SEC Form 4 Explained for Beginners

One of the best ways to track how management feels about the company they work for is to watch for insider buying or selling. Using Form 4 can help you determine any trades leadership makes regarding their stock options.

With the increase of pay for insiders (C-suite) in the way of stock options, tracking their moves can give you great insight into what insiders think about the strength or weaknesses of the company.

A note of warning: not all insider buying or selling is a result of some move taken by leadership; it might also be that the manager needs to use a large amount of cash to buy a home or pay for school for one of their kids.

Using Form 4 is not difficult once you know where to find them and how they read the report. Unlike the 10-k, 10-q, or 8-k, Form 4 remains not as well known but can provide valuable insights once you know where to look.

In today’s post, we will discuss:

Ok, let’s dive in.

What is the SEC Form 4?

From Investopedia:

SEC Form 4: Statement of Changes in Beneficial Ownership is a document that must be filed with the Securities and Exchange Commission (SEC) whenever there is a material change in the holdings of company insiders. Insiders consist of directors and officers of the company, as well as any shareholders, owning 10% or more of the company’s outstanding stock. The forms ask about the reporting person’s relationship to the company and about purchases and sales of such equity securities.

The filing of Form 4 relates to Sections 16(a) and 23(a) of the Securities Exchange Act of 1934, as well as Sections 30(h) and 38 of the Investment Company Act of 1940. Disclosure of information required on Form 4 is mandatory and becomes public record upon filing.”

All that tells us is that whenever the CEO, CFO, or any other manager that owns more than 10% of the company’s stock buys or sells any of their shares, they must report on the Form 4.

picture of financial analyst

The buying or selling of the shares refers to, most often, insider buying or selling. Insider buying or selling remains a big deal as insiders understand the internal goings-on inside the company. They may have information allowing them to take advantage of that information for their own profit.

Recently in congress, there has been an investigation into insider selling of stock before the Coronavirus outbreak. Some committee members may have had details allowing them to profit unfairly compared to those of us without the knowledge.

The SEC created Form 4 during the Great Depression to offer some safeguards against insiders of companies from unfairly profiting with the knowledge they possess.

It is such a big deal, criminal fines and penalties could result from failing to report any such transactions, as evidenced by the congress members’ scrutiny.

So what triggers the Form 4 filing? Let’s look at that in the next section.

What Triggers a Form 4 Filing?

Form 4 is a two-page report covering any buy or sell orders insiders place on the open market and any exercising of stock options we mentioned earlier.

Any individual or company must file a Form 4 when a change in holdings of company insiders occurs, i.e., CEO, CFO, COO, and so on.

The filing is related to Forms 3 and 5, which cover insider changes to any company holdings.

key takeaways of sec form 4

The SEC can use these documents, including Form 4, to refer to other government agencies. If investors don’t file within two days of the transactions, an assessment of criminal charges or fines could result.

The SEC uses Form 4 in any investigations or litigations involving federal securities laws.

Individuals or companies file a Form 4 on the SEC.gov website using the EDGAR system that we know and love from our studies of financial reports such as the 10-k. I won’t go into the nitty-gritty of filing a Form 4; for our purposes, it is more important to read the form and understand its meaning.

Let’s move on to Form 4 itself and discover what it can teach us.

What Does Code M Mean on Form 4?

Now that we understand what a Form 4 is and how it works, let’s explore the actual form itself.

First question, where do we find Form 4?

Good news! The exact same place you go to find the annual and quarterly reports on the EDGAR website through the SEC. Instead of looking for a 10-k, you type in a “4” and then hit search, and voila! One note you do need to change the radial dial in the middle of the page to include ownership, and then form 4 will pop up.

Now that we know where to find our form, let’s look a little closer at some of the more important sections of the Form 4.

example form 4 from Facebook
  • Section 1 – Name of the owner of the shares
  • Section 2 – Company name and ticker symbol
  • Section 3 – Date of transaction
  • Section 5 – Relationship of the owner to the Company
  • Table 1
    • Title of security, i.e., common stock
    • Transaction Date
    • Transaction Code – more on this in a moment
    • Amount of shares purchased or sold
    • A or D – means acquired or disposed
    • The price paid for the transaction of shares

Ok, let’s break those down a little.

The name is straightforward, as is the date of the transaction. One thing to note is the position held by the person buying or selling the shares. If you see the CFO buying shares constantly, that could mean he believes in the company’s financial strength.

Reed Hastings Form 4 from Netflix

The most important section of Form 4 is the table that outlines the buying or selling of the stocks.

In the table, you can see what kind of stocks he transacts. For example, you might see common stock, convertible preferred, and employee stock options. The above are the most common ones you will see, but there can be up to 10,000 types of equities! Don’t worry; the bulk you will encounter will be common stock, employee stock options, and preferred.

You will also notice that it lists the number of shares bought or sold and these trades’ dollar amounts. They list them as acquired or disposed of, which translates to buy or sell.

The last item, which we need to clarify, is the transaction code. On Form 4 from Netflix for Reed Hastings, you see two types of codes listed, M and S.

Every Form 4 filed contains filed transactions, and the form uses transaction codes to help describe the action taking place.

A good starting point for understanding the transaction codes and deciphering insider trading is remembering that P stands for purchase and S stands for sale. They equal the most common codes you will encounter.

Another code you will encounter is code M, which stands for the exercise or conversion of derivative securities. If that subject interests you, please click the link below for more detail on the derivative securities transaction codes

Derivative Security Transaction Codes

Looking closer at the Form 4 from Netflix, we can see that Reed Hastings sold shares of his stock during the time listed on the form other than exercising the derivatives.

What can we derive from that? That is a subject we will tackle next.

What Can We Learn From Reading a Form 4?

The legendary investor Peter Lynch of Fidelity Investments once said, “Insiders might sell their shares for any number of reasons, but they buy them for only one: they think the price will rise.”

Peter Lynch was a staunch believer in fundamental analysis and understanding the company and what it makes and sells completely before buying. He felt that as a group, who knows a company’s product, management, and future prospects better than the company’s leaders?

picture of dice displaying buy and hold

Investors can benefit from insider knowledge legally by following public databases that track insider buying or selling.

One of my focus points on my stock checklist is studying management, and Warren Buffett discusses his thoughts on management multiple times throughout his Letters to Shareholders.

And what better way to evaluate management than studying their actions regarding their ownership of the company they work for?

Many investors regard tracking insider trading as an integral part of their company analysis.

Why is buying or selling their shares a big deal?

Generally, insider buying illustrates management’s confidence in their company. Many consider insider buying a bullish sign or a sign that they feel that the company’s price will rise in the short term.

On the flip side, selling is considered a more bearish sign that management is offloading its shares before the company’s price falls.

Studies have shown that being on top of insider transactions represents profitable investments, as insiders tend to beat the market, as one would expect.

The studies have shown that the odds in favor of more insider buying following more insider buying remain three times greater than the odds of a purchase followed by a sale.

buy and sell stock graph

There are some general rules to follow when tracking insider trading:

  • Insider buying continues as far more significant than insider selling. As I mentioned earlier, insider selling could indicate the need for cash for larger purchases such as real estate, funding a college education, paying taxes, etc. We could only consider this a red flag if the whole management team sells large volumes of shares.
  • Who’s doing the buying of shares? Most of us would assume that following the chairman, chief financial officer, and vice presidents as a no-brainer, which corresponds to the right answer. However, don’t ignore transactions occurring farther down the food chain. Managers closer to the company’s operations buying shares equals a great vote of confidence.
  • Pay attention to the size of the purchase relative to the total holdings; those purchases speak volumes about the confidence in the company. When a CEO buys 250,000 shares when he already owns 500,000, that equals a very bullish signal; if you see a lower-level manager who owns 5000 shares triple his ownership to 15,000 shares, that equates to incredibly bullish.

The following examples illustrate general fundamentals that you should follow when tracking insider buying. The behavior of insiders will speak volumes about the trust in the company, and there remains no better way to observe the behavior of the leadership team of your company than their stock ownership behaviors.

Fundamentals of Tracking Insider Buying:

  • The size of the trade is important. The dollar value of a buyer equals emphasis. If Bill Gates buys a few shares, not that big of a deal, but if the regional vice president spends a year’s salary on purchasing shares, pay attention!
  • The type of dealing is important; buying exemplifies far more impact than selling shares. The sales of shares indicate a cash flow issue for the seller; they need cash for a large purchase, and liquidating their shares remains easier than taking out a loan.
  • Pay attention to the number of insiders buying or selling; the best scenario is finding a situation that includes two or more insiders buying shares in a compressed period.
  • The price paid for the transaction is important, as you would expect that insiders would buy when the price was low and sell when the price was high. Pay attention to when the transactions occurred and the selling price; if the price is significantly different from the current price, wait for more insider buying to confirm the behavior.
  • Insiders tend to be early in their transactions, especially when buying shares.

Ok, now we know how to read a Form 4 and have some general rules on tracking the transactions. Where do we find the data to follow these transactions?

Where Can We Track Form 4 Transactions?

Several websites offer the ability to track insider activity of any company:

All the above sites provide free access to search for different companies and their insider activity.

Another opportunity to track any financial forms filed by your company is to sign up for RSS alerts on the SEC.gov website. A radial dial allows you to sign up for alerts to your feed for any company you follow. As a side note, this is a great way to be aware of when your company files a 10-k, 10-q, or 8-k.

Final Thoughts

The Form 4 is a straightforward filing that allows the average investor to get insight into the stock transactions of the management of any public company that they are following.

Using the form to your advantage to find companies that management has confidence in enough to invest their own money back into the company is an extremely bullish signal.

A whole sector of the investment community tracks these transactions quite closely, and it is a major factor in their analysis of companies.

When I am looking at buying a company, one of the checkboxes I have on my list is to look and see if any insiders are currently buying shares or selling shares. Assessing management is difficult, especially without direct access. Using Form 4 gives a little insight into what the management thinks about the future prospects of its company.

That is going is going to wrap up our discussion on Form 4 today.

Thank you for taking the time out of your day to read this post. I hope you find some value that you can use on your investing journey.

If I can be of any further assistance, please don’t hesitate to reach out.

Until next time.

Take care and stay safe out there,

Dave

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