When To Watch Out For Insider Selling

January 29, 2008 by Joe Ponzio

Somebody send Angelo Mozilo to jail. I can only think that it is a matter of time. If you think investing in stocks is as simple as looking at past earnings (or cash flow) and buying, you have another thing coming. As a silent partner in business, you have to dive into the financials and filings, and determine whether or not your management is acting like partners…or thieves.

Countrywide’s Angelo Mozilo? Let’s explore the tell-tale signs of a thief.

Over the past few days, the big Countrywide news was that Mozilo is giving up some $37.5 million in severance and benefits upon completion of the Bank of America acquisition. In a cut-and-dry acquisition, that may make a ton of sense and may be a sign of an executive that really believes in doing what is right for shareholders. In Countrywide, it is a meaningless gesture of a man who likely knows that his company is dead without the acquisition, and that he may be headed for legal trouble as well.

When is insider trading excessive?

If you were a Countrywide silent partner back in October of 2006, you would not have seen a ton of insider buying or selling. In fact, you could have felt pretty comfortable that your managers were not running from a ticking time-bomb. (We’ll ignore the business of Countrywide for this example).

In October of 2006, something magical happened. Call it “managerial intuition” or whatever you like, but Countrywide instituted a trading plan for Mozilo. In and of itself, not a cause for concern. What followed is quite likely the most grievous breach of duty – both fiduciary and to shareholders – I’ve seen since the tech crash of the early 2000s.

When your manager starts selling…a lot.

In November and December of 2006, Mozilo sold 891,999 shares of Countrywide, cashing out more than $35.5 million. At that point, Countrywide’s stock was still in the $35-$40 range, and investors should have heeded the warnings. But that’s not all.

I don’t preach that you should watch every transaction, but you should check in every quarter or so to see what the heck is happening at your company. Let’s say you didn’t catch it at the end of 2006. In the first quarter of 2007, Mozilo exercised and immediately sold another 1.6 million shares – for a total of $64.6 million. That was just in January through March of 2007.

Countrywide was still selling between $33 and $42 a share.

It gets better.

The price of Countrywide’s stock started tanking in early July of 2007. From April 1st through July 6, Mozilo went on to exercise and immediately sell another 1.7 million shares, cashing out another $66 million in the quarter.

From the date of the October 2006 trading plan to July 2007, Mozilo sold 4.3 million shares totaling $167.7 million.

Yep. It gets better still.

In July of 2007, Countrywide’s stock started falling, but that didn’t stop Mozilo. From July through October of 2007, Mozilo continued on his liquidation spree, exercising and immediately selling another 1.3 million shares for $34.2 million.

At least someone made money in Countrywide.

In just twelve months (November 2006 to October 2007), Angelo Mozilo was granted and immediately sold 5,536,539 shares for a total of $201.9 million. During this time, his personal holdings in Countrywide never increased, save the 11,799 shares he added to his 401k plan.

(At this point, you may be wondering why nobody was talking about Mozilo’s cash out. I’m wondering the same thing. Of course, it’s Wall Street’s job to sell, not analyze or protect.)

Was Mozilo ever really a partner?

When analyzing management, you should be looking for executives and managers that hold a significant amount of the company’s stock. Angelo Mozilo owns just 2 million of the company’s 576.8 million outstanding shares – 0.35%. In twelve months, he exercised and sold more than twice as many shares than he owned.

That is hardly the sign of committed management.

What do your partners have to lose?

What does Mozilo have to lose if the acquisition fails and Countrywide goes belly up? What is his incentive to turn this business around? What would prompt him to spend less time in the tanning salon and more time in the office?

Should we be cheering Mozilo’s shareholder sensitive plan to forego the $37.5 million severance and consulting package? (I’ll hold my applause until they take him away in handcuffs.)

What is reasonable for insider sales and holdings?

It is impossible to set a hard, fast rule on how many shares your managers should hold or be allowed to sell. Remember: Everything is a judgment call. Unless something jumps out at you – be it a great investment at a great price or a thieving manager cashing out hundreds of millions of dollars – follow Charlie Munger’s advice:

Another thing you have to do, of course, is to have a lot of assiduity. I like that word because it means: sit down on your ass until you do it.

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