Insiders Trading on Form 3, Form 4 & Form 5
Once pegged as an insider, the SEC becomes very interested in how you may be benefiting from the unfair advantage you have when trading your own company's shares. The concept of "disclosure" mandated in the Securities Exchange Act of 1934 (the 1934 Act) was put into practice by Section 16(a), which requires insiders to report their stock holdings and trading activity on Forms 3, 4, and 5.
Insiders must make an initial statement of holdings within 10 days after gaining their insider status, even if they don't yet own any shares in the company they have become an insider of. This is done via the SEC's Form 3.
Subsequent changes in ownership must be received at the SEC on a Form 4 by the second business day following the trade.
To help guard against any funny business just before becoming an insider, trades made up to six months prior to achieving the status must also be reported on a Form 4 soon after filing the Form 3. Filing requirements linger on for another six months after insiders lose their status as well. This, it is hoped, stops abuses such as a director giving up his seat on a company's board just in time to buy the company's shares before an imminent merger.
The SEC's nosiness doesn't stop there. Insiders must also file a Form 5 within 45 days after their company's fiscal year end to disclose transactions that are required to be reported under Section 16(a) of the 1934 Act, but aren't required to be shown on a Form 4. These include dividend reinvestments, certain transactions by market makers, and certain merger-related trades, among others. Any Form 4 transactions not previously reported also must be included on this form.
A Form 5 not only has to be filed by anybody considered an insider at fiscal-year end, but also by anyone who was considered an insider for any part of the previous year. This is another way the SEC attempts to stop people from popping back-and-forth between being an insider or not just to skirt filing requirements.
The Form 4: Insiders Buying and Selling
Of these three Forms, Form 4s are generally considered THE most important source of useful insider information. While Forms 3 and 5 record a snapshot of an insider's holdings of their company's shares, the Form 4 tells investors how insiders came to hold the positions. It is the dynamic piece of insider data that gives the best window into the feelings insiders have about the prospects of their firms' shares.
The basic statement of holdings illuminated in Forms 3 and 5 seem mundane in comparison to the information accessible on a Form 4. So much so that Forms 3 and 5 can generally be passed over in favor of spending whatever time and resources you have on prospecting through the more useful Form 4 data.
A Form 4 lists the name of the insider, their relationship to the company, how many shares were traded, and at what price. It also gives the dates of an insider's trades, total holdings of the insider after the transactions, and if the trades were open market, related to the exercise of stock options, or some other special reason. Besides being quite detailed, a Form 4 is also timely--especially after the filing deadline was shortened to just two business days by the Sarbanes-Oxley Act in July 2002. With the deadline for filing being the second day following a transaction.
Investors should keep in mind, however, that filling out a Form 4 and all the other SEC documents is just annoying paperwork for insiders, most of whom are busy executives. It is typical that the burden is passed to an overloaded secretary or company lawyer to complete, and the Forms are not likely their first priority either. This may explain why some (anecdotal evidence suggests around 5%) of the From 4s filed the SEC are not filled out correctly, and require some interpretation. Indicating a share purchase when it should have been a sale, typing in the wrong transaction price or total holdings figures--virtually every field on the Form can fall prey to human largesse. Mistakes seem to be made as much by highly paid legal counsel as overworked secretaries as well.
Another subset of filings also reaches the SEC late. In any given week, Form 4s with trade dates that are months or even a year old betray the tardiness of insiders or their charges. But again, this is annoying paperwork, and tardiness is more likely the result of a mistake than intended deceit. Let's face it, any insider trade that is really illegal is not going to be reported at all to the SEC!
Fortunately, the vast majority of insiders are both diligent and accurate when filing their Form 4s, and they supply the market with high-quality investment information every time they trade their own companies' shares in the open market.