Understanding

Insider Trading Policies

not for dummies

. The use of Insider Trading Policies to diminish the value of employees' equity compensation. In this presentation, I will explain why Apple Computer created an updated Insider Trading Policy in January 2012, which adds a prohibition against selling (writing) calls and buying puts, even when the trading of stock is allowed. The purpose of this prohibition is to deny the use of the only efficient method of reducing risks in holding concentrated positions in employee stock options. That prohibition therefore allows only the use of the highly inefficient method of reducing risk which is highly beneficial to the company and the Wealth Managers. That method is called "early exercise, sell stock and diversify" and when used will eliminate the main purpose of the ESO grant, which is to align the interests of the shareholders with the employees.

. Before going further let me state some un-deniable facts: 1. Apple's Employee Stock Plan and the Grant Agreements with the company do not prohibit selling covered calls or buying puts. Those agreements can not be changed without approval from the grantee/ employee if the change may diminish the value of the grants. 2. The prohibition in any Insider Trading Policy of selling calls and buying puts, when sales of stock are legal and allowed, has never and will never prevent a violation of SEC Rule 10b-5 or Section 16 b or c of the 1934 Act. This is true because if selling stock is legal and allowed, it is impossible to violate SEC Rule 10b-5 or Section 16 b or Section 16c of the 1934 Act by sales of calls or buys of puts. 3. Selling covered calls and/or buying covered puts while holding employee stock options or holding stock of the company, while reducing the alignment with shareholders, will preserve the remaining alignment longer than exercising the ESOs and selling the stock.

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4. The subsequent possible assignment of exercise notices to the employee writer of covered calls, can be eliminated completely by permitted purchases of such calls prior to exercise. If an exercise and assignment occurs, the assignment can not possibly cause a violation of SEC Rule 10b-5 or Section 16 b or c of the 1934 Act. Exercises of puts or calls owned by an employee has never and will never cause a violation of SEC Rule 10b-5 or of Section 16 b or 16 c of the 1934 Act. 5. Sales (writes) of covered calls and/or purchases of puts will reduce the risks of holding in-the-money employee stock options. It will avoid the need to forfeit the remaining "time value" back to the company and will delay the payment of early taxes when early exercises are made. This will delay the receipt of the forfeited "time value" by the company and delay the receipt of the much desired cash flows to the company in the form of tax credits and flows from the issuance and sales of new shares of company stock to the employee. In fact, if the employee efficiently manages the employee stock options, the employee stock options will never be exercised if the stock is below the exercise price immediately prior to expiration day. This will cause no forfeiture of "time value" and no flows to the company. It will also cause no Assets Under Management by the Wealth Managers.

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6. The sales of covered calls to reduce risk is less a bet against the stock of the company than early exercises of employee stock options followed by sales of stock and diversifying the net after tax proceeds. In fact the early exercise, sell and diversify strategy does not reduce market risk but essentially the early exerciser is betting that the company stock will under-perform the market. 7. The idea that selling covered calls to reduce risk allows short term speculation (or the appearance of short term speculation) on the company stock is non-sense. Exchange traded calls and puts have up to three years time to expiration and cause less appearance of speculation than sales of stock. 8. The officials of Apple Computer have the purpose to reduce the costs of equity compensation by adding trading restrictions that have no other purpose than to reduce costs and add benefits to the company and assist their allied Wealth Managers.

. In the introduction to a paper by Todd Henderson of the University of Chicago Law School, called Insider Trading and CEO Pay, we find the two following statements: "First, the evidence suggests executives whose trading freedom is increased experience reductions in other forms of pay to offset the potential gains from trading. This result is consistent with (and the flipside of) a study by Darren Roulstone, finding firms that restrict trading increase compensation to offset the lost opportunities from trading". and "Roulstone's data and result does not differenciate between two reasons for why trading freedom is valuable: the value of liquidity and the value of information asymmetry." The conclusion can not be clearer that when companies restrict the trading freedom of employees holding company equity in the form of employee stock options, restricted stock and unrestricted stock, those restrictions decrease the value of those equity holdings.

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So what is the real answer as to why some companies prohibit selling calls and buying puts by insertions into the Insider Trading Policies. The company officials either do not understand what they are doing or have motives beyond what is expressed in their documents. My view is that they are being advised by attorneys and so called experts who are deliberately misrepresenting the reasons for the prohibitions. The officials and the attorneys know that the object of such prohibition is to benefit the company and the Wealth Managers at the expense of the employees, thereby lowering the costs of the equity compensation of the grantee/employees' and getting Assets Under Management for the Wealth Managers.

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But the officials want to lower the equity compensation costs of the employees without appearing to violate the contract that exists between the grantee/employees and the company as outlined in the Stock Plan and the Grant Agreements. They also know that very few employees will challenge this violation of the contract because the violation has been obscured inside of the Insider Trading Policy and the employees fear that they will be retaliated against if they do. But there is a way to correct Apple's and others use of Insider Trading Policies designed to diminish the value of equity compensation grants. I will explain the remedy if you call me. John Olagues504-875-4825