I'm just curious, it seems a CEO could make a lot of money by shorting a huge amount of shares on his company through a third party and then purposefully tanking the company before being fired. Surely this is illegal right?

  • 2
    bloomberg.com/bw/magazine/content/10_10/b4169044647894.htm could be worth reading as an example where there are deals for CEOs that can appear to be like a short. – JB King Jan 25 '16 at 20:55
  • 16
    Samuel D. Waksal, CEO of ImClone did exactly this, landing himself (and Martha Stewart, who he indirectly tipped off) in prison. – Digital Trauma Jan 26 '16 at 4:50
  • 1
    Not the U.S. but yes, this has reportedly happened as recently as last year: greentechmedia.com/articles/read/… – Michael Jan 26 '16 at 16:55
  • what does tanking the company mean? – bubakazouba Jan 27 '16 at 1:13
  • 1
    @bubakazouba Force it to preform poorly, for example making bad executive decisions that would reflect in the stock price. Actual dictionary definition (3) is "fail completely, especially at great financial cost." – Albert Renshaw Jan 27 '16 at 1:20

That would be the ultimate in insider trading. They made a stock transaction knowing in advance what was going to happen to the share price.

They could easily expect to face jail time, plus the CEO would still face lawsuits from the board of directors, the stockholders and the employees.

  • 1
    It wiould be insider trading PLUS manipulating the share price. Each equally bad. – gnasher729 Jan 25 '16 at 20:36
  • 3
    @AlbertRenshaw It would be funny except for everyone who invested in the company, or now transfers their lack of faith in that company to all similarly run companies, causing people to stop investing, causing companies to stop innovating, etc. The negative effects of those actions are more than just the shorted shareholders. – corsiKa Jan 25 '16 at 22:11
  • 1
    Also as CEO most of your compensation usually comes (or at least should) in form of stocks, or stock options, so by shorting, you would be actually only exiting current long position. – Hurda Jan 25 '16 at 22:22
  • 3
    can a CEO go short in any other situation? like on a predetermined schedule - just like their selling has to be? what about a synthetic short via buying 1 atm put and selling 1 atm call. – CQM Jan 25 '16 at 22:28
  • 3
    @gnasher729: plus a direct violation of the CEO's fiduciary duty to the board and shareholders. – Steve Jessop Jan 26 '16 at 15:53

mhoran_psprep has answered the question well about "shorting" e.g. making a profit if the stock price goes down.

However a CEO can take out insurance (called hedging) against the stock price going down in relation to stocks they already own in some cases. But is must be disclosed in public filings etc.

This may be done for example if most of the CEO’s money is in the stock of the company and they can’t sell for tax reasons. Normally it would only be done for part of the CEO’s holding.

  • Interesting! Is the term used still shorting? I see JB King listed a bloomberg article which seems to say it's legal under certain circumstances but I don't see any terminology other than "short" being used. They are talking about doing it through a hedge-fund. – Albert Renshaw Jan 26 '16 at 0:28
  • 3
    @AlbertRenshaw: Taking out insurance on your existing holdings is known as hedging, not shorting. This might be done using put options, for example. The purpose is to shield yourself to some degree from a decline in the price of securities that you own. Short-selling a stock is the act of borrowing shares today and selling them, with the hope that you can buy back the stock in the future at a later price to repay the person you borrowed the shares from. In that case, you only profit if the stock price goes down. – Jason R Jan 26 '16 at 1:52
  • 1
    I just noticed a typo in my comment above. It should say "buy back the stock in the future at a lower price." – Jason R Jan 26 '16 at 4:18
  • 1
    @JasonR Also not to be confused with "shorting against the barrel" which involved actually shorting a stock that you simultaneously held long shares of. I think at one time this was done for tax purposes before the law was changed, but my Google searches now are only turning up results involving firearms and oil... – Michael Jan 26 '16 at 16:51
  • So just so I understand. Say I'm a CEO locked in from selling my stock for 9 months because we just went public, but I think the stock may go down drastically over the next 9 months. I can protect myself by having a hedgefund short the stock for me, and I just use my shares as collateral for the short with the contingency that the hedgefund can't get said shares from me for at least 9 months? – Albert Renshaw Feb 8 '16 at 17:00

If we take only the title of the question "can the CEO short the stock": It was probably different before Enron, but nowadays a CEO can only make planned trades, that is trades that are registered a very long time before, and that cannot be avoided once registered. So the CEO can say "I sell 100,000 shares in exactly six months time". Then in six months time, the CEO can and must sell the shares. Anything else will get him into trouble with the SEC quite automatically. I don't know if shorting a stock or buying options can be done that way at all. So it's possible only in the sense of "it's possible, but you'll be in deep trouble".

Selling shares or exercising share options may indicate that the company's business is in trouble. If the sale makes that impression and everyone else starts selling because the CEO sold his shares, then the CEO may be in trouble with the board of directors. Such a sale would be totally legal (if announced long time ahead), but just a bad move if it makes the company look bad. Shorting sales is much worse in that respect. If the CEO wants to buy a new car, he may have to sell some shares (there are people paid almost only in share options), no matter where the share price is going. But shorting shares means that you most definitely think the share price is going to drop. You're betting your money on it. That would tend to get a CEO fired, even if it was legal.

  • Thanks! Make sure to look at Steven's answer above too about PVF trading – Albert Renshaw Jan 29 '16 at 6:54

Yes. It's called executive hedging, and it's a lot more common than most people know. As long as it's properly disclosed and the decision is based on publicly available information, there's technically nothing wrong with it.

Krispy Kreme, Enron, MCI, and ImClone are the most notable companies that had executives do it on a large scale, but almost every company has or had executives execute a complex form of hedging known as a prepaid variable forward (PVF). In a PVF, the executive gives his shares to an investment bank in exchange for a percentage of cash up front. The bank then uses the executive shares to hedge in both directions for them. This provides a proxy that technically isn't the executive that needs to disclose.

There's talk about it needing to be more public at the SEC right now. http://www.sec.gov/news/statement/020915-ps-claa.html

  • 1
    Thanks for the PVF reference! Researching more now :) +1 – Albert Renshaw Jan 28 '16 at 1:10

(yes, this should probably be a comment, not an answer ... but it's a bit long).

I don't know what the laws are specifically about this, but my grandfather used to be on the board of a company that he helped to found ... and back in the 1980s, there was a period when the stock price suddenly quadrupled

One of the officers in the company, knowing that the stock was over-valued, sold around a third of his shares ... and he got investigated for insider trading. I don't recall if he was ever charged with anything, but there were some false rumors spreading about the company at the time (one was that they had something that you could sprinkle on meat to reduce the cholesterol). I don't know where the rumors came from, but I've always assumed it was some sort of pump-and-dump stock manipulation, as this was decades before they were on the S&P 500 small cap.

After that, the company had a policy where officers had to announce they were selling stock, and that it wouldn't execute for some time (1? 2 weeks? something like that). I don't know if that was the SEC's doing, or something that the company came up with on their own.

  • Yeah, realizing you're the target of a pump & dump would be a reasonable reason to short company stock but the regulators would no doubt pounce--being reasonable wouldn't make it prudent! – Loren Pechtel Jan 26 '16 at 3:48

It seems also on some international markets this is allowed.


Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.