Prepared for Insider Trading?

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New York – As was widely forecast, Countrywide’s CEO, Angelo Mozilo, is facing an “informal” investigation by the SEC as to the nature of options sales he executed over the first half of the year. Mr. Mozilo sold a total of $130 million in the first 6 months of the year. That was more than twice the value he sold in the previous year and was contemporaneous with the company’s share price falling by 50%.

Our knowledge base of research companies contains a number of firms that track insider activity. The value-add here is the assumption that the insiders are acting on “material non-public information” and therefore are making better decisions about the direction of the stock than non-insiders.  Whether those decisions are legal or not is another question. Needless to say, none insider trading analytical firms were surprised by the investigation.

Mr. Mozilo did have some protection against investigation in the form of a 10b5-1 plan. These plans allow insiders to conduct regular stock sales. Since they are set up ahead of time and do not change over the term that they are in place, they are seen to be less legally assailable. However, given that Mr. Mozilo’s 10b5-1 plan roughly quadrupled from 2006 to 2007, some suspicion remains.

The firms that have an ability to assess insider trading are looking for just such changes in insider activity. Of course, the majority of insider activity is sales, since it represents an additional compensation channel for the management of the firm. As such, the RPs assess for changes in 10b5-1 plans and other required filings to see if any discernible trends are developing.  There tend to be more short opportunities uncovered by this approach than long opportunities.

Some of insider research firms include (but are not limited to): 3-D Advisors, Form4Oracle, Insider Insights, Insider Intel, Insider and The Washington Service. Overseas, there are several insider trading analytical firms of note, including Asia Insider Alerts, Directors Deals Limited and Vickers Stock Research.

Certainly, insider analysis is a useful addition to any money manager’s research firm portfolio. For hedge funds the short ideas are directly actionable, while for the long-only crowd, the input could be considered early warning systems for positions held.

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