What can be learnt from the news that a Director in a listed company has bought or sold shares?

NEW CONKERS3 FEATURE : An article by Tim Rogers,

Former CEO of AB Dynamics Plc, now owner and Non Exec director of a number of companies involved in SME new business development and advanced engineering technology.  For the past 20 years I have been operating at CEO, senior director and board level with private and public companies including NASDAQ and AIM listed businesses involved in the advanced engineering and environmental sector.

In my experience from managing AIM and Nasdaq business’s I think you can interpret a lot but actually learn very little. One thing that is true is that directors in successful companies, will sell shares in their company from time to time and often in a seemingly random way. To make any informed decisions you do need to understand the reasons why it might be happening.

Perceived wisdom follows that if a company director is buying more shares in their company, then you take it as a signal that they value the company well and should follow their example, reasoning that a company’s directors would only buy shares if they think they will go up in value. So, it seems a safe and logical strategy to follow when you see an insider buying.

Conversely, it follows that if a company director is selling shares in their own company, you should also sell your shares because the reverse is true right! It is normally when directors sell shares, you’ll hear people shouting “so-and-so sold their shares, they must know something bad about the company”.

I think that is a too simplistic view.

What are the rules?

It is worth saying that on AIM there are strict rules around insider share dealing. These rules were further strengthened by the introduction of Market Abuse Regulations (MAR) in 2016. It applies to all Plc company directors and was extended to include People Discharging Management Responsibility (PDMRs). I don’t want to go root and branch into this so I will simplify it by saying that as a PDMR if you are party to material information that may affect the future share price of the company, then you are restricted in dealing in the company’s shares. MAR further instructs the company on how to manage the company’s share dealing policy for all staff (and family members) including when to apply blackout dates on share dealing for example, on the run up to Interim and Full year results.

Does this mean now mean when company directors sell then by definition there is no negative news?
Well, interpretation of these new MAR rules by a number of AIM company boards has, in my opinion, been inconsistent.  I noted a few share sales by directors in an AIM company recently, which although maybe legal, I believed were wrong given the spirit of the rules! Either that or the circumstances leading to the disposal was not sufficiently explained!

I would say that for a company to give approval to any director or PDMR to trade in their company’s share, whilst complying with MAR at its most basic level, then the company will need to have done the following:

  1. Have a clear procedure to ensure that all intended staff share dealing requests are passed to the CFO’s office for initial approval.
  2. Oversight from the Company’s CEO, CFO, Board, NOMADs and broker to consider such a request and to determine whether any material inside information prohibits such a deal and whether this person is a PDMR requiring disclosure.
  3. If agreement is given and the individual is deemed to be a PDMR, then an RNS would be issued on the day after the share trade, giving the execs’ name, the amount they sold or bought and what their resultant holding is.

Before the MAR was introduced it was normally only the Plc board directors who announced their share dealing. Post MAR, it is now all Directors and PDMRs (as identified by the board and NOMAD) who are required to announce their share trades. As you might expect a small company might have a disproportionate percentage of people on this list than a larger one.  As a result, there are a lot more insider trades being announce on AIM than before, this is not because there more insider sales being made, it’s simply because disclosure has been widened to include more staff.

As an aside, share sale RNS’s often generate more interest from the company’s staff than the investors. They read otherwise undisclosed information and see the execs benefit package laid bare. For me there was a great deal of satisfaction in seeing other directors and execs’ in my company having their share dealing and financial details made public and subject to staff scrutiny as well as mine.

So, what factors lead up to a Director selling shares?

This is what you really want to know!
Well, the answer lies in the method by which the executive ended up with the shares in the first place. These could be:

  1. Shares belonging to original private founder(s) pre-IPO
  2. Shares obtained and earned through share based remuneration packages like LTIPS, share options, share buy schemes.
  3. Both of the above

By understanding the rules by which they are permitted to trade shares you can determine the pressure they may come under to sell shares.

This is complicated so I have simplified it a lot.

One: Shares belonging to original Founder(s).
In this scenario the directors had them from the start pre-IPO.
Typically most companies begin as a private ltd company.Often there is often one or two main directors/ shareholders, with one or two directors who later “bought” into the company whilst it was privately held. These directors possess shares which in reality have little real monetary value whilst they are privately held, because really the only people who would want them are the other directors or a Private Equity vulture who might swoop in.  The percentage of shares held do determine however, the proportion of the company dividend they receive. For small companies, dividend payments were until recently, a very tax efficient way of remuneration. In effect the value of acquiring more shares is a calculation of the longer-term return from having a greater portion of the dividend. It all gets a bit messy with the lead shareholders assigning more value to the company than the junior shareholders do. Mind you when it comes to an IPO, they all tend to become magically aligned.

It is interesting to note that small private companies pre-IPO tend to have low valuations but relatively high dividends.

The selling bit: “The Ducks are quacking”.
When a company IPO’s on to AIM for example, suddenly the founder’s shares now have value. In theory they are free to sell away to their hearts content, in practice they are restricted. Although they may have elected to dispose of some of their stock at the time of the float, the rest will be subject to lock-in clauses and the like, to protect new investors from a disorderly exit by the founders.

On IPO there are often two kinds of Shares that come to the market. The “Primary shares” made up of the existing founder shares and the “Secondary shares, i.e. new shares issued for the company to raise some additional money to grow with.

The Primary AIM shares often qualify for Venture Capital Trust (VCT) and Enterprise Investment Scheme (EIS) tax relief and are highly prized by certain institutions, who take up the shares and hold for a number of qualifying years before they can release them. Once placed they become “normal” shares and usually cannot be recycled into other EIS VCT funds. The Secondary shares are placed in the normal way and are picked up by Private investors or Institutional Investors not requiring EIS/VCT wrappers. All of the shares get admitted to AIM on the same day at the same price.

Yes, yes you might be saying but what about the selling stuff?  Well, over time IF the stock performs well, the institutions will want more and new institutions will want in.  If half of the Primary stock is stuck in VCT/EIS funds then the broker will be pressing the company to release a substantive amount of shares, they will phone and say the words and I kid you not “the Ducks are quacking and they need feeding”! Meaning there is a demand from the Institutions for more shares.

The CEO can either issue new shares (not a good idea unless there is use for the cash and dilution is not an issue) or persuade the founders to release more of their shares in the company. This is a dilemma for the founders, as they have done well with the share price going up, so why sell? Conversely it is argued that the lack of liquidity and free shares on the market may start to drag the share price down. It’s inevitable that they will have to release more shares one day so do it whilst the ducks are quacking!

Any subsequent disposal is subject to the MAR rules, where it is best practice to place the shares with a prospective buyer via the company’s house broker. Initially large disposals of stock do not normally go onto open markets. However, over time as liquidity improves small amounts of shares can and will be sold on the open market. As time progresses and as more shares are released to the Institutions by the founders and they will in time soon be joined by the company’s own Option holders with their shares. Eventually the Institutions will happily to drop their shares into the retail market to end up with the Private Investors (funny that). That’s why Small cap Funds often need Private Investors.

Two: Shares obtained and earned through share based remuneration packages like LTIPS, share options, share buy schemes.

It’s a fact that in smaller companies – in order to keep control of salary cost whilst at the same time attracting and retaining good people – company executives are often given share based remuneration packages. These are in the form of share options or shares as a bonus, because of that they are unlikely to buy actual shares.  It is however, highly likely that directors in a successful company will be seen selling shares in the company. After all it’s their company, they have worked hard and it’s what they are owed. As long-term option holders they have no interest in crashing the share price, normally these share disposals are sensibly place and timed.

The best explanation for directors selling option derived shares was one I found elsewhere on a US share blog site.

“The truth is that you can’t eat or drink shares. If that company director owning shares worth a million dollars wants to buy a new Ferrari, he will find that Ferrari doesn’t give free cars to people owning lots of shares. He actually has to sell the shares to get the money for the car, and that’s what he does.
When an executive insider sells shares in his or her company, they are valuing the money more than the shares. That means, they are either purchasing something near and dear to them (a house, a car) and can’t afford it on salary or savings alone (a bad sign for an executive who should be making a high enough salary for these purchases)”.

All Plc company option schemes have to be approved by the board and the details published. A quick perusal of the Annual Report or historic RNS’s should tell you all you need know. Namely the amount of options and warrants outstanding, the exercise/vesting dates and relevant prices. They are set up in a way to be tax efficient for both company and employee as a result are complicated in regards to knowing when and how long they must be held.

Although options can be nice to have, they do cost money as they are a taxable benefit, having both a purchase price and a selling price. Options are normally priced using the share price on the day the scheme is bought into being.  If you take an example where the lucky exec’ is given 30000 options to vest over 3 years. If share price on the day is 600p then that is the strike price for their options. Roll forward one year and the company has done well and the shares are trading at 1000p! So they exercise the first third of their share options and they need to find £60 k buy the shares. It’s a lot of money for some and so it is likely that on the run up to the options being exercised, they will sell previously held shares to fund these options this time around.

It’s worth noting that many option schemes in AIM companies are under water i.e. the shares are now worth less than the original option price, meaning the company’s share price has done badly. As a result, it would be unlikely to see staff exercising options. The converse is true. Given what has been said above, it follows that a company doing well would see Director options being exercised and the resultant shares being sold. To interpret the mood of the staff with regards to future growth, try this for an equation when looking at the RNS.

Seeing staff exercising share options and holding on to their resultant shares> Seeing staff exercising share options and selling some of their resultant shares> Seeing staff exercising share options and selling all their resultant option shares.

At AB Dynamics we took efforts to ensure the staff got their options stock away in an orderly fashion, normally in the form of a single placing once or twice a year.

In summary, I would be more relaxed seeing an executive selling their hard-earned shares than seeing a large shareholder or institution selling them.

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