Calls for Faster, Fuller Disclosure by Insiders

Under current financial disclosure rules, not even the most diligent shareholder could have figured out whether former Enron Corp. Chairman Kenneth L. Lay was bullish or bearish on his company’s stock in the critical few months before Enron’s Dec. 2 bankruptcy filing.

It wasn’t until mid-February that Lay was required to fill in a key piece of the puzzle: The revelation that he sold $70.1 million worth of stock back to the company last year, including $26.1 million worth after Vice President Sherron S. Watkins sent him her now-famous Aug. 15 memo warning that Enron could “implode in a wave of accounting scandals.”

Lay’s defenders say he was bullish on the stock to the end, and that the sales were forced upon him by margin calls, or demands from lenders that he pony up cash collateral to make up for the declining value of holdings in his personal brokerage accounts.

Whatever Lay’s true opinion of Enron’s prospects, critics say, the salient fact is that he wasn’t legally required to make public the bulk of his 2001 sales of company stock until it was far too late for the information to do investors any good.

Outrage over the Enron scandal has prompted Congress and the Securities and Exchange Commission to try to plug loopholes in the laws and regulations governing disclosure of such insider stock trades.

Because executives and other corporate insiders often have huge sums at risk in company stock, their actions with those shares are of great interest to other investors.

Reformers want to speed up disclosure deadlines for insider transactions, make terminology in transaction reports more understandable to investors and require that the filings be done electronically so they are instantly available.

Although technology for electronic filing has been in place for years, 95% of all insider-transaction disclosure still is filed in paper form, the SEC says.

The main goal of disclosure is to monitor company insiders--defined as executives, directors and holders of 10% or more of a firm’s shares--so they don’t violate federal laws against trading in their own stock while in possession of “material nonpublic information.”

An executive who knows his company is about to announce surprisingly strong earnings, for example, could make easy money by buying shares and waiting for the good news to drive up the stock price. That also would be illegal.

A second reason for disclosure is to enlighten investors. Some experts say the trading activities of insiders are a good signal of where a firm’s stock is headed. A cottage industry has sprung up of research firms that issue buy or sell recommendations based on what insiders are doing with their own shares.

But current federal rules on the timing of disclosures can make such monitoring difficult, said Lon Gerber, research chief at Thomson Financial in Scottsdale, Ariz., which tracks insider trading.

Currently, insider purchases or sales made in public stock markets must be disclosed within 10 days after the end of the month in which they occur. So if a sale takes place Feb. 1, it does not have to be reported to the SEC until March 10.

“My clients would shoot me for saying this, but 10 days after the end of the month is a long time to wait,” said Alan L. Dye, a former SEC lawyer who now is a securities law partner in Washington law firm Hogan & Hartson.

The monthly filing rule also covers the exercise of options, a popular way to compensate executives.

However, the rules for reporting so-called dispositions, or sales of stock back to the company, are more lenient. Disposition transactions aren’t required to be reported to the SEC until 45 days after the close of a firm’s fiscal year. In Enron’s case, Feb. 14 was the 45th day after its fiscal year ended. Lay filed his disclosure on that day.

Such transactions, which require advance authorization by either company directors or stockholders, typically have been elements of long-term compensation plans, experts said. For example, executives may be awarded stock that vests, or becomes their property, at periodic intervals. Each time a block of stock vests, it’s a taxable event. For the convenience of the executives, some firms will allow them to sell back a portion of the stock to cover the taxes owed.

Dispositions aren’t rare, and normally they aren’t controversial.

“In retrospect, sales back [to a company] should be reported more timely,” Dye said. “But in the past, [investors] never made much of those types of transactions.”

Lay’s was a spectacular exception because his $70.1 million in sales back to Enron in 2001 dwarfed the $15.9 million in net public market sales that he had previously reported in monthly SEC filings. Moreover, Lay’s public market sales, which had been occurring like clockwork at the rate of 3,000 to 4,000 shares a day virtually every trading day, halted abruptly July 31.

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Lay Controlled Timing Of Stock Sell-Backs

So the investing public had no way of knowing until mid-February that Lay kept right on selling--but to the company, not in the market--through August, September and October as damaging revelations about Enron’s finances were pounding its stock lower.

A big difference between Lay’s dispositions and others that are done on a regular basis to cover taxable stock-vesting events is that Lay controlled the timing of his sell-backs, so they appear much more like voluntary investment decisions, Dye said.

Lay’s fellow Enron officers, including former Chief Executive Jeffrey K. Skilling and former Chief Financial Officer Andrew S. Fastow, also have been accused of profiting at other investors’ expense, but all of their 2001 stock transactions apparently were reported in regular monthly filings.

Skilling sold 240,000 shares for $15.5 million last year, with none of the sales coming later than June 13, according to SEC filings. Fastow did not sell any company stock in 2001, the filings show.

Lay’s $26.1 million in sales after his Aug. 15 warning from Watkins also came while he was reassuring employees in teleconferences and e-mail messages that Enron was solid and the stock was a good buy.

“Such a dramatic insider sell-off would have been a big warning sign to investors, but this information was not readily accessible to them,” Sen. Jean Carnahan (D-Mo.), a member of the Senate Governmental Affairs Committee investigating Enron, said in a statement accompanying reform legislation that she proposed recently.

Carnahan’s bill would require company insiders to electronically report transactions both to the SEC and on the company’s Web site by the end of the day they occur. Similar legislation by Rep. George Miller (D-Calif.) would require such notification to the company’s employee pension plan within 24 hours.

Some House Republicans, led by Ohio Rep. Michael G. Oxley, chairman of the Financial Services Committee, also favor a one-day disclosure deadline.

Thomson’s Gerber said daily filing might be “overkill,” but weekly filing would bring U.S. markets into line with a number of foreign markets, including Hong Kong.

Alan Beller, chief of the SEC’s corporate finance division, said recently that the agency is considering stepping up the filing deadlines to within two days of a transaction. The SEC also is considering placing the filing requirement on companies rather than on the individuals, where the burden now lies.

Kelly Kimberly, a spokeswoman for Lay and his family, said Lay halted his long-standing program of regular, public market stock sales July 31 because “he thought the shares were undervalued.”

The sole reason for his huge sales of stock back to the company--carried out in 20 transactions from Feb. 1 through Oct. 26--was that Lay was being squeezed by margin calls, Kimberly said. He had pledged his Enron shares as collateral in his brokerage margin accounts and was using loans secured by the stock to buy other kinds of securities so he could diversify his holdings, she said.

At the start of 2001, she said, Lay’s outstanding margin loans totaled $80 million. At the same time, Lay’s Enron stock was 80% of his net worth, she said.

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Former Enron CEO Has Sold Off Other Assets

Enron’s most recent proxy statement said that as of the end of 2000, he personally owned 5.4 million shares. At the price then of $83.13 a share, his stake would have been worth nearly $450 million. If that was 80% of his net worth, his non-Enron assets would have come to an additional $110 million. Kimberly said these estimates are too high but she declined to provide details.

As Enron’s stock and the value of Lay’s other securities declined, his broker-lenders kept demanding more cash collateral, Kimberly said. Lay had to keep relinquishing more Enron stock to the company in $4-million blocks, she said.

If Lay was so certain that Enron shares were a good buy, why didn’t he sell off all of his other assets before selling more company stock?

Kimberly said Lay has sold many of his other assets, noting that in February he sold his stake in the Texans, Houston’s new National Football League team.

As to why Lay didn’t report his stock transactions on a more timely basis, Kimberly said, “Enron made all the disclosures that were required by the SEC.”