Billionaires Forced to Bail Out

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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.

Steverman is a reporter for BusinessWeek's Investing channel.