By Anil Arya, Brian Mittendor and Ram N.V. Ramanan
Elon Musk sent shockwaves through the business world for a series of stock sales during the closing weeks of 2021. He unloaded $16.4 billion in Tesla stock (https://reut.rs/3wMhbM5) during the course of two months. Unbeknownst to the public, he was also donating more than $5.7 billion in Tesla stock (https://on.mktw.net/3wQ3uvB) to charity during this time. Why did his sales make headlines while his enormous charitable gifts slipped under the radar?
The reason lies in securities rules that require corporate insiders to disclose sales of stock within two days (on Form 4), while gifts need only be disclosed on an annual basis (on Form 5). The result in Musk’s case is that the public did not learn of his Tesla stock donations until months after the fact.
This contrast in securities rules — immediate disclosure of insider sales but deferred disclosures of gifts — has recently come under scrutiny, culminating in a proposed rule change (https://bit.ly/3Grd6QU) by the Securities and Exchange Commission (SEC). The proposed change would require the speedier Form 4 disclosures for stock donations. Such a shift may be warranted to curb exploitative behavior by insiders, but it also would notably change the environment of giving by influential stockholders.
Why Stock Donations Matter
Though altruism is certainly at play, taxes can explain why giving frequently takes the form of stock instead of cash. The tax code has an added nudge for donating securities that have gone up in value. Not only is there a tax deduction for the price of donated stock, but the donor also gets to bypass recognizing taxable income for any built-up investment gains. The net effect has been a boon in stock giving.
As a prominent example, Fidelity Charitable reported in its 2021 Giving Report (https://bit.ly/3lOclrj) that publicly-traded securities accounted for 57% of the gifts they received. The emergence of tech stocks that have skyrocketed in value — while paying little or no dividends along the way — means there are a growing number of corporate insiders whose wealth has yet to be taxed. And much of this wealth won’t ever be taxed if they choose the donation option.
Risks Of Unregulated Insider Stock Gifts?
Since stock gifts have important financial implications for the donor, some of the same concerns with insider stock transactions arise with insider giving as well. If regulators worry insiders will sell stocks when they are overvalued, a related risk arises in the form of insiders claiming tax deductions when prices are at their peak. Recent academic research has confirmed this is more than a possibility, it is a reality.
A study published in Duke Law Journal (https://bit.ly/3ar4gXl) in 2021 shows that insider gifts tend to come after stock price run ups and precede stock price drops. That study adds to other strong evidence of strategically-timed insider gifts previously documented in University of Pennsylvania Journal of Business Law (https://bit.ly/3NzPPOU) and Journal of Financial Economics.
As the Journal of Financial Economics study also shows, the apparent tendency for insiders to time giving for maximum tax benefits is greatest with gifts to private foundations. As in other instances, gifts to public charities can bring market pressure. The rapid liquidation policies of many public charities can push down prices if donors seek to dump too much stock at once. However, with private foundations the donor typically controls the subsequent stock sale too, so such market discipline is absent.
Possible Effects Of The Proposed Rule
In light of the evidence insider gifts can reflect motives beyond altruism, the SEC’s proposed rule seeks to put a similar safeguard in place as with insider trades. Quick public disclosure of trades ensures the marketplace holds timely information about the behavior of influential stockholders. Applying these requirements to gifts may help restrain insiders tempted to secure tax deductions by donating before future price drops. Transparency can allow market pressures to rein in such behavior even with gifts to private foundations.
At the same time, efforts to curtail exploitation in insider giving may have notable ripple effects. Viewpoints of stock gifts seem to vacillate between the extremes of giving as purely virtuous or as them being no different than routine stock trading. If rules treat them as either extreme, they miss the distinct role of insider giving in both stock markets and philanthropy.
Recent research (https://bit.ly/3xo3uCf) we conducted examines an economic model of equity market to look at the net effects of insider giving. The research demonstrates that both trading and giving can risk insider exploitation, but insider giving promotes both greater stock market liquidity and more accurate stock prices than insider trading. The reason behind the difference is that donors and traders view the financial consequence of stock price differently. While a stock seller receives the market price for any stock sold, the price is material to a donor only to the extent it impacts the tax break they receive.
Insider donations also have the upside of promoting pro-social charitable activity, a feature not present with insider trades.
In short, treating giving and trading as equals means that insiders will be more reluctant to choose the more socially-beneficial of the two options.
Time will tell what posture the SEC ultimately takes on gifts of stock by corporate insiders. Whatever the outcome, one thing is clear: the SEC’s foray into insider giving may seem to be regulatory minutiae, but it will have serious implications both for stock markets and the philanthropy of corporate elites.
Anil Arya is the John J. Gerlach Chair of Accounting, The Ohio State University, Brian Mittendorf is the Fisher Designated Professor of Accounting, The Ohio State University, and, Ram N.V. Ramanan, Associate Professor of Accounting, Binghamton University.