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Insider Trading in 4Q96 and 1Q97: "Do As I Say Not As I Do"

Some Insiders Cashed In On IBM Stock's Rise, Buybacks


PHOENIX - Six senior vice presidents and the IBM controller exercised many of their stock options last fall and in early 1997, cashing in on IBM stock's rise, fueled by the company executives' hype and the multi-billion dollar stock buybacks.

As the Big Blue's chairman, Lou Gerstner and the rest of the IBM brass, including some of the seven insiders, finally got the Wall Street analysts to endorse the supposedly rosy "Nouveau IBM" future, the "Group of Seven" were raking in millions of dollars for themselves.

Our analysis of the insider trading between Oct. 1, 1996 and Mar. 31, 1997, based on the Dow Jones Corporate Ownership Watch (DJCOW) report , which in turn is based on the SEC filings, showed that the seven senior IBM executives sold $35 million-worth of IBM shares at an average price of about $144. They acquired only $8 million-worth of stock during this period, even at the discounted price of $78 per share. The "Group of Seven" sold 2.5 times more IBM stock than they acquired (231,000 vs. 91,000 shares), for an estimated pretax profit of almost $14 million.

The value of the IBM stock surged in the last two quarters without a commensurate rise in earnings (see Annex Bulletins 97-16, 4/23/97 and 97-18, 4/29/97). So as IBM invested in hype and its P/E ratio, some insiders evidently took advantage of the situation.

Ned Lautenbach, senior VP in charge of worldwide sales and marketing, topped the list of insider-sellers with about $13.7 million-worth of stock options and open market sales between Nov. 24 and Nov. 29, according to the DJCOW report. He sold his shares at an average price of $159, while buying them for an average price of $91. For the year (1996), Lautenbach acquired 122,053 shares on exercise of stock options, realizing $10.4 million in value, according to IBM's 1997 Proxy Statement.

"Yeah, I’ve had the gains, but I kept the stock. I haven’t cashed it in," Lautenbach claimed.


Lautenbach explained that his holdings "have gone up from basically 10,000 to 50,000. So I have bought the stock and kept it."

We suspect that these broad-brush figures were a reference to the 10,695 shares which Lautenbach reportedly held as of the end of 1994, i.e., over two years ago, versus the 52,098 - the total he held as of the end of 1996, including the restricted stock, according to the Proxy Statements.

"If you look at year to year what’s happened to my holdings," Lautenbach continued undaunted, "they’ve gone up significantly... I didn’t sell the stock. I’ve bought the stock (in 1996)."

Looking only at the year end totals, while disregarding the buy-sell transactions during the year, is like judging a company's business only by its inventory levels (the balance sheet items), while ignoring the revenues (the income statement data). We wonder what Lautenbach would think of an analyst who would use the same criteria for his/IBM's business performance? For example, since IBM's inventory went down in 1996, does that mean its business stank?

Of course, not. As a matter of fact, IBM's CFO was boastful about it.

And even when Lautenbach and other insiders did buy the stock by exercising their IBM stock options, they did it for a song - for about 55 cents to the dollar in "Group of Seven's" case - compared to the "ordinary" investors who can only acquire the stock on the open market.

John M. Thompson, IBM's "software czar," sold about $7.5 million-worth of his IBM stock between Oct. 24, and Nov. 20, according to the DJCOW report. His average selling price was $141 per share. When Thompson bought the IBM stock by exercising his stock options, he was able to do it for about $66 per share, or some 47 cents on the dollar, vis--vis "ordinary" investors.

Like Lautenbach, Thompson also denied that he had cashed in on IBM stock's rise.

"That just isn't true," he said. "If you want to be fair, you'll say that I exercised my stock options and reinvested most of the profits back into the IBM stock."

Well, that certainly did not happen during the last two quarters, when Thompson reportedly sold 55,222 shares while acquiring only 14,403 of them. For the full year, however, Thompson said that he has spent more money acquiring IBM shares during 1996 than selling them.

The IBM 1997 Proxy Statement shows Thompson to be the second highest beneficiary of exercised stock options after Lautenbach, with $6.1 million of total value realized.

To his credit, Thompson did admit that, "when the stock appreciated enough to make his exercising of options worthwhile, I decided to diversify" (and put some of the proceeds from his IBM stock sales into other forms of financial instruments). "I've been working for IBM for 30 years; most of my assets are (still) tied to IBM."

To his discredit, however, two days later, when we persisted with double- and triple-checking all the figures and claims, Thompson became quite testy. "I think you're out to embarrass some officers of the company," he said. "And I am not going to help you do that."

Well, if holding up the mirror to what "some officers of the company" have done, is embarrassing to them, shouldn't the officers blame their own actions rather than try to smash the mirror?

Evidently not... at least not at IBM.

Nick Donofrio, IBM server divisions' boss, cashed in for about $6.2 million-worth of the IBM stock on Nov. 25, according to the DJCOW. Most of his transactions were the "open market sales," implying that he simultaneously exercised the buying and selling of his stock options.

His trading was not reported in the IBM 1997 Proxy statement, so no data is available about the value he realized from the stock option trading. Nor were those of Thomas Bouchard, IBM's top human resources exec, John Joyce; the IBM controller, or of Paul Horn, the head of IBM's R&D division - the remaining members of the "Group of Seven." The three insiders sold about $2.4 million- , $717,000- and $26,000-worth of the IBM stock respectively by exercising their stock options.

When asked why he chose to exercise his stock options in 1996, Donofrio said that, "the rules have changed. IBM’s interpretation has also probably changed. I mean the stocks are worth something."

Donofrio added that he was "complying with all of IBM’s rules and regulations that tell me when I can and when I can’t buy and sell stock and the SEC's (rules)."

Asked in what respect did the IBM rules change, Donofrio replied: "I am not an expert here. But we were very rigorous about things like that in the past, suggesting very narrow windows as to when we (the insiders) could sell or buy" (the stock).

No wonder, therefore, that none of these insiders exercised their stock options in 1995 or before, when IBM was being run by people groomed by the conservative Watsons, who were concerned about perceptions of impropriety and the spirit of the law, not just the letter of the law.

So it looks as if Gerstner's administration has ushered a new era at Armonk - the Era of Greed, matching the spirit which rules Wall Street.

Bob Stephenson, the head of IBM's PC, Storage, Networking, Printing and Consumer divisions, sold about $4.6 million-worth of the IBM stock during the last two quarters - all in the first quarter 1997, according to the DJCOW report. In 1996, he realized a $5.2 million value by exercising stock options, according to IBM's Proxy Statement.

By contrast to these seven senior IBM executives, the two other officers listed in the IBM 1997 Proxy Statement, Lou Gerstner and Rick Thoman, realized "only" $3.5 million and $1.7 million of value from the stock options in 1996 - a relatively small amount of trading compared to their overall holdings. In Gerstner's case, the value of the exercisable and unexercisable stock options at the end of 1996 was $45 million and $36 million respectively. In Thoman's case, it was $4.0 and $6.6 million respectively.

One can conclude, therefore, that these two IBM executives at least believe in their own hype about the supposedly rosy IBM future. Unlike some other insiders, Gerstner and Thoman have mostly put their money where their mouths were.

How Some Insiders Took Advantage of IBM's Stock Hype

Following Lou Gerstner's and his IBM lieutenants' pitch to Wall Street analysts in early September, investors suddenly began "rediscovering" the Big Blue as an exciting stock to own. One after another, Wall Street analysts started raising their P/E (price/earnings) ratios, even though there was no corresponding increase in earnings. This, plus the multi-billion IBM stock buybacks ($1.9 billion in the fourth quarter of 1996 and $2.0 billion during the first quarter 1997), gave the IBM stock a strong upward push. As we have now learned, the "Group of Seven" IBM insiders took advantage of the opportunity to cash in on the Wall Street investors' gullibility.

The fact that all this was perfectly legal, as Donofrio, for example, pointed out, only illustrates how imperfect our financial laws and regulations are. If all this was within the rules, than we need some new rules; the rules which would protect the ordinary investors from abuses of their trust in our financial system.

For, there were SUBSTANTIAL real or perceived conflicts of interest at work in these transactions. For example, IBM, a company run by these insiders, was buying back its stock by the billions at the time the insiders were cashing in on their stock options. So it is conceivable that some the insiders' shares were sold to IBM.

That's like a homeowner "selling" himself portions of his property at inflated prices so as to allure other arms-length bidders to up the ante. And then bailing out when the price is high enough.

And that's "legal" on Wall Street? That's legal in America? Frankly, to us this looks like a scheme which might even do Charles Keating proud.

The stock buybacks are the second example of conflict of interest in IBM's case. After all, besides being a tremendous waste of capital, the stock buybacks are a scam on a par with a homeowner bidding against prospective buyers to raise the price of his/her property. Yet, IBM's Gerstner was even boastful about creating this "illusion of prosperity" (our term) at the IBM Annual Meeting in Dallas (see the Annex Bulletin 97-18, 4/29/97). And Wall Street applauded the move by pushing the IBM stock to its all-time high. Guess there is no such thing as a "conflict of interest" in a world ruled by Greed?

Consequently, how can Wall Street claim any more credibility than Las Vegas, if it sanctions such rip-offs of "ordinary" investors by corporate insiders?

Worse, how can Washington justify being the "government of the People for the People..." when it lets Wall Street take advantage of the People in such an odious way? Bring on the Albanian or Bulgarian politicians. At least they didn't pretend to be the "elites" as they siphoned off their countrymen's savings in pyramid schemes.

Maybe it's time Americans found out the same thing about our Wall Street "elites." That they are merely a more perfidious, pin-striped version of crooks.

Happy bargain hunting!

Bob Djurdjevic

P.S. In the interest of fairness and accuracy, it should be noted that Lautenbach, Stephenson and Bouchard, among other IBM executives, had also exercised significant quantities of IBM stock options in the first half of 1996, obviously at lower selling prices than in the last two calendar quarters. But cynics could see this as their having lost faith in Gerstner's long term plan even before the latest stock surge, which merely provided them the opportunity to top up their pots of gold.

Happy bargain hunting!

Bob Djurdjevic

Volume XIII, No. 97-22
May 27, 1997

Editor: Bob Djurdjevic
Published by Annex Research

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