That was my takeaway from this chart in the Wall Street Journal this morning.
Oh, I mean, sure, their takeaway is that a lot of insiders were selling just before bankruptcy, and that's also true, but: I can understand that. The company's going bankrupt! You want to get out of the stock! But some - fewer, but a nontrivial amount - were buying: hundreds of buys in the six months before the bankruptcy filing, and at least a handful in the company's last month alive. You could take this chart as a rough way to measure how much in-hindsight-incorrect CEO optimism is cynical bullshit, to cover for the CEO's frantic efforts to get out of Dodge, and how much is genuine self-delusion, with the CEO himself doubling down on his doomed company. Depending on the timeframe I'd say, like, half and half.
Now while economically you can see why corporate insiders would be selling stock as the company nears bankruptcy, nonetheless you could imagine why they might be hesitant to do so. Being that (1) it's generally illegal to trade on material nonpublic information, (2) corporate insiders have some tendency to have nonpublic information about what's going on at their companies, (3) an imminent bankruptcy filing tends to be the sort of thing that people consider "material," and (4) jail is terrible and people who sell their stock just before bankruptcy have some track record of going to jail for decades.1
So you can understand why both insider buying and insider selling taper off just before bankruptcy filing: buying, because it's dumb, and selling, because it's illegal. But why don't they taper off more? Why are some insiders still trading the month before a bankruptcy filing?
Simple lack of knowledge is part of it - maybe nobody bothered to tell the chief accounting officer that the company is spiraling towards bankruptcy.2 Otherwise ... the buying is easy enough to explain - optimism, risk/reward, last-ditch plans to salvage the company, etc. The selling is weird, right? Jail and so forth.
My simplistic explanation starts with 10b5-1 plans. A quick review: Corporate officers and directors often have inside information so it's hard for them to trade in their companies' stocks without breaking the law. But there's some argument for letting them trade in their companies' stocks, because (1) it focuses the mind for them to have a lot of their wealth tied up in company stock, but (2) they're people so sometimes they need to convert that wealth into cash to pay their kids' college tuition or whatever. So the SEC lets them set up 10b5-1 plans: when they don't have any inside information, they enter a binding contract saying "I will sell X shares each month that the price is above $Y" or whatever. Then they leave it on autopilot and, even if they sell when they have inside information, they won't get in trouble. Because they didn't sell; the plan did.
Also you can cancel the plan at any time, even if you have inside information.3
It's pretty easy to sketch out how to game this; it goes like:
- Adopt a 10b5-1 plan, Plan A, that is like "the fifth day of each quarter, I will buy 10,000 shares of stock."
- Adopt a different 10b5-1 plan, Plan B, that is like "the tenth day of each quarter, I will sell 10,100 shares of stock."
- On the first day of each quarter, get a sense of the previous quarter's as-yet-undisclosed results.
- If they're fine, carry on; if they're terrible, cancel Plan A; if they're great, cancel Plan B.
- Repeat discreetly.
I mean, this is not legal advice and don't try it at home! You can't just, like, do that, it's too obvious, and there are rules against frauds that are too obvious.4Subtle fraud is the name of the game.
But while any individual who had a plan like that would look super, super suspicious, the aggregate of 10b5-1 plans looks pretty much like that, no? There are hundreds of people with plans that are more or less "sell a bunch of stock every few weeks," and hundreds more with plans that are more or less "keep buying stock." If you're one of the former, and your employer is heading towards bankruptcy, you're pretty glad you have that plan in place. If you're one of the latter, and your employer is heading towards bankruptcy, you cancel the plan, unless you're oblivious or overly optimistic. The overall result would look a lot like the Journal's chart: both insider buying and insider selling are reduced just before bankruptcy (because discretionary trades, either way, are perilous), with insider buying going close to zero (as 10b5-1 plans are canceled) but insider selling staying robust at, say, half its normal level.
I dunno. If that's the (main) explanation it's perfectly legal. You're always allowed to trade on autopilot, and you're always allowed to not trade. Sometimes the results of that end up looking a little unfair.
1.By the way these are mostly maybes. Like, if your company is 3 months from bankruptcy, I posit:
- Lots of people, not just company insiders, have an inkling: you've probably disclosed some bad news, some analysts are worrying, and the stock is down. The Journal's lead example is A123 Systems; here is their chart:
They filed for bankruptcy in October 2012. Presumably not everyone was surprised.
- Obviously outsiders can have trouble distinguishing "bad news that we're going to get through stronger than ever" from "everything is fucked," but then so do insiders. There's typically not like a secret file labeled "WE'RE GOING BANKRUPT IN THREE MONTHS" at companies that are. Normally, they're working optimistically to survive, and are probably more hopeful than the market. I mean, they're working there in the first place.
2.As seems to have been the case at Patriot Coal, whose CAO sold shares in February 2012 even though two major customers weren't taking delivery on their contracts, which ultimately led to a bankruptcy filing:
Mr. Knibb, the officer who sold some shares in February, said he did so because he planned to buy a condo in Florida, though the transaction ultimately fell through. "I had no knowledge of there being a problem with a contract. I wouldn't have sold shares if I had nonpublic information," Mr. Knibb said.
3.See this May 2001 telephone interpretation (number 15) from the SEC:
Does the act of terminating a plan while aware of material nonpublic information result in liability under Section 10(b) and Rule 10b-5?
No. Section 10(b) and Rule 10b-5 apply "in connection with the purchase or sale of any security." Thus, a purchase or sale of a security must be present for liability to attach. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975).
4.As we've discussed. Under Rule 10b5-1(c)(1)(ii), your plan needs to be "entered into in good faith and not as part of a plan or scheme to evade the prohibitions of this section." And that telephone interpretation I mentioned above goes on to say:
Does termination of a plan affect the availability of the Rule 10b5-1(c) defense for prior plan transactions? Does canceling one or more plan transactions affect the availability of the Rule 10b5-1(c) defense for prior plan transactions?
Termination of a plan, or the cancellation of one or more plan transactions, could affect the availability of the Rule 10b5-1(c) defense for prior plan transactions if it calls into question whether the plan was "entered into in good faith and not as part of a plan or scheme to evade" the insider trading rules within the meaning of Rule 10b5-1(c)(1)(ii). The absence of good faith or presence of a scheme to evade would eliminate the Rule 10b5-1(c) defense for prior transactions under the plan.
But of course they'd have to notice. Anyway here is a proposal to do things like "prohibit the adoption of multiple, overlapping trading plans" and "limit the frequency of modifications and cancellations of trading plans," which would shut this thing right down, but which is not currently the law.