August 31, 2021

Insider Trading: Big Exec Sales are a Red Flag for Class Actions

Watchdog Research recently reported the results of its analysis of trading by public company executives, which indicated that there’s a correlation between executives dumping large amounts of stock and subsequent securities class action filings.  While acknowledging that executives often sell some stock to support their lifestyle, Watchdog assigned a “red flag” to sales involving more than 50% of an executive’s holdings or sales of more than $500K by either the CEO or the CFO.  Here’s what they concluded from analyzing those red flag transactions & class action filings over a five-year period:

In our analysis we found that red-flag insider sales nearly doubled the probability that a company would be subject to a securities class action lawsuit in the following year. Interestingly, this correlation between insider sales and securities class actions is significantly weaker if you look at events in the same calendar year. A red-flag insider sale only increases the probability of having a Securities Class Action during the same calendar year by a factor of 1.35.

This disparity in risk between the year the trade is made, and the year following the trade means that the correlation is not simply due to the fact that both red flag insider sales and securities litigation disproportionately affects large companies. The fact that the association between insider sales and securities litigation grows stronger over time has troubling implications. It indicates that executives may be trading on material information concerning potential adverse events as much as a year before that information reaches the public.

John Jenkins