Restoring Public Trust in the Market

The rhetoric is coming fast and furious from new SEC Chairman William Donaldson. Among other things, he recently said that the Securities and Exchange Commission "will demand responsible corporate governance throughout the business and financial world." President Bush has chimed in, too, saying, "We're committed to creating a climate of confidence in the markets."

By themselves, comments like these do nothing to change the pattern of shareholder abuse infecting the financial markets. Action is required. The mandate for the chairman is simple enough: Protect shareholders.

An obvious place for Donaldson to start is to restrict insider trading severely. He has already said that "we will hold accountable all those who have violated the public trust." But the public is going to struggle with the trust issue as long as corporate insiders can still sell their stock on the open market ahead of bad news.

As a turnaround investor who looks at down-and-out companies, I have seen insider selling before calamity all too often. I have detailed it in prior columns, with many instances of insider selling coming just a few weeks (in some cases, 20 days or less) before the revelation of bad news. This has happened at such companies as Tenet Healthcare (THC - commentary - Cramer's Take) and Michaels Stores (MIK - commentary - Cramer's Take), among others.

At each of these companies, let's assume that insiders didn't know that bad news was around the corner. I haven't seen any case law on the subject, but I would argue that corporate insiders, as part of their fiduciary duty to shareholders, have a "duty to inquire" before selling stock. They owe it to shareholders to ask the CEO and/or CFO whether serious issues that could affect the stock might be made public in the near future.

The SEC chairman could formalize this duty to inquire, making insiders sign off on a statement, prior to selling shares, that they've asked the CEO and/or CFO if any material negative developments on the immediate horizon may affect the company.

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Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor specializing in turnaround situations. At time of publication, neither Alsin nor ACM held a position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail]. Click here to receive Arne's latest favorite stock picks from his newsletter, The Turnaround Report.