Billionaires Forced to Bail Out
The same kind of "deleveraging" that crippled credit markets also is slamming billionaires, chief executives, and other well-heeled investors where it hurts. After borrowing to buy stock, an unprecedented number of executives are being forced to sell off their holdings at steep discounts.
So far in October, almost $1.24 billion in stock has been sold by CEOs and other executives to cover debts, according to Ben Silverman, director of research at InsiderScore.com, which monitors SEC filings. Another $250 million in stock sales may also be related to so-called margin calls—when lenders force the sale of stock to cover debts.
Adding insult to injury, these stocks are being unloaded at what may be the worst possible time—when a typical equity has lost more than a third of its value this year.
The point was driven home on Tuesday, Oct. 21, when billionaire Kirk Kerkorian's Tracinda Corp. disclosed it sold off 7.3 million shares in Ford Motor (F) and may sell the rest of its stake in the automaker. Originally valued at almost $1 billion, Kerkorian's stake has lost more than two-thirds of its value as Ford's stock price has plummeted. It closed Tuesday at 2.17 a share, down 7% for the day. Though the exact reasons for Kerkorian's sale aren't clear, he had borrowed $600 million to buy the Ford stake and recently needed to use casino holdings to back that debt.
Kerkorian Has Plenty of Company
All in all, it's been a bad month for billionaires.
First Sumner Redstone, chairman of Viacom (VIAB) and CBS (CBS), sold $233 million in stock to help cover a loan. Then John Malone, chairman of Liberty Media (LCAPA), sold $49.5 million in stock to pay back a loan to Bank of America (BAC).
Chesapeake Energy (CHK) Chief Executive Aubrey McClendon may be the worst hit by this sort of stock squeeze. As Chesapeake's stock surged higher, the firm's enthusiastic founder borrowed to buy more and more shares. That worked until the middle of 2008: Since the beginning of July, Chesapeake shares have slid almost 65%. From Oct. 8-10, McClendon was forced to unload $569 million in his company's stock, or 94% of his stake in the firm, to cover those debts.
"The CEOs have been dreadfully surprised—just like the rest of the world," says Rawley Thomas of the Financial Management Association, an organization of financial professionals and academics.
Selling During a Free Fall
Indeed, several top corporate executives have dumped big portions of their company holdings, as identified by InsiderScore.com's Silverman, based on SEC filings that indicate these shares were sold to meet margin calls. Many of these sales occurred the week of Oct. 10, the worst week ever for the Dow Jones industrial average, which dropped 18.15%. Those include:
• Marvin Herb, a director at large bottling firm Coca-Cola Enterprises (CCE), who sold $17.7 million worth of shares Oct. 8-9.
• The co-founders of Boston Scientific (BSX), Peter Nicholas and John Abele, who sold off a combined $292 million in shares Oct. 8-17.
• Mark Grier, vice chairman of Prudential Financial (PRU), who sold off $1.75 million in shares on Oct. 10.
• Scholastic (SCHL) Chairman and CEO Richard Robinson, who sold shares valued at $3.1 million on Oct. 10.
• Tesoro (TSO) Chairman and Chief Executive Bruce Smith, who sold $2.2 million in shares on Oct. 10.
• Williams-Sonoma (WSM) Chairman and Chief Executive Howard Lester, who dropped $12.98 million in shares of his firm Oct. 13-14.
• XTO Energy (XTO) co-founder, Chairman and Chief Executive Bob Simpson, who sold off $101.3 million in his company's stock from Oct. 6-7.
Sales Were Almost All Involuntary
When executives sell off such big stakes, they often try to reassure investors that they haven't lost faith in the company. On Oct. 16, after Micki Hidayatallah, chairman and chief executive of Allis-Chalmers Energy (ALY), had to sell off 400,000 shares to cover a margin loan, he issued a statement: "My sale of shares in no way reflects my views of Allis-Chalmers' current financial position or future performance." Allis-Chalmers shares had lost half of their value in a month, forcing his sale.
These sales were almost entirely involuntary, says Silverman, caused by the steep drop in stock prices over the past month as well as the tightening of credit. The credit crunch has made lenders less willing to take risks on loans to even well-heeled executives. However, investors may wonder whether executives could have found other ways to come up with cash other than by selling stock.
"You would think one of the last things they would want to do is sell shares into [this] market," says Kurt Schacht, managing director of the CFA Institute Centre, which studies markets ethics and policy. "It shows you that CEOs are not immune from the pressures everyone else is feeling."
But Thomas, of the Financial Management Association, isn't surprised that CEOs ended up so heavily leveraged on the stock of their own company. It's a classic investor mistake of not diversifying enough. Also, as an executive, often "you're overconfident about the prospects of your own firm."
A Very Risky Spot
The use of debt to buy stock only adds to the risk that any investor takes on by not diversifying enough. When something goes wrong and a stock plummets, your losses can be magnified. "There is an extraordinary amount of risk in putting yourself in this situation," Thomas says.
There are basically two reasons why executives might get themselves in this situation. First, execs may borrow first, and then buy stock to boost their holdings in the company. In other cases, longtime executives—often the firm's founders—find much of their wealth tied up in the company's stock, so they raise cash by using the shares as collateral.
Investors often take it as a positive sign when SEC filings show executives buying their own company's shares, and penalize firms when insiders disclose they are selling. That's another reason—despite the dirt-cheap valuations—that few executives should want to sell at a time like this, when the stock market is extremely sensitive and investors are fearful.
Revisiting CEO Stock Holdings
Company boards also encourage executives to buy stock in the companies they run. Often boards require CEOs to have holdings totaling five times their annual salary, says Don Delves, an executive compensation expert and president of the Delves Group.
But the forced stock sales of the past month may cause some firms to reconsider these policies. "This is going to cause a rethinking of how much stock risk we want our CEOs to have," Delves says. In some cases, too much stock exposure may lead executives to make too many risky bets while leading the company. "What really is too much risk?" Delves asks.
Maybe more important for investors, there may be more forced stock sales to come—sales that can drive down share prices and further shake confidence in those companies.