In my last article about how multi-baggers hide out in “easy money” places, I discussed five strategies microcap investors can add to their tool box.  Deep “in the trenches” microcap and nanocap investors are always looking for an information edge to exploit positive or negative information and to make money or protect portfolios.  One of these Information Arbitrage (“InfoArb”) tools is tracking buy and sell stock transactions disclosed in Form 4 filings (Form 4’s) by Management, Employees, Board of Directors or 10% Owners (MEBO).  I wrote this article for beginner investors, and for those who may still have a vague understanding of the overall layout of Form 4 filings, including related codes contained within them.

“The insider anomaly advantage has been estimated to be as much as 11 percentage points over the market return annually. The advantage tops out closer to seven percentage points, says Ian Dogan, founder of Insider Monkey, who wrote his doctoral dissertation on insider trading.”

Tracking Form 4 Filings

I monitor Form 4’s for several reasons:

  1. To see when insiders or large investors start loading the boat after shares have fallen hard
  2. To see if insiders start buying stock after a hit piece has been published
  3. To see if management is buying stock near new 52 week highs
  4. To find patterns that set a near-term bottom in a stock
  5. To see if insiders are selling as they glowingly talk about their company

Why do I consider the Form 4 as a type of InfoArb? The default view at SEC.gov that lists a company’s filings does not include Form 4’s. The example below is that of EVANS SUTHERLAND (OOTC:ESCC).

form 4 unfiltered

I even bet that some beginner microcap and nanocap investors may not even know that they can track Form 4’s. However, all you need to do is select “include” or “only” under the “Ownership” header to view Form 4 and other types of ownership filings.

form 4 filtered

I know it’s subtle, but any task that takes the slightest extra effort for can be your investing advantage. Luckily, there are some services that allow you to track Form 4 activity such as SECFilings.com, where you can track stock symbols for free (to a limit).  You can also set up an RSS feed from the SEC website that will send Form 4 filings to your email, free of charge. Or you can link to the RSS feed directly from the page that lists the Form 4 filings of a target company (see above).  However, you can’t really customize your searches.

We conveniently track the last handful of Form 4’s at GeoInvesting here, and are planning to address some of the shortcomings of different services that allow you to track Form 4 activity in the microcap universe.

It really irks me when a microcap management team does not have skin in the game as opposed to just “acquiring” shares through indirect methods with little cash outlay.  That’s why it’s important to learn how to read a Form 4 filing.

The Form 4

The Form 4 must be filed before the end of the second business day after the execution of a transaction resulting in a change in beneficial ownership. There are many transactions that can result in purchases by MEBO.  Some of these include “FREE” or below-the-current-price instances such as options, warrants, share based compensation and other indirect transactions.  Boiling it down to what it is important, we focus on the buys that took place directly in the open market where MEBO is taking on the same risk as any other market participant.

Below is an image of a Form 4 filed on January 27, 2017 by billionaire Peter Kellogg on microcap Evans & Sutherland (ESCC), highlighting two open market purchases made on January 25 and 26:

escc for 4 detail

The first thing to take note of is that Mr. Kellogg bought his shares through one of his companies, Bermuda Partners.  Still, “cold hard cash” was laid out to execute these two purchases at open market prices.   The “I” in column 6 signifies that the recent purchases were indirect (through Bermuda) and shows that he also owns 2.9 million shares acquired in his own name (“D”).  Column 5 shows how much a filer owns after each transaction.

We began to take notice of Mr. Kellogg’s purchase of shares on September 16, 2016 when the stock was trading at $0.83. Looking into it further, we saw that he already had a sizable ESCC position. Whenever we notice large blocks or high volume in ESCC, we speculate that “Peter is back in town.”

Next, notice that the filing is divided into two sections

  • Non-Derivative Table
  • Derivative Table

The non-derivative section is what you want to focus on when searching for bullish signals related to purchases by insiders at market prices. This is where it gets a little tricky, as you can’t automatically assume that a transaction outlined in this section did not originate from a derivative security.

For example, insiders often own stock options or warrants awarded to them by their company (approved by the Board). The initial grant of these derivatives is first recorded in the Derivative section of a Form 4.  But when/if insiders convert them (also referred to as exercise) into ownership of common stock at predetermined prices (usually below market prices and sometimes at zero), the transaction shows up in the Non-Derivative table. That is why it’s important to reference codes that are included in the filings.

form 4 non-derivative table

The Secret Codes

The codes are outlined here on page 6 so that you can determine if a purchase was or was not related to a derivative security reported on various transaction filings such as Form 3, Form 4 and Form 5. The direct purchase non-derivate codes you should be most interested in are “P” for buy and “S” for sale. Essentially, all other codes are mainly related to derivative instruments or other transactions that are not the result of meaningful “skin in the game” transactions.

As you can see, Peter Kellogg executed his purchase of ESCC shares indirectly through open market transactions as evidenced by the code “P” in column 3 next to the corresponding transaction (as opposed as “D” for disposed).  Leave it to the SEC to use similar letters for different codes.

Take another example of a stock we are long, GSE Systems (NYSE:GVP).

A constant flow of non-derivative direct market purchases by insiders confirmed by Form 4 analysis was a big reason we placed a bullish bet on microcap GVP at around $1.40 (even though shares appeared expensive at face value). Similar purchases have continued at prices over $3.00.   You can see our initial coverage on GVP here.

Insiders were also awarded performance based stock warrants that can be exercised in different tranches when shares reach certain predetermined levels. Some of these levels have been reached, which prompted insiders to exercise some of their warrants. Notice that even though the transaction is included in the Non-Derivative Table, the codes “M” and “F” show that it was

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