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?
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.
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
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.
(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.
It seems also on some international markets this is allowed.