Suppose J. Hapless Corporate has put most of his savings into Conglom-O stock, only keeping a small amount of cash on hand. On Monday, he learns at his team’s Morning Meeting at Conglom-O that earnings will be lower than predicted and that their team will be doing something related to softening the blow, but nonetheless, everyone at the meeting has recieved Material Nonpublic Information and may not trade in company stock until earnings are released in May.
Later that week, our hero encounters a serious personal or family problem and desperately needs funds - so much, in fact, that he doesn’t have enough cash and determines that the only reasonable way to get the money is to sell some of his Conglom-O stock. But then he realizes that selling would probably be considered illegal Insider Trading and he would rather not have to worry about not dropping the soap.
What can he do, legally?
Has this happened in real life? What happened? Do corporate insiders often go into foreclosure, repossession, or bankruptcy over cash-flow issues relating to their inability to liquidate stock to pay their debts?
E.g.:
Loan Officer: “So, Mr. Corporate, I see that you are applying for a mortgage. I reviewed your credit report and balance sheet and I’m surprised that someone like you with a quarter million in stocks would have an auto repossession and a history of late credit card payments on his record.”
J. Corporate: “Well, it’s because back last March, I was expecting that any financial problems could be cushioned by my large holdings in my company’s stock. But then I was pulled into a special corporate initiative where I was given material nonpublic data. Then my sister was arrested and needed $20,000 bail and that wiped out my savings account and then I was left in dire straights until earnings were announced in May and I could finally sell some stock to meet expenses, but by then my car had been repossessed and I had been late on my credit card payments several times.”
I do not know if this has happened in real life. If it were me I would take a loan using the stock as collateral. As you note, insider trading doesn’t mean you can never trade the shares, just that you have to wait for certain trading windows. So the money isn’t tied up indefinitely. Worst case scenario is he borrows against the stock then the stock tanks before he sells it.
Considering the fact that Bernie Madoff stole billions, as long as you don’t take out a full page ad in the NYT and make some effort to cover your tracks, I suspect that you could get away with it.
Off the top of my head, I think I’d open a couple of overseas accts and then buy deep-out-of-the-money puts on the stock with short settlement dates. They’ll be virtually worthless but will spike after the announcement. As long as you’re careful to spread the purchases around and don’t buy like 20k contracts (=2M shares), it would probably go undetected. I wouldn’t do it, but if you like living dangerously . . .
I don’t know enough about trading, but I would think that if he were close enough to the company to be an insider he would be close enough to know exactly when they were going public with this info and be able to sell ASAP after that. He might lose a little but he wouldn’t be in as bad of a place as a random trader that doesn’t realize there’s a problem until his stuck that was worth $25/share last week is suddenly at $11.40 a share and he’s wondering if he should sell or stick it out.
The other option would be to find a broker who’s willing to put in an order to sell it if it falls below a certain price (say $23) and pre-date it so it looks like he placed that order before the information even existed. OTOH, I think that’s what Martha Stewart said.
Will probably be a mitigating circumstance and if he is reasonable about it he might escape sanction totally. A sentencing Judge will probably understand if the sale was to fund your daughters urgently needed kidney transplant, rather less so if it was to buy your mistress the necklace she demanded.
Keep in mind that insider trading is proven after the fact. There’s no flag with the SEC letting them know, in advance, that trading is not permitted for a certain window. So it’s entirely possible the guy could make his sale and not even be investigated for it (which is not the same as saying it’s OK, of course).
I’m not familiar enough with the rules on insider trading, but if you were able to show some extreme need, then that might be enough to get you off. It’s not as if the trade was motivated by your insider information if you can show that it was motivated by the need.
The problem I see with the hypothetical is that corporate insiders usually have lots of assets, so it’s rarely going to be a case where they have to sell that particular stock to make up some emergency shortfall.
This is actually a frequent problem for corporate insiders. The restrictions on trading do not go away just because the insider needs the money. And, contrary to the suggestions above, neither the SEC nor judges are very understanding about it all. As some have noted, borrowing against the stock is an option.
Bernie Madoff was able to get away with his fraud because regulators just couldn’t believe that such a large operation, run by someone so prominent in the industry, could be a complete fraud. There is no similar misapprehension with respect to insider trading. The chances of getting caught are very high.
When I worked for a listed company, they would often produce a memo of stock trading windows. People at a certain level of the company were forbidden to trade at that time until quarterly results wer released, often a few weeks’ window. So, it’s not like the fact you can’t trade is somehow secret. It’s also not indicative of poor performance (it could be good news, or neutral). The local bank prez would be familiar with this and understanding about no-trade windows, so would happily lend you money. Of course, the odds are he would not lend 100% of value; how much would depend on the possible volatility of the company. Apple stock - good risk. Pipeline company or drug company waiting for government OK - not so good.
They certainly are not, nor are they hesitant in going after smaller scale traders. A guy at my company got in very serious trouble for transmitting material information to friends and family, who then traded based on that information. It wasn’t a very large amount–less than $100k, but it still ended up with prison time, or at least the possibility thereof.
The stock is not going to become totally worthless because of a bad quarter alone, or any isolated piece of bad news. You would just limit the amount you borrow to no more than what you expect your shares to be worth after the news breaks.
If you need money equivalent to the total current value of your shares, you’re out of luck. They’re really not worth that much anymore - it’s just that the general public doesn’t know it yet.
If his holdings are in an account seperate from an employee stock purchase plan, my WAG is this wouldn’t ever come across anyone’s radar. Someone would need to have a reason to check. And if it’s just $20k, it might not even be a red flag size amount. Again, a regulator would need to be looking to find the trade.
I don’t know how many people per day have trading restrictions but it has to be in the thousands if not tens of thousands. It would probably go unnoticed.
Now that the original question has been answered, here’s a twist–suppose that you have already borrowed against your stock, and the bank is demanding payment. For whatever reason, you have no other available collateral for another loan, and no cash. What do you do if you’re in a no-trading window?
Can a bank repossess stock in the same manner as a car? If so, are you still liable to the SEC?
Or, someone could decide to “strategically default” on their stock-backed loan during a no-trading window, figuring that if their stock is repossessed now, the bank will value it at its current fair market value of, say, $40/share, and apply that amount to paying off their loan, knowing that the stock is going to tank in a few weeks when the earnings data is released to the public.
E.g. if you owe $10,000 against stock collateral currently worth $12000, could you intentionally default now even though you could pay it, figuring that if the repossession occurs before earnings are announced, the bank will value the repo at $12000 and then possibly give you your $2000 back, as opposed to waiting until after earnings are reported (after which the stock drops to a total value of $5000, leaving you with a whole five thousand dollar deficiency to make up?