Charitable insider trading and backdated donations
It doesn't look good for our heroes:
Giving to charity has tax benefits. But some chief executives may be unfairly trying to increase the tax advantages in gifts to their family foundations.
That's the implication of research by David Yermack, a finance professor at New York University whose seminal research in 1997 helped unearth the option-backdating scandal nearly a decade later.
In a new study, Yermack finds that chief executives and chairmen of public companies have an uncanny ability to time large stock gifts to their own family foundations directly prior to big declines in share prices. For example, he found that four out of five stock gifts in the week before an earnings announcement were made right before a decline in the price of the stock.
Such gifts, which are exempt from insider-trading rules, typically come right after a run-up in a company's stock price and right before an abnormal 3 percent drop within the following 20 trading days. In comparison, other types of large charitable stock gifts—while also well-timed—come before a smaller 1 percent average drop in share prices.
Of course, the big question is how are these executives able to time their gifts so well?
Insider knowledge is one possibility. If executives know the company is about to release some bad news, they may legally gift stock at higher prices and in turn earn a higher tax benefit while still holding on to the voting power of the shares. That's because most family foundations are run by the executives themselves or close family members.
Evidence supporting this view is that 15 out of 18 donations made following earnings announcements came after the news was good.
Another explanation is that since stock gifts don't have to be reported for long periods after they have been made, executives may be backdating the donations.
This would require collusion on the part of both the foundation and the company. While there is no evidence that this has happened, it is also not difficult to imagine, given what emerged in the investigations into backdating.
A personal tax return claiming a charitable deduction based on backdated gifts "would likely represent tax fraud," says Yermack.
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