Introducing the INK No Go List

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Introducing the INK No Go List

At INK Research, our mission is to help you make better investment decisions by tracking the legally reported buying and selling of public company executives, a group also known as corporate insiders. To help point investors in the right direction with their investments, we combine insider activity with valuations and momentum factors to identify which stocks might make the best investment destinations. 

The foundation of our process looks at insider commitment. We rank every stock on a standard INK measure of insider commitment which takes into account the number of common shares company officers and directors hold on a beneficial basis as reported via SEDI or the SEC along with recent buying or selling of company shares. It is a pretty straight forward concept. The more stock that key insiders own and are buying, the greater the insider commitment towards the firm.

You can find our insider commitment rankings in the INK Edge outlook summary for a stock on the INK and Canadian Insider websites.

As critical as holdings and buying are in assessing insider commitment, there is at least one more important consideration, and that is commitment to disclosure. In INK's view, insiders who seek to legally delay or intentionally fail to disclose significant transactions within normal filing requirements are seeking to gain an advantage which can tilt the playing field in favour of the insiders. INK believes strongly in pro-market principles, and that means a level playing field for all investors.

In Canada, there is a big disclosure shortcoming possible under an Automatic Securities Disposition Plan (ASDP). These plans typically allow insiders to sell shares even during blackout periods under an agreed upon formula which is typically not disclosed. Safeguards are supposed to be put in place. Insiders cannot be in possession of material non-public information at the time the plan is adopted, and it is supposed to be difficult for the insider to alter the plans once they are in place. Such plans are common in the United States, but not without controversy because studies have shown that such plans can beat other investors in the market.

Unfortunately for Canadian investors, there is one huge difference between Canada and the United States. In Canada, believe it or not, for sales made under an ASDP insiders can apply to regulators for an exemption from normal insider reporting requirements which usually means reporting within 5 days. Such exemptions are unheard of the United States.

Yet, here we are in Canada where regulators have provided reporting exemptions which allow insiders to delay reporting public market trades under an ASDP for up to 15 months. Moreover, since 2006 when the regulators started granting exemptions in Canada, the market structure has changed. In particular, last year the OSC dealt another blow to investors by giving the TSX permission to shut down its insider marker program which publicly flagged insider trades within 24 hours. With insider markers gone, ASDP insider reporting exemptions further tilt the playing field away from the public.

If there is any doubt about the ability of these plans to beat the market in Canada, one only has to look at a couple of examples, both of which start with B. Let's start with a blast from the past, Research in Motion, now called BlackBerry (Cloudy; BB).

On January 22nd, 2010 the OSC provided the two Research in Motion CEOs Jim Balsillie and Mike Lazaridis with an exemption from having to file stock sales under a 2009 ASDP in the normal filings period on SEDI. Instead, filings could be delayed until up to 90 days from the end of the calendar year. Another provision of these exemptions is that they allow insiders to enter the details in summary form so investors cannot see when the individual transactions were made. Such summary form provisions are typical of ASDP filing exemptions.

On Christmas Eve 2010, the OSC provided the two CEOs with subsequent exemptions for a 2010 ASDP. Unless an investor was regularly reading OSC orders or had a very keen eye on reading company press releases, this development would have gone unnoticed. Investors would have been oblivious to those ASDP public market sales until, after a long and permitted delay, a filing was finally made.

The rest is history. The stock experienced a lengthy slide following the exemptions. BlackBerry stock has lost about 80% of its value since the first exemption was granted.

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Bombardier (BBD.B) provides a more recent example of an ASDP beating the market. On August 15th of last year, Bombardier issued a press release stating that certain executives had entered into an ASDP describing that it had been set up “in accordance with applicable Canadian provincial securities legislation”. That language left investors guessing whether or not sales under the plan would be filed in 5 days as normally required, or would they get an exemption. Regulators eventually provided the answer in a decision found on the OSC website dated September 14th, that yes insiders covered by the decision would be able to delay disclosing their ASDP sales until March of the following year.

So, thanks to the exemption, the public had to wait until this year to find out how much and at what price insiders made their ASDP sales. In the meantime, the stock tanked on the back of poor operating results, dropping more than 50% from the day of the exemption date. However, after prodding from regulators, the company agreed to terminate its ASDP.

However, the horse had already left the barn. On March 22nd we learned for example that CEO Alain M. Bellemare had sold 3,650,000 shares at a reported price of $4.55. Based on the reported plan-related acquisition price for the shares, INK calculates he pocketed $10.585 million before any transaction costs. We don't know the dates those transactions were made as the regulators gave him an exemption from having to tell us. Moreover, we don't even really know how he disposed of those trades, as they were filed as being made under a purchase/ownership plan (INK shortens this in its reports to category to company plan), a category that in our view could mean many things. It is INK's general view that if an insider's trades was made in the public market, the transactions should be filed as such, and not under a purchase/ownership plan which could leave investors wondering how the shares were sold.

Although the appropriateness of regulators permitting ASDPs to transact during blackout periods is controversial, INK Research opposes the willingness of Canadian regulators to grant insider reporting exemptions for these plans. If US studies do not provide enough cause for concern about the practice, the two B's should serve as a wake-up call. We believe if regulators continue to grant these exemptions, they will undermine the value of the insider reporting system, erode the confidence of investors in Canadian capital market disclosure practices and provide an unfair advantage to insiders.

While we hope that Canadian regulators will stop providing ASDP insider reporting exemptions, the wheels of change for reform typically move slowly. In the meantime, INK is going to do its thing. In efforts to discourage the growth of an insider filing exemption culture in Canada and encourage company boards to think twice before approving applications to regulators to grant insider filing exemptions, INK will not rank in our INK Edge process any issuer who has an officer or director insider who has sought and received an insider reporting exemption in relation to an ASDP. A key consideration in taking this step is the need for our INK Edge ranking process to incorporate timely insider commitment data. When that data is not available due to a filing exemption, INK will no longer rank the issuer.

We would also point out that stocks are not eligible for inclusion in the INK Canadian Insider Index if they do not have an INK Edge ranking.

We will help investors keep tabs on these issuers by putting them on our new INK No Go list. As of May 15th, there are 6 issuers on the list.

 

 

INK No Go List.

Going forward, INK will do its best to add issuers to the list when we become aware of an ASDP exemption being granted. However, that in itself presents a big challenge because it is our understanding that regulators do not have a requirement for issuers who receive these exemptions to notify the public by a standardized press release or filing. If regulators continue to provide ASDP filing exemptions for insiders, INK believes issuers should be required to issue a standard early warning to investors that a filing exemption has been granted and that the insiders will be delaying their trading disclosure. This is not a preferred solution, but it would be better than what we have now which is more often than not an investor guessing game.

INK would also like to encourage regulators to ensure that insider trades are filed properly. That includes correctly reporting whether shares are beneficially owned. If the trades are executed in the public market, we believe they should be filed as such, and not under an ambiguous filing code that leaves investors guessing further as what went on.

INK will remove an issuer who is on the No-Go list if the issuer stops its reliance on an exemption in place. However, the termination of an ASDP is not enough to be removed from the list. If an ASDP that was subject to an exemption has been completed or terminated, the issuer will remain on the No-Go list unless it issues a press release or indicates to INK that it will not apply for such filing exemptions in the future, or if there is a change in senior management at the firm that has not sought such exemptions.

As an example, BlackBerry is not on the list as the company has undergone a change in management and we are not aware of any subsequent applications for ASDP filing exemptions from the issuer.

While we wait for regulators to hopefully reconsider ASDP insider filing exemptions, investors can help stop the growth of an exemption culture by demanding that company compensation plans presented to annual meetings include a commitment not use ASDP filing exemptions.

In INK's view, the longer ASDP filing exemptions remain in place, the less confidence investors will have in the Canadian insider reporting system. That will ultimately drive the cost of capital up for all Canadian-listed issuers, even those that have solid governance practices.

This post first appeared on INKResearch.com.

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