No Dark Alleys : This Version of Insider Trading Is Strictly Legal and Has Its Supporters
Harry Woodcock didn’t engage in insider trading until this year. He wishes he had started earlier.
But Woodcock, chief executive of TS Industries in Huntington Beach, has nothing in common with the high-powered brokers and arbitrageurs caught in the federal government’s crackdown on illegal insider stock trading on Wall Street.
The kind of insider trading in which Woodcock engages is strictly legal. It is the buying or selling of shares by high-level corporate executives according to rules dictated by the U.S. Securities and Exchange Commission. And it has spawned a small industry of stockbrokers, analysts and newsletter publishers who specialize in handling or tracking insider trades.
If Woodcock had sold some of his company’s stock last year, he could have received as much as $34.50 per share. Instead, a series of bad breaks has since caused the stock to plummet to slightly more than $1 a share.
$74-Million Drop
Like many top executives of smaller public companies, Woodcock has most of his personal assets tied up in TS Industries. Because of the stock-price decline, Woodcock has seen his net worth drop from about $76 million last year to around $2 million today.
Although he’s not exactly a pauper, he would be worth a lot more if he had met Richard Gadbois a few months earlier.
Gadbois, a 30-year-old broker at Shearson Lehman Hutton in Costa Mesa, approached Woodcock earlier this year and persuaded him to sell 125,000 shares of TS Industries stock in order to diversify into safer investments.
Gadbois is one of a handful of Orange County brokers who specialize in handling insider stock trades for the roughly 1,000 officers and directors at the county’s 250 public companies.
While the term “insider trading” evokes images of Bahamian banks and bags full of money changing hands in dark alleys, the legal variety consists of nothing more sinister than corporate officers and directors selling shares of their companies so they can send their kids to college, buy a boat or raise cash for a divorce.
Insider trading by corporate executives is perfectly legal provided that certain government requirements are met and as long as insiders aren’t trading on information that’s not available to the public.
In the securities industry, stock owned by corporate officers and directors is known as “144” stock, in honor of the SEC rule established after passage of the Securities Act of 1933 to protect against illegal insider trading.
The 144 rule states that an insider cannot sell more than 1% of a company’s outstanding shares during any 90-day period. It also requires insiders to report sales or purchases of company stock to the SEC, which in turn makes the information available to the public.
The rule prevents insiders from dumping large blocks of stock before public investors have the same opportunity. For example, corporate officers who know about a negative earnings report before it has been made public can’t sell their stock until the news has been released.
An insider is any person in a company who has access to key information before it is announced to the public. Typically, that means top executives, directors and their relatives. Other stockholders who own more than 10% of a company’s shares are also considered insiders.
Stock trading isn’t something that executives of small companies do very often, said Gadbois, who has built a career as one of Orange County’s top “144” brokers.
“Entrepreneurs concentrate on running their businesses, not their personal finances,” said Gadbois, whose Orange County clients include executives at CMS Enhancements, Archive, Amplicon and Quiksilver.
Price and Legality
“What we try to do is protect these people from making poor trades, both in terms of price and with regard to the legality of the transaction,” said Gadbois.
Insiders at small, entrepreneurial companies typically have most of their net worth tied up in the stock of their companies. While that may demonstrate faith in the future, it isn’t necessarily good money management, Gadbois said.
According to Gadbois and other “144” brokers, few Orange County insiders are alert to selling opportunities because they are too emotionally involved with their businesses.
“The stock is very near and dear to them,” said Terrance Malloy, a broker with Kidder, Peabody in Newport Beach.
“It often represents a large portion of their net worth,” said Malloy, who counts Orange County insiders at Carl Karcher Enterprises, FHP, Laser Precision and Nichols Institute among his clients. “And, typically, they have spent a large part of their lives building their companies. So, it’s tough for them to sell, even if they know they should.”
There are a number of reasons why insiders often are reluctant to sell stock. For one thing, the market may interpret a sale as a sign that something is wrong with a company. If an insider is selling, the reasoning goes, he may have lost confidence in his own business.
And, in fact, after an insider sells shares of a small company whose stock is infrequently traded on the over-the-counter market, the share price usually does fall.
That’s where the “144” broker can help. By lining up big institutional investors to buy the stock, the broker arranges a transaction that can actually can send a positive signal to the market.
Grenada Venture Failed
Woodcock, the TS Industries chief executive, acknowledged that he is an example of an insider who couldn’t part with his company’s stock until it was too late.
The company invested more than $2 million to build an insulation plant to provide material for 1,000 homes in Grenada as part of a U.S. government program to improve relations with the island nation. But the program faltered, the houses were never built and TS Industries was stuck with an idle manufacturing plant in the tropics, Woodcock said.
Even worse, the company’s New York investment bank, Haas Securities, went belly up shortly after last year’s stock market crash. The firm’s collapse triggered a series of events that caused the stock to dive. In less than one week last October, TS Industries stock fell from $26 a share to less than $3.
The company wound up posting a loss of $2.3 million on sales of $68 million in 1987. Its stock is currently trading for about $1.30 a share.
All in all, a pretty lousy year.
Woodcock has since begun selling off some of his shares through Gadbois. Even though the price is extremely low, Woodcock said he believes he is better off transferring some of his assets to more secure investments.
“He (Gadbois) takes the opinion that I’m gambling with my company, so now is the time I need to be very conservative in my personal investments,” said Woodcock.
Gadbois, for example, has advised Woodcock to begin diversifying by selling some of his TS stock and investing the proceeds in certificates of deposit, bonds and real estate.
Woodcock’s story is somewhat extreme, but other corporate insiders agree that having the services of a “144” specialist can’t hurt.
One of those is Peter Shaw, an executive who lives in Trabuco Canyon and who has helped turn around a number of ailing Southern California companies.
Shaw was president of Cyprus-based Genisco Computers, which makes aerospace computer equipment, when Gadbois approached him last year about liquidating some of his Genisco shares.
“Sometimes I think if I paid as much attention to my personal investments as I do on operating my business, I could make more money from investments than from working,” said Shaw, who sold a 50,000-share block of stock through Gadbois. “You come to depend on guys like Rich.”
‘Took Some Work’
Gadbois was able to line up a buyer at a good price for Shaw.
“It took some work to place that stock,” Gadbois said. “With a thinly traded company like Genisco, a block like that could crash the whole stock. But the sale didn’t affect the stock price at all.”
Another Gadbois client is Richard Simon, who founded Computer City, a four-store retail chain based in Santa Ana. In 1983, the company was merged into Inacomp Computer Centers, a Michigan chain, and Inacomp went public in 1984.
Simon, who received about 600,000 Inacomp shares, used Gadbois to sell 125,000 shares in 1985. Gadbois was able to get the prevailing market price even though Inacomp was a thinly traded company.
“Rich is very cognizant of what ‘144’ stock is and how to handle it, whereas most brokers have no idea of how to handle it,” said Simon. “Most other brokers would have had to drop the price in order to move the stock.”
Gadbois, according to most accounts, is the king of the “144” market in Orange County. He’s been at it since starting work at E.F. Hutton in 1981 after graduating from college. Hutton was acquired last December by Shearson Lehman American Express.
Gadbois has made insider trades the cornerstone of a business that brings in more than $1 million in gross commissions a year, according to other brokers and Richard MacInturff, a headhunter with Wall Street Recruiters in Newport Beach. MacInturff said that Gadbois ranks among the top 10 brokers in the county in terms of gross commissions.
To some extent, Gadbois has a competitive advantage because he has access to Shearson’s huge over-the-counter trading desk in New York, the largest of its kind in the industry. When an executive at a small Orange County company wants to sell stock, Shearson’s trading desk generally can locate a buyer quickly.
Although the pool of prospective “144” customers is fairly limited, Gadbois said that about a third of his 120 insider clients are Orange County executives.
And those who know Gadbois think he is likely to find more business. Said Chris Massey, managing partner of the Irvine accounting firm Touche Ross: “Rich knows more people in Orange County than anyone I have met in my life.”
