VideoBecause of USANA's compensation philosophy and its long-term commitment to stock-buyback programs, Fuller says there have been times when insiders were selling stock at the same time the company was buying. "But there hasn't been an orchestrated effort to link when insiders were selling to times when the company was buying back shares," he says.
The idea that companies could connect the two practices has caught the attention not only of academics and attorneys, but even Warren Buffett. In his annual letter to shareholders last year, the chairman and CEO of $82.5 billion Berkshire Hathaway Inc. raked the practice of orchestrating buyback programs with a vignette about a fictitious caretaker executive, Fred Futile, CEO of Stagnant Inc. In Buffett's example, Futile gets rich on stock options simply by using buybacks to boost his company's reported EPS — and hence the company's stock price, which investors calculate as a multiple of EPS — despite being unable to grow the company's net income.
This June, Audit Integrity, a Los Angeles–based accounting and governance analysis firm, sent a note to clients identifying 16 companies with market capitalizations of at least $100 million that it considers at high risk for fraudulent behavior, including USANA, because the companies have high levels of both stock buybacks and insider selling. Meanwhile, attorney Lerach is putting the finishing touches on a lawsuit he plans to file against "one of the most high-profile companies in the United States," along with its CEO, over issues relating to its buyback programs.
Fuller notes that USANA has simply followed a practice shared by many companies: pay modest salaries that are accompanied by sizable equity-based compensation, and work to make the latter as valuable as possible.
Companies can, of course, arrange for their executives to sell their stock through so-called 10b5-1 plans, named after the Securities and Exchange Commission rule that allows them to transact in company shares at all times, not just during open trading windows, without running afoul of insider-trading rules. Under such plans, the executive must specify in advance the amount, price, and date of any stock purchase or sale, or provide a written formula for determining the amounts, prices, and dates. These decisions must be made at a time when the executive is not aware of any material, nonpublic information. Similarly, many companies seek to conform their buyback programs to SEC Rule 10b-18, which provides them with a safe harbor against charges of manipulating their own stock price. A new "cashless buyback" equity instrument advocated by MG Holdings of Summit, New Jersey, may give companies another option.
Perceptions vs. Incentives
Attorney Stephen Riddick, a principal
shareholder with law firm Greenberg
Traurig in Washington, D.C., says steady
selling activity by insiders pursuant to
10b5-1 plans, which are designed to be
active in good times and bad, could be
skewing the perception that insiders are
timing sales to coincide with buybacks.
Lerach sees it differently. "Most of the time, we find there aren't 10b5-1 programs," he says. "Most of the sales look to be discretionary and a result of insider decisions, not some preexisting program. But even if there is a 10b5-1 program, I continue to believe there's an inherent inconsistency in using the stockholders' money to buy back stock while you're unloading your stock."
Jack Zwingli, CEO of Audit Integrity, is similarly skeptical. "Common sense and history suggest that problems arise when management has a short-term financial incentive to behave in a certain way," he says. "If management benefits more from doing stock buybacks than from paying dividends or reinvesting in the business, it will buy back stock."
Some may regard that as a cynical view, but if so the cynics appear to be on the ascendancy. Companies may have to look at this issue within the boardroom, lest they find themselves looking at it in the courtroom.
Randy Myers is a contributing editor of CFO.
More Knocks Against Buybacks
Researchers have found virtually no link between buybacks and share-price increases.
While it is commonly thought that buyback programs foreshadow higher stock prices, substantial research suggests otherwise. Critics also say that firms run the risk of bungling the timing of buybacks, the net effect being a substantial waste of corporate cash.
In a 2003 study entitled "Changing Motives for Share Repurchases," J.F. Weston and Juan Siu, of the Anderson Graduate School of Management at UCLA, surveyed the academic literature from the prior two decades and found that, while buybacks in the 1960s and 1970s tended to precede substantial stock-price gains, that phenomenon has largely disappeared. Part of the reason may be that during that time, most buybacks were accomplished through fixed-price tender offers in which management made it clear what it thought the firm's stock was worth. Since the 1990s, most buybacks have taken the form of open-market transactions, which are less transparent.
A 1981 study by Larry Dann in the Journal of Financial Economics looked at 143 fixed-price tender offers between 1962 and 1976. Dann found that in the three days following the announcement, share prices enjoyed a "cumulative abnormal return" of 23 percent on average. By the expiration of the tender offer, share prices on average were 13 percent above their preannouncement levels.
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