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.

This June, Audit Integrity, a Los Angeles–based accounting and governance analysis
firm, sent a note to clients identifying
16 companies with market capitalizations
of at least $100 million that it considers
at high risk for fraudulent behavior,
including USANA, because the companies
have high levels of both stock buybacks
and insider selling. Meanwhile, attorney
Lerach is putting the finishing touches on
a lawsuit he plans to file against “one of the
most high-profile companies in the United
States,” along with its CEO, over issues
relating to its buyback programs.

Fuller notes that USANA has simply
followed a practice shared by many companies:
pay modest salaries that are
accompanied by sizable equity-based
compensation, and work to make the latter as valuable as possible.

Companies can, of course, arrange for
their executives to sell their stock through
so-called 10b5-1 plans, named after the
Securities and Exchange Commission rule
that allows them to transact in company
shares at all times, not just during open
trading windows, without running afoul of
insider-trading rules. Under such plans,
the executive must specify in advance the
amount, price, and date of any stock purchase
or sale, or provide a written formula
for determining the amounts, prices,
and dates. These decisions must be made
at a time when the executive is not aware
of any material, nonpublic information. Similarly, many companies seek to conform
their buyback programs to SEC Rule
10b-18, which provides them with a safe
harbor against charges of manipulating
their own stock price. A new “cashless
buyback” equity instrument advocated by
MG Holdings of Summit, New Jersey, may
give companies another option.

Perceptions vs. Incentives

Attorney Stephen Riddick, a principal
shareholder with law firm Greenberg
Traurig in Washington, D.C., says steady
selling activity by insiders pursuant to
10b5-1 plans, which are designed to be
active in good times and bad, could be
skewing the perception that insiders are
timing sales to coincide with buybacks.

Lerach sees it differently. “Most of the
time, we find there aren’t 10b5-1 programs,”
he says. “Most of the sales look to
be discretionary and a result of insider
decisions, not some preexisting program.
But even if there is a 10b5-1 program, I
continue to believe there’s an inherent
inconsistency in using the stockholders’
money to buy back stock while you’re
unloading your stock.”

Jack Zwingli, CEO of Audit Integrity,
is similarly skeptical. “Common sense and
history suggest that problems arise when
management has a short-term financial
incentive to behave in a certain way,” he
says. “If management benefits more from
doing stock buybacks than from paying
dividends or reinvesting in the business,
it will buy back stock.”


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