Insiders' Actions Tell the Tale at Investment Technology

The folks who run this electronic trading network have been persistently accumulating shares without any showboating.
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Electronic trading is hot. But although most of the market action is centered on Internet trading by Netheads, one electronic trading network for institutions is experiencing the kind of heavy insider buying that could signal the beginning of something bigger.

We're talking about the shares of

Investment Technology Group

(ITG)

, the creator of the POSIT electronic stock-crossing system, an automated transaction system used by pension plans, banks and trust companies to trade shares confidentially among themselves. In six daily "crossing" sessions, POSIT allows index funds and other program traders to execute large buy or sell lists at low cost, without revealing their identity.

Spun off from the

Jefferies Group

(JEF) - Get Report

-- which used to own more than 80% of the shares, now mostly divested -- Investment Technology shares have retreated from their highs as concerns have mounted about the company's exposure to both increasing competition and potential decreases in equity trading volume.

But if the Street is worried, someone forgot to tell the company's insiders. They've been accumulating shares in a very subtle but persistent fashion in recent months. And it's action we like: no showboating, not even through the open market, just via the kind of option exercising that implies they think the shares are heading higher. Specifically, from April 28 to June 25, eight insiders exercised options, retaining all of the underlying shares in the process.

Company CFO John MacDonald says all the options were of the nonqualified variety. Such options cause an insider to incur a personal income-tax liability -- for the difference between the exercise price and the stock's market price -- whether they sell the shares or not. In other words, the insider will have to pay taxes on that gain -- even if the stock subsequently sinks below the price on the date of exercise. Clearly, for the insider to take this risk, there must be good reason for holding onto the shares. And only the insider knows what that reason is.

It should come as no surprise that insiders tend to behave in this fashion when they feel their stock price has been oversold. In the case of ITG, insiders seem to have felt this way in late April when their shares were trading in the 36-to-37 range after having fallen from a near-term high of 45 1/2. At that time, seven of them exercised options -- all nonqualifieds -- totaling 451,886 shares.

Tempering our enthusiasm back then was the fact that their options were expiring. But the very fact that they were retaining all the shares -- an important factor -- should have offset our caution at the time. It didn't, and we failed to comment on the action. And within a month, the shares shot back up to 48.

Fortunately, a reprieve came in June. With the shares dropping again, insiders provided us with another clue: As the shares approached the 30 range, four insiders exercised nonqualified options once again, this time picking up 68,737 shares. The only difference was that this time none of the options faced the threat of near-term extinction.

There are a couple of reasons to like Investment Technology's prospects. Until now, the company's been known primarily for providing automated trading for passive managers such as index funds. But a recent joint venture with

Bloomberg

could provide the potential to execute trades for virtually all segments of the institutional market.

And there's more. According to a report issued by

Jefferies & Co.

analyst Charlotte Chamberlain -- who, given the company's lineage, should understand the business -- the company is not only trading at a 34% discount from its peer group, but also might make an attractive acquisition target for one of the big electronic information companies.

As always, we can never really know what insiders know; we can know only what they do. The clues from their actions are what guide us. In this case, their actions say loud and clear that Investment Technology shares are poised for a move.

Bob Gabele has been tracking and analyzing insider trading since 1978, most recently for First Call/Thomson Financial. This column is not meant as investment advice; it is instead meant to provide insight into the methods of insider trading. At time of publication, Gabele held no position in any of the companies discussed 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. Gabele appreciates your feedback at

rgabele@thestreet.com.