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Should investors be wary when company insiders buy shares with borrowed money?
Eila Rana, CFO Europe Magazine
December 10, 2007
Investors often cheer when companies buy back their own shares, and sometimes it sends an even more bullish signal when directors dip into their own pockets to purchase company stock.
Investec Private Bank hopes to make it easier for CFOs to buy their own companies' shares. Two years ago, the Anglo-South African bank started issuing loans of more than £1m (€1.4m) each to UK-based CEOs, which they can invest as they see fit as long as they disclose their investment plans with the lender beforehand. Having built up a loan book of around £80m, the bank is now aiming to target CFOs in the UK, Germany and France.
Borrowers pay a margin over base rate of between 1% and 3%, plus an arrangement fee. For particularly risky loans — say, for investing in shares of a newly listed company — Investec takes a percentage of any trading profit at the end of the loan term, typically 10% to 20%.
The bank's marketing materials suggest that these loans are a good way to finance purchases of shares in an executive's own company. But when directors buy their own shares on credit, does that dilute the traditionally bullish insider-buying signal? David Drewienka, head of specialized lending at Investec, reckons not. "If the shares go down in value, the borrower still has to repay the loan," he says. "Because the client is at risk, the market still views it as if it were his own money."
The markets beg to differ. Giampaolo Trasi, deputy chairman of the European Federation of Financial Analysts' Societies, says that when directors buy their own shares with borrowed money, "it signals a more speculative approach." While investment assessments are rarely based solely on insider buying trends, he notes, such loans would push these purchases further down the list of useful leading indicators.