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PairGain: Lots of Pain, Not Much Gain

After some very public mishaps, it's no wonder PairGain's stock is down. But with takeover rumors persisting, why are insiders selling?
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You can't help but feel for

PairGain Technologies

(PAIR)

, which suffered two highly publicized mishaps within the space of a month this past spring.

First, on April 15 an engineer at the telecom-equipment maker's Raleigh, N.C., plant was charged with posting on the Internet on April 7 a bogus news report touting a company takeout. By all accounts the plan was executed without PairGain's knowledge. And the perpetrator didn't even profit from the ensuing 30% price spike, although -- as he has since admitted -- it was his intention to do so.

Then, on May 19 the

Los Angeles Times

reported that a federal investigation had been launched into the roles of two of PairGain's top officers -- chairman Charles Strauch and chief financial officer Charles McBrayer -- in a 1995 investment loss of $15.8 million.

Capital Insight

, a Beverly Hills firm that managed the money for PairGain, lost a total of $100 million of its clients' funds -- including PairGain's $15.8 million. For the record, PairGain admits to no wrongdoing in the affair and accused Capital Insight of "substantial unauthorized trading activities." The

U.S. Attorney's Office

suggests the fiasco should have been disclosed in a more timely fashion.

With all the intrigue, how did the stock fare? Little surprise, the shares retreated straightaway on the news that the Internet report was a hoax. Since then, the stock has gone up and down.

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Now there are persistent rumors that PairGain is being shopped around. And with the help of some exceedingly kind words from an analyst at

SG Cowen

, the stock has managed a series of slightly less dramatic pops. Lately, though, it has shown signs of fading.

All the more surprising, then, that in April and May five prominent insiders together disposed of 189,000 shares of PairGain stock. Notable among the sellers: the company's chairman, chief technical officer and chief financial officer.

On the whole, it's a curious time for PairGain insiders to be selling. Rumors of takeouts and federal inquiries aside, it's never encouraging to find insiders selling stock at successively lower prices. Keep in mind, PairGain shares traded up to $31 in October 1997 and as high as $40 earlier that same year. What strikes us is that a number of the recent sellers had the good fortune of having sold at those higher prices. The take from the most recent sales: just $11 to $15.56 per share.

Indeed, the stock's performance in the past two years has been so woeful that to retain its key employees, the company has resorted to "repricing" many of its employee stock options. Under the newly approved plan, employees -- including ranking executives -- have been granted lower-priced replacements for outstanding stock options exercisable at higher -- and out-of-the-money -- prices.

Although many vehemently oppose repricing, the employee morale and retention issues stemming from incentive options that are deep under water are very real, and solutions have been hard to come by. Short of repricing the options, few remedies exist to stem the potential brain-drain of such a company's key employees. That said, arguments against repricing are compelling, especially those that cite the lowering-of-the-bar mentality the practice arguably rewards.

Which brings us back to the recent insider sales. Why are they coming now, just as analysts are raising their targets and upping their ratings? Officials at PairGain couldn't be reached for comment, so one can only speculate. In their defense, we should point out that PairGain insiders aren't strangers to the open market, and that company insiders have sold in the past -- some even into falling prices.

On the other hand, a number of insiders -- indeed, many of the very individuals who are selling now -- exercised options to

acquire

shares earlier this year. What's more, past sales have often been well timed: Clusters of PairGain executives sold stock in late 1997 before a 30% price decline, and they did so again in early 1998 before a 50% price drop.

Which makes investors wonder. Anything's possible, but it's been a long time since investors have profited from trading PairGain against the example set by the company's execs.

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.