Corporate Executive Insiders
The insider that you will hear about in the popular financial press is the corporate executive insider. This first class of insider successfully conspires to gain control of the board of directors of a publicly traded corporation. They do this to obtain large gifts employee stock options for free when share prices are low and shareholders are desperate.
The corporate executive insider does everything possible to get the price of the stock to go up over the next few years as their options vest. They use news leaked to the media and also use legally (or illegally) misleading financial statements to draw in inexperienced public investors.
America Online (AOL)
For example, America Online (AOL) corporate executive insider Bob Pittman used both Wall Street and the general media effective- ly to promote AOL as the bull market heated up in 1996: “During Pittman’s first full year as president…AOL held twice as many analyst conference calls and received 10 to 20 times the coverage in media and entertainment publications as any other company in its then-peer set, which included Yahoo! And Lycos.” See note.
What inexperienced investors fail to realize is that all U.S. media sources are now fully owned by large publicly traded corporations that are controlled by inside corporate executives. This was not so before
World War II, but it is today. Is it any wonder that insiders use the media to promote their stock to get the public to bid it up to astro- nomical prices? Is it any wonder that inside corporate executives bail out at the top and leave the public holding the bag?
AOL Books Were Cooked
In addition, the inside corporate executives at AOL were “cooking the accounting books” to intentionally mislead inexperienced public investors into believing that the company was profitable. This was done to seduce inexperienced investors into buying more stock to pump up the share price so that the inside corporate executives could dump their holdings of stock on the inexperienced public. These same inside corporate executives had acquired their stock at low, low prices with their free employee stock options they had received from a corporate board of directors they controlled.
Lisa Buyer, a fund manager at T. Rowe Prices Associates, said about AOL in the fall of ’95: “What the shorts [short sellers] can’t understand is that Wall Street, witnessing such growth, is willing to overlook the company’s losses and well-known aggressive accounting methods.”3 The “growth”, however, that she was talking about was a growth in the number of subscribers, not a growth in earnings. The cost of acquiring those customers was so high that AOL had not, in fact, yet earned a profit — though, thanks to its creative accounting, it was reporting profits. Nobody in the public knew that AOL insiders were also hiring themselves out to teach other different company insiders how to cook their accounting books — they were proud of their accounting skill at deceiving the public!
Inside corporate executives’ employee stock options also create misleading financial statements. Remember that the employee stock option was intended to retain highly skilled employees critical to the key engineering and production processes of the firm. The reality is that the idea was poorly thought out and implemented, because options flow straight to the top of the corporate pyramid far from production. Today, employee stock options are the biggest corporate governance problem in the field of finance. In 2000, the Bureau of Labor looked at who actually received options in 1999 and found that, nationwide, only 1.7% of non-executive private sector employees received any stock options and only 4.6% of executives received them — 93.7% went up to the CEO and his or her cronies!
Back at the Pig Trough
In 1999 — a banner year for employee stock options exercised — 98% of all U.S. workers of publicly traded corporations did not
receive a single stock option as part of their pay. At the end of ’99, the CEOs running the 800 largest companies in the United States were sitting on “fully vested” options worth $18 billion. They could cash them in at any time when they knew they had driven the market up as high as they could — and this is exactly what they did. Not one inside executive was prosecuted or even subpoenaed by the SEC for inside trading which nearly all of them had done in masse. Perhaps, now you understand why Martha Stewart was so flippant with the judge when she was subpoenaed and prosecuted as a scapegoat for alleged inside trading that amounted to a few hundred thousand dollars!
Even more sinister, a 1999 study by the Federal Reserve of 138 firms estimated that, by legally not accounting for the value of corporate executive employee stock options, the companies had falsely boosted their profits by 10.5% — the managers walked away with a big cut of the owner’s profits. Do you trust P/E ratios now? I hope not. This has occurred because inside corporate executives have been successful in garnering the support of Washington, through executive special interest groups, to stop the SEC’s attempt to force corporations to show inside employee options as a cost to the company.
These people as a group buy stock low and then manipulate the stock price up to dump it on an eager, overly-optimistic, in- experienced public. I first learned of these investors when I began studying the history of the stock market. These individuals still to this day operate in teams to buy up (corner) the supply (float) of a company’s stock. They created investment pools and became no- torious as part of the corruption on Wall Street. These investment pools were renamed mutual funds after the depression to get people to forget their very murky past.
– Doc Brown
BIO: Doc Brown is a national expert on the stock market. His courses “How to Make a Million Dollar Portfolio from Scratch” at the Oxford Club is a national bestseller. Dr. Brown’s research appears in some of the most prestigious academic journals in the field of finance. See Journal of Financial Research and Financial Management. Scott is an associate professor of finance in the Graduate School of Business at the University of Puerto Rico.
NOTE: Amy P. Hutton, “Four Rules for Taking Your Message to Wall Street,” Harvard Business Review, May 2001, 125.
FURTHER READING: Linda Sandler and Jared Sandberg, “Heard on the Street: America Online Lures Investors, Dismays Shorts,” The Asian Wall Street Journal, 13 November 1995, 15.
TIP: Buy low when nobody you know is looking at the stock market. Sell high when every- body you know wants into the stock market!
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