Timing of Sales
Many insiders of a firm own stock in the firm. In some cases, like Microsoft's Bill Gates and Oracle's Larry Ellison, insiders participated in founding the company and own substantial amounts of the firm's stock.
Insiders have material information about the firm that the public does not. Therefore, the SEC regulates trading by these insiders so that they do not take advantage of public investors with this inside information. Insiders are allowed to buy and sell their firm's stock, but they need to convince the regulators that the trades were driven by motives other than profiting from inside knowledge. Common motives for selling are to generate money for consumption or to diversify wealth. However, even with noble motives, the timing of stock sales may look suspicious to investors. This is particularly important now because investor perceptions have an especially strong impact on their confidence.
Consider the stock sales of Bill Gates, co-founder of Microsoft. Gates sells hundreds of millions of dollars of Microsoft stock every quarter. This is actually just a drop in the bucket for Gates, given that he owns tens of billions of dollars in Microsoft stock. No one questions the timing of his stock sales because he sells every quarter ”nearly every month ”and has been doing so for many years. Gates is dollar-cost averaging his sales over many years ”even decades.
On the other hand, Bill Gates' nemesis, Larry Ellison of Oracle, has taken some heat for the timing of his sales. Like Gates, Ellison owns tens of billions of dollars of stock in his company, but Ellison has only sold stock once in recent years. During a week in January 2001, Ellison sold $900 million worth of stock. He had not sold any material amounts of stock for five years before this sale, and he has not sold any stock since. A couple of events have made this sale look suspicious to investors. First, in late 2000, Ellison mocked Microsoft for lowering its earning forecast and blaming the slowdown in the economy. Ellison said that it must be Microsoft products and not the economy because Oracle wasn't seeing any slowdown .  These comments helped increase Oracle stock when Microsoft's was falling.
A month later, Ellison made his stock sale. A month after that, Oracle warned that it would not meet earnings forecasts.  Figure 4-2 shows Oracle's stock price in relation to these events. When an insider sells substantial amounts of stock over a short period, such as one week, then he or she risks appearing to be trading on inside information. Certainly in Ellison's case, investors have a reason to be suspicious.
Figure 4-2. Oracle stock price in relation to Larry Ellison's selling and earnings warning.
Financial economists have investigated executive stock option exercises and found some evidence of timing. Specifically, Jennifer Carpenter and Barbara Remmers of New York University examined nearly all executive option exercises between 1992 and 1995.  They show that the stock price of firms in which managers are exercising options had been steadily increasing. Indeed, during the 12 months before the option exercise, the stock outperformed the market by nearly 20 percent. The stock outperformed the market by 75 percent during the previous 10 years. During the year immediately after the option exercises, the stock stopped outperforming. It didn't collapse, but it just stopped performing better than the general stock market. The study did not examine the stock prices more than one year after option exercise. Managers seem to have some timing ability.
This study ended in 1995. Since then, it appears that some executives have pushed accounting methods and have even lied in order to keep profits climbing when the economy started waning. In many cases, executives have cashed in stock or options when the stock price was high and then restated earnings a few years later. These actions and events make it appear that executives are taking advantage of shareholders with their inside information.
Consider Bristol-Myers Squibb, one of the world's largest pharmaceuticals firms. The SEC is investigating whether the company inflated its revenues by $1 billion in 2001.  This was also the year that its CEO, Charles Heimbold, cashed in more than $70 million in stock options. The aggressive accounting used by Bristol may turn out to be perfectly legal, but the timing of the large option sale looks suspicious. In September 2001, Heimbold retired from Bristol and immediately became the U.S. ambassador to Sweden. 
Also consider the predicament of the U.S. President. In 1986, George W. Bush sold his failed oil drilling company to Harken Energy Corp. After the sale, Bush owned more than 200,000 shares of Harken stock and was appointed to its board of directors. By 1990, Bush was part owner of the Texas Rangers baseball team and wanted to pay off the $500,000 he had borrowed to purchase his ownership stake. On June 22, 1990, Bush sold 212,140 shares of stock at around $4.00 per share for a total of $848,560.  What is suspicious about this event is that Harken announced huge losses for the quarter ending June 30 and the stock price plunged. Over the ensuing six months, the stock price slowly declined to around $1.60 per share, for a loss of 60 percent.
The timing of Bush's sale is suspicious because, as a board member and consultant to the firm, he likely had inside information about the performance of the firm.  Did he really desire to pay off his loan at that time? If so, the subsequent stock price plunge was just a coincidence . Or, did he know it was time to sell the stock and just used his loan as an excuse ? Records show that the SEC looked into the matter and concluded, "Based upon our investigation, it appears that Bush did not engage in illegal insider trading because it did not appear that he possessed material nonpublic information."  Whether Bush sold out because he knew of the upcoming problems or whether he just wanted to pay back his loan, we may never know for certain. However, from the stockholders ' perspective, it looks bad. A board of directors member liquidating nearly all of his stock before the stock price plunges shows ”at the very least ”that he was not looking out for the shareholders. Boards of directors are supposed to be looking out for the shareholders' interests, not their own.
Or consider the lawsuit filed against Martha Stewart and her associates at her company, Martha Stewart Living Omnimedia (MSLO). The suit was filed on behalf of investors who bought stock in early 2002 and claimed that MSLO insiders sold tens of millions of dollars in stock after realizing that the ImClone insider trading scandal could significantly affect the price of the MSLO stock.  Insiders to a public company are not allowed to sell stock based on important information that has not yet been made public. The suit alleges that the SEC made inquiries about the ImClone trades in early January 2002, around the time Stewart sold 3 million shares of stock for $45 million. Other insiders sold shares in March 2002. The link between Martha Stewart and ImClone insider trades were publicized in June 2002. Again, when insiders sell around the time of trouble for a firm, it looks suspicious. Martha Stewart didn't exactly sell out ”the 3 million shares represent less than 10 percent of her ownership in MSLO.
The suit names other MSLO insiders as defendants, such as President and Chief Operating Officer Sharon Patrick. Patrick sold 150,000 shares (for $2.8 million) in March 2002. This lawsuit will not be resolved by the time this book goes to print, but Patrick will probably be able to show that her sales were not motivated by inside information because she has frequently sold shares. In December 2000, she sold 120,080 shares, and in 2001, she sold 356,400 shares in November, 93,600 shares in August, and 120,000 shares in June. Therefore, Patrick can claim that the $15 million in stock she sold was spread out over one and a half years. This looks much less suspicious than a large, one-time sale.
Whether selling stock options or restricted stock, the timing of many executive sales has been suspicious. Global Crossing Chairman Gary Winnick sold $735 million in shares from 1999 to 2001 ”the firm is now bankrupt. Another $500 million in shares was sold by other Global Crossing executives. At bankrupt Enron, Chairman Kenneth Lay cashed in for more than $100 million. At troubled Tyco, the CEO and CFO sold $500 million in stock back to the company. Galesi Francesco of WorldCom sold more than $25 million worth of stock six months before the firm filed for bankruptcy. The list goes on.
Timing of Sales
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