[This is an important article because the officers and directors of many biotech companies have 10b5-1 selling plans. The article exposes a gaping loophole in these plans that makes 10b5-1 selling more bearish than many investors realize.]
>> Even With Planned Trades, Executives Still Can Beat Overall Market Performance
By TONY COOKE and SERENA NG Staff Reporters of THE WALL STREET JOURNAL August 5, 2005
Federal regulators changed rules for executives in part to make it harder for them to trade using inside information. These so-called insiders are still doing just fine trading their own companies' stock, thank you.
In 2000, the Securities and Exchange Commission came up with rule 10b5-1 to address ambiguity about when an insider could legally trade. Using plans named after the SEC rule, insiders now map out a schedule for buying or selling their companies' shares, and can trade according to that schedule even if they later learn of market-moving news.
The SEC gave insiders leeway in designing these plans, which have become a common feature at hundreds of companies. The plans can span weeks or months, and trades can be pegged to specific stock prices or executed by brokers at market prices on preset dates. The ground rule: Insiders must establish the plan in advance, at a time when they don't possess material nonpublic information.
Analysts of insider transactions have been skeptical of the rule ever since it was instituted and insist that trades under the plans still carry signals that investors shouldn't discount. A study by Stanford University's Alan Jagolinzer suggests that stock sales under trading plans indeed say something about the future performance of a stock. [I strongly agree.]
Prof. Jagolinzer, who describes his research as preliminary, found that insiders using 10b5-1 plans earned returns on those trades that beat the market on average by 5.6% percentage points over a six-month period. His study covered 307 insiders from 180 companies that voluntarily disclosed such plans from 2000 to 2003. He contends that insiders' trades as part of the plan appear to be "information-based."
It's not possible to know for sure. Insiders and companies aren't required to disclose the terms of their plans, or even their existence.
But the SEC rule has some leeway that could benefit insiders. For one, while insiders cannot enact plans while they have material information, they can use such information in deciding to cancel a plan. That guidance follows a time-honored legal principle: It has always been all right to abstain from trading based on inside information. [Thus, the mere fact that an executive has not canceled a 10b5-1 plan is bearish.]
"I just think that that's such a major loophole in terms of that particular rule, and it need not be there," says Constance Bagley, associate professor of business administration at Harvard Business School. Insiders, Prof. Bagley says, "can get rid of the bad trades and keep what look like the good trades."
In recent months, insiders at Trex Co., Oscient Pharmaceuticals Corp. and United Online Inc. canceled trading plans as their company's stock hit a trough. Officials from Trex didn't return calls, and representatives of Oscient and United Online declined to discuss their executives' trading plans.
In late June, after Trex shares fell sharply on an earnings warning, Trex Chief Executive Robert G. Matheny disclosed that he had terminated a plan to sell shares. At that time, Trex shares were fetching about $25 apiece on the open market. A month later, the company's earnings announcement sent the stock above $29. Mr. Matheny hasn't reported any sales in that period. Trex shares were down 51 cents to $28.37 in 4 p.m. composite trading on the New York Stock Exchange yesterday.
Shares of Oscient and United Online recorded similar dips. The Oscient insider reinstated his plan later, selling shares again as the price recovered.
While abstaining from trades is a legally safe option, observers speculate that there may be other explanations for Prof. Jagolinzer's findings.
For example, while a 10b5-1 plan commits an insider to a trading schedule, it doesn't commit an insider to a schedule for announcing important news. So a company executive who has a big trade scheduled for Tuesday could have an incentive to hold off on putting out a negative press release about the company until Wednesday.
"I would be shocked if there wasn't any manipulation of announcement timings," says Jesse Fried, professor of law at the University of California, Berkeley, who has co-authored a book on executive compensation.[Exhibit “A” could be NSTK’s CEO, Steve Quay (#msg-7207429).] "There's empirical evidence that managers shift the timing of their disclosures around option grants, and so it's likely they would do the same thing around their 10b5-1 plans."
Harvard's Prof. Bagley says timing an announcement that way would be a breach of fiduciary duty. [LOL]
It's also possible that insiders are simply setting up plans when they know that bad news is on the horizon. Of course, insiders can sell stock that way without the benefit of rule 10b5-1, but the rule affords them some legal cover, lawyers say, because it may be harder to prove an insider knew something months in advance. <<
[To those who say that posts on message boards don’t matter, I say: wrong, they do matter. I think the incessant bashing of NSTK’s proposed stock offering on the Yahoo message board during the past 48 hours played a role in the company’s withdrawing the offer. My own posts—and those of Biowatch—were especially hard on the company and the CEO, labeling the proposed offering as an ugly case of “front running” by the CEO, who exercised options and sold his own shares immediately before announcing the proposed offering (#msg-7207429).
For me personally, the company’s withdrawing the offering shows good faith, but it doesn’t entirely erase the smell from the matter. I have no immediate plans to buy NSTK shares.]
BOTHELL, Wash., Aug. 5 /PRNewswire-FirstCall/ -- Nastech Pharmaceutical Company Inc. (Nasdaq: NSTK ) announced today that it has withdrawn its previously announced public offering of 1.5 million shares of common stock under its shelf registration statement.
"We appreciate the interest shown by the investment community in Nastech as we continue to make progress in our research and clinical programs," said Steven C. Quay, M.D., Ph.D., Chairman, President and CEO of Nastech. "However, our present valuation requirements are not met by current market conditions, and we are fortunate to be in a strong financial position."
Nastech intended to use the net proceeds from this offering for general corporate purposes, including, among other things, funding of Nastech's intranasal Parathyroid Hormone (PTH 1-34) and RNAi clinical research and development programs, the clinical development of Nastech's other product candidates, capital expenditures and working capital needs. Nastech will continue to evaluate market conditions and other financing opportunities on an ongoing basis for the advancement of these research and development programs. <<
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