in one of the nation’s struggling technology companies. They hailed this insider as a guy showing confidence in a beaten-down company… That this insider loved to “average down.” That this was a very bullish signal because of all the money he was dropping.

It was idiotic. Simply lazy and careless.

The company was American Superconductor (Nasdaq: AMSC), and at the time, it had tumbled 35% from its peak from October 2010 to April 1, 2011. And then collapsed a brutal 47% from April 1 to April 6 following a dismal earnings report.

The articles were full of nonsense – these “insider” buys showed AMSC was oversold and that the insider, “Kevin Douglas,” was a repeat purchaser of shares and this showed faith in an imminent recovery, blah, blah, blah…

So, let’s look at these brilliant trades by “Kevin Douglas” (in quotes, because, it’s not actually Kevin Douglas purchasing anything, it’s a group of Douglas family and annuity trusts buying):

  • April 4, 2011 – 38,000 shares at $24.67 ($937,460)
  • April 4, 2011 – 57,000 shares at $24.67 ($1,406,190)
  • April 5, 2011 – 80,000 shares at $24.91 ($1,992,800)
  • April 5, 2011 – 120,000 shares at $24.91 ($2,989,200)
  • April 6, 2011 – 1.2 million shares at $14.27 ($17,124,000)
  • April 6, 2011 – 1.8 million shares at $14.27 ($25,686,000)

Golly… He must really love himself some American Superconductor.

Now, the articles never made the distinction between “direct” and “indirect” purchases of those above. And never bothered to look at the SEC forms to see that these are trusts. And never bothered to address the fact that there were purchases in March, January, December 2010 and November 2010 (all at higher prices, including the statement of beneficial ownership).

But that’s not the point, is it? The point is this dude is so jazzed about AMSC’s future he dumped $50.135 million into the company in a three-day span.

“Hot damn! Everybody in the pool because this thing is heading to the moon!”

Right? That’s what that means…

So, how’d “Kevin Douglas” do?

Well, just those purchases from three days in April 2011 are worth $13,641,300 today… If you’re keeping score, that’s a 73% drop.

Wheee! Let’s follow this “insider” straight to poverty!

True and False

Now, the SEC doesn’t make a distinction between “true insider” activity and what I call “false signal insider” activity.

But that doesn’t mean you shouldn’t.

True insider buying is a person using his own money – from his own pocket – to purchase more shares in the company he works for. It’s not a trust. It’s not an options exercise. It’s not an indirect purchase. Or anything else like that… It is a living, breathing person – I can walk up and poke ‘em in the eye. They’re putting their own money – their paycheck – on the line.

I don’t necessarily look for CEOs and beneficial owners for insider signals. When I do look at insider activity, I look for directors, any of the credit officers, or general counsel.

Small fish have a tendency to speak louder than big fish when following insiders.

For example, let’s stroll on over and look at Microsoft’s (Nasdaq: MSFT) insider transactions…

“Dear lord! Bill Gates just dumped $585 million worth of Microsoft stock between July 22 and July 26! The new version of Windows, Internet Explorer and bringing back Hotmail and naming it ‘Outlook’ must be death for the company! Run children! Run for your lives!”

But that would be silly. If I said that, people would walk up to me on the street and kick me in the crotch.

That’s “false signal insider” activity. We can all understand that. But somehow, investors get suckered in if the insider isn’t clearly labeled “Bill Gates.”

Let’s look at Facebook’s (Nasdaq: FB) insider activity. CEO Mark Zuckerberg sold 30 million shares… back in May. Before the stock plummeted.

With the stock’s post-IPO woes, this is getting some play in mainstream news outlets and blogs. As well as other early Facebook investors unloading shares and pocketing riches while the small investors lost out.

But they’re ignoring the reality: Zuckerberg sold 30 million shares (less than 6% of his total holdings) for around $1.3 billion because he has to pay taxes.

That’s not a new revelation, it’s old – foretold by Facebook in its S-1 filing prior to its IPO.

But for some reason that doesn’t mean everyone else out there can’t trot the misinformation back out now that Facebook shares are down and make false claims about it. Get you all riled up with lies.

The simple fact is: Insider activity by itself tells you nothing.

You have to look at it in the context of the company. Trading solely on insider activity will get you burned more often than not. You have to look at the fundamentals and a company’s market opportunities. And, as I said above, if you’re going to follow an insider, they have to have a history of selling for a gain.

The problem with trying to follow the moves of beneficial owners – for instance, the Douglas family group of trusts – of a company as an indicator of a stock’s direction is that they’re imprecise and often misleading.

This group of investors is cobbling together a power base. They’re not really unloading shares for gains.

So, for example, the set of Douglas family trusts have purchased some $339.4 million worth of shares over the last decade. But have only sold $34.8 million in stock, most of that coming from a single transaction.

That tells you all you need to know, doesn’t it?