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CEO insider stock sales: ‘Dirty secret,’ ‘perfectly legal’ or a real problem?

Are corporate insiders who make big money selling their stock in advance of bad news just lucky?

Maybe not, suggests the Wall Street Journal. The newspaper examined the trades of more than 20,000 executives over the last eight years, all of which occurred during the five trading days "before the company released material, potentially market-moving news."

The Journal's conclusion: "Among 20,237 executives who traded their own company's stock during the week before their companies made news, 1,418 executives recorded average stock gains of 10 per cent (or avoided 10 per cent losses) within a week after their trades. This was close to double the 786 who saw the stock they traded move against them that much."

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The problem, as the Journal identifies, is the so-called "pre-arranged" 10b5-1 trading plans that allow U.S. executives to trade in their companies' stock even if they possess material, nonpublic information that would normally leave them susceptible to insider-trading charges.

Unlike the trading records, filed after an executive or insider completes a sale, the 10b5-1 trading plans are confidential, the Journal notes. "That means the plans aren't readily available for regulators, investors or anyone else to examine."

Also: Executives can buy or sell outside the provisions of the plan. And they can cancel or amend them with no disclosure.

Critics of the Journal story emerged Thursday. Reuters blogger Felix Salmon said "it seems like much more of a fishing expedition than a wide-ranging scandal."

He argues here the Journal's "methodology seems designed to produce exactly the results that it came up with … Firstly, stocks tend to take the stairs up and the elevator down: if there's a sharp move in a stock, it's much more likely to be a fall than a rise. Secondly, executives trading in their own stock are much more likely to be sellers than buyers. They get awarded stock as part of their compensation package: that's not trading. And once they're awarded it, they have every right to sell it – and selling it makes perfect sense, in terms of portfolio diversification if nothing else. Put those two assumptions together, however, and you get exactly the result that the WSJ is so shocked by."

Similarly, John Carney of cable channel CNBC said "it's far from clear that anything illegal is going on here." Executives with a 10b5-1 plan can change their plan to stop their sales in advance of good news, while those who know bad news is coming can just keep to their scheduled sales.

"This is also very likely completely legal. There's no legal prohibition on corporate insiders using non-public information not to trade. In fact, to run afoul of the insider-trading rules, you actually have to trade. There has to be a transaction coupled with the possession of non-public information."

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It's tough to look at some of the examples provided by the Journal and not wonder, however.

One such: Jeffrey Lorberbaum, the chairman and CEO of flooring manufacturer Mohawk Industries Inc., established his 10b5-1 plan on March 9, 2006; on March 15, he began selling Mohawk shares through a family partnership, ultimately grossing about $10.4-million over two weeks. On March 30 – the day after his last sale, the Journal says – the company said it expected to report lower-than-expected earnings for the quarter, and the stock fell 5.4 per cent, its largest one-day decline in more than two years. (The Journal says the company didn't return its phone calls or e-mails seeking comment.)

CNBC's senior stocks commentator Herb Greenberg, a colleague of Mr. Carney's, "respectfully disagreed" with the two critics Thursday via Twitter, calling insider selling a "dirty secret known [for] years."

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