Can You Have Your Stock and Sell It, Too?

Critics contend that something is amiss when companies buy back stock at the same time executives are selling.

“The world in which [insider trading] laws were made existed before the world in which there were massive buyback programs,” says Robert Monks, a shareholder activist, attorney, and investment-fund partner. “I don’t think anyone foresaw how these two trends would play out together.”

Options Play

Critics contend that potential conflicts of interest take several forms. For starters, options holders aren’t eligible to receive dividends, which may make them turn a blind eye to a practice that would benefit other shareholders. And dividends dilute the value of options because the share
price is typically marked down to reflect the value of the dividend issued. In addition, a prime motivator for buybacks — to boost earnings per share — is seen by critics as potentially self-serving because many executives are compensated at least in part based on EPS targets, so using company money to inflate that figure can result in personal gain. Less clear is whether buybacks actually bump up the price of shares, allowing executives to garner more than they would have otherwise (see “More Knocks Against Buybacks” at the end of this article).

But as those recent figures on buyback activity indicate, rumblings from certain quarters seem to be having no effect on the popularity of the practice. “I think
there’s a responsibility, if you accumulate too much cash on the balance sheet, to make a decision of some kind to return money to shareholders, unless you have it
earmarked for something else,” says USANA executive vice president and CFO Gilbert Fuller. “Over the past five years, we’ve bought back something like 6.5 million
shares, and spent $130 million doing so. And we’ve chosen to do that rather than issue a dividend, primarily because it gives us more flexibility.”

The company spent nearly $50 million
between 2005 and the first quarter of
2006 alone, a period during which company
insiders sold USANA shares worth
approximately $64 million. Fuller cites
several reasons for that activity, noting
that the company’s stock went from less
than $1 a share in 2002 to more than $40
per share this year. “First of all, it takes an
iron stomach not to sell into that,” says
Fuller. “Second, it’s a way for executives to
balance out their cash needs. And third,
there’s the issue of diversity. If you wake
up and see that your stock has gone from
under $1 to $44, common sense says you
should diversify some of your holdings.”

Because of USANA’s compensation
philosophy and its long-term commitment
to stock-buyback programs, Fuller
says there have been times when insiders
were selling stock at the same time the
company was buying. “But there hasn’t
been an orchestrated effort to link when
insiders were selling to times when the
company was buying back shares,” he says.

The idea that companies could connect
the two practices has caught the attention
not only of academics and attorneys, but
even Warren Buffett. In his annual letter
to shareholders last year, the chairman and
CEO of $82.5 billion Berkshire Hathaway
Inc. raked the practice of orchestrating
buyback programs with a vignette about a
fictitious caretaker executive, Fred Futile,
CEO of Stagnant Inc. In Buffett’s example,
Futile gets rich on stock options simply by
using buybacks to boost his company’s
reported EPS — and hence the company’s
stock price, which investors calculate as a
multiple of EPS — despite being unable to
grow the company’s net income.

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