Corporate Insiders Shift From 'Buy' to 'Sell' as Bankruptcy Nears

 
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One day in September 2011, Wall Street analysts trundled into the spacious lobby at the Livonia, Mich., plant of a company called A123 Systems Inc. to view a slide presentation describing a rosy outlook for the maker of lithium batteries.

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"They stood up in front of investors and painted a very bullish picture," said Andrea James, an analyst at Dougherty & Co., who took pictures of the lobby's two-story floor-to-ceiling window. "It looked like the lobby of a company that was making money hand over fist."

Thirteen months later, it filed for bankruptcy protection. But not before insiders unloaded a total of $2.5 million of its stock. The company said the sales conformed to its policy for insider transactions.

The episode suggests how corporate insiders' trading can shift in the months before their companies file for bankruptcy. A Wall Street Journal review of thousands of trades by insiders in their own company's stock found the trades veering heavily toward selling rather than buying as bankruptcy filings drew nearer.

Such trading is sensitive because insiders often are in position to know of a company's worsening problems ahead of other investors. The data raise a question of whether some insiders at stressed companies see the writing on the wall before ordinary investors and take action to protect their own investment. Like all shareholders, insiders are prohibited from trading on material nonpublic information.

In some cases, "insiders anticipate bankruptcy filings and they reduce their holdings so they don't suffer the same loss as [other] shareholders," said H. Nejat Seyhun, a University of Michigan finance professor who has studied bankruptcies and insider trading.

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Bloomberg

Machines used to fabricate lithium batteries at A123 Systems, which filed for bankruptcy last year.

The Journal paired a list from S&P Capital IQ of bankruptcy filings announced since 2007 with trading by corporate insiders. Going back to three years before the filings, to detect changes in trading patterns, the analysis identified nearly 11,000 trades by insiders at 550 publicly traded companies.

The review found that insiders' trading initially skewed toward buying. But in the last months before the bankruptcy filings, that trend dramatically reversed.

In the final three months before the filings, the average number of insider stock buys each month plunged to 29, from 176 a month one year earlier, a drop of more than 80%. Insiders' selling eased only slightly, to 86 trades a month from 91.

Some experts say any trading at all by insiders during the last months before a bankruptcy filing can be problematic, because this corporate trauma often wipes out shareholder value.