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SEC Form 4 Explained for Beginners

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

With the increase of compensation for management in the way of stock options, tracking their movements can give you great insight into what management is thinking about the strength or weaknesses of the company.

A note of caution, not all insider buying or selling is a result of some action taken by management; it might also be that the manager needs to make a large payment like buying a home or paying 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 the Form 4 is not as well known but can provide valuable insights once you know where to look.

In today’s post, we will discuss:

  • What is an SEC Form 4
  • What Triggers a Form 4 Filing?
  • What Does Code M Mean on Form 4?
  • What Can We Learn from a Form 4 Filing?

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.”

What 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, it must be reported on the Form 4.

The buying or selling of the shares is often referred to as insider buying or selling. The reason this is a big deal is insiders have a real understanding of the internal goings-on inside the company, and they may have information that would allow 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 by some committee members that may have had information that would allow them to profit unfairly compared to those of us without that information.

The bottom line, the SEC Form 4, was created during the Great Depression to offer some protection against insiders of companies from unfairly profiting with the information they possess.

It is such a big deal that there are criminal fines and penalties for failing to report any such transactions, as evidenced by the scrutiny the congress members are currently facing.

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

What Triggers a Form 4 Filing?

The Form 4 is a two-page document that covers any buy or sell orders that management places on the open market, in addition to any exercising of stock options that we mentioned earlier.

Form 4s are required to be filed by any company or individual when there is a change in holdings of company insiders, i.e., CEO, CFO, COO, and so on.

The filing is related to Forms 3 and 5, both of which cover changes to any company holdings by insiders.

The SEC can use these documents, including the Form 4 as referrals to any other government agencies. If the document is not filed within two days of the transactions, there could be criminal charges or fines assessed.

The SEC uses the Form 4 in any investigations or litigations that involve any federal securities laws.

Form 4 is filed 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 be able to read the form and understand its meaning.

Let’s move onto the actual 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 they work let’s dive in and explore the actual form itself.

Click to zoom

First question, where do we find the 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 the 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.

  • 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 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 financial strength of the company.

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

In the table, you can see what kind of security is transacted. Examples that you might see include common stock, convertible preferred, employee stock options. The above are the most common ones you will see, but there can be up to 10,000 types of securities! Don’t worry; the majority 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, as well as the dollar amount these transactions occurred. They list them as acquired or disposed of, which translates to buy or sell.

The last section, which requires a bit of explanation, is the transaction code. On Form 4 from Netflix for Reed Hastings, you see two types of transaction codes listed, M and S.

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

A good starting point to understand the transaction codes and deciphering insider trading is to remember that P stands for purchase, and S stands for sale. Those are the most common codes you will encounter.

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

Derivative Security Transaction Codes

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

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

What to 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, who 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 any future prospects better than the leaders of the company?

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 of management multiple times throughout his Letters to Shareholders.

And what better way to evaluate management than studying their actions in regards to 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. The buying of shares is considered a bullish sign or a sign that they feel that the price of the company is going to rise in the short-term.

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

Studies have shown that being on top of insider transactions are profitable for investors, 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 is more than three times greater than the odds of a purchase followed by a sale.

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

  • Insider buying is 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, and so on. The only time this could be a red flag is if the whole management team is selling 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 would be a no brainer, and they are correct. However, don’t ignore transactions occurring farther down the food chain. Managers closer to the operations of the company buying shares would be 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 is a very bullish signal if you see a lower-level manager who owns 5000 shares triple his ownership to 15,000 shares that is incredibly bullish.

There are some general fundamentals that you should follow when tracking insider buying. The actions of management will speak volumes about the confidence in the company, and there is no better way to observe the behavior of the management team of your company than their stock ownership activity.

Fundamentals of Tracking Insider Buying:

  • The size of the trade is important. The dollar value of a buyer can be very significant. 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 transaction is important; buying is far more significant than selling shares. The sales of shares indicate a cash flow issue for the seller; they need cash for a large transaction, and liquidating their shares is easier than taking out a loan.
  • Pay attention to the number of insiders that are buying or selling; the best scenario is finding a situation that includes two or more insiders buying shares in a compressed period.
  • The price being 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 at what price it was sold; if the price is significantly different from the current price, then wait for more insider buying to confirm the behavior.
  • Insiders tend to be early in their transactions, especially when it comes to buying shares.

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

Where To Track Form 4 Transactions?

There are several websites that offer the ability to track insider activity of any company they are following:

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. There is a radial dial that allows you the opportunity to sign up for alerts to your feed for any company that 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 as well.

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.

There is a whole sector of the investment community that 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 too look and see if any insiders are currently buying shares or selling shares. Assessing management is difficult, especially without direct access. Using the 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.

As always, 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