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The Investment FAQ (part 18 of 20)

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Archive-name: investment-faq/general/part18
Version: $Id: part18,v 1.62 2005/01/05 12:40:47 lott Exp lott $
Compiler: Christopher Lott

See reader questions & answers on this topic! - Help others by sharing your knowledge
The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance.  This is a plain-text
version of The Investment FAQ, part 18 of 20.  The web site
always has the latest version, including in-line links. Please browse

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Neither the compiler of nor contributors to The Investment FAQ make
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provided to the user "as is".  Neither the compiler nor contributors
warrant that The Investment FAQ will be error free. Neither the
compiler nor contributors will be liable to any user or anyone else
for any inaccuracy, error or omission, regardless of cause, in The
Investment FAQ or for any damages (whether direct or indirect,
consequential, punitive or exemplary) resulting therefrom.  

Rules, regulations, laws, conditions, rates, and such information
discussed in this FAQ all change quite rapidly.  Information given
here was current at the time of writing but is almost guaranteed to be
out of date by the time you read it.  Mention of a product does not
constitute an endorsement. Answers to questions sometimes rely on
information given in other answers.  Readers outside the USA can reach
US-800 telephone numbers, for a charge, using a service such as MCI's
Call USA.  All prices are listed in US dollars unless otherwise
Please send comments and new submissions to the compiler.

--------------------Check for updates------------------

Subject: Trading - Direct Investing and DRIPs

Last-Revised: 24 Aug 2000
Contributed-By: John Levine (johnl at, Paul Randolph (paulr22
at juno dot com), Bob Grumbine (rgrumbin at, Cliff (cliff at, Thomas Price (tprice at, David
Sanderson (dws at, John Belt, Brett Kottmann (bkottmann at

DRIP stands for Dividend (sometimes Direct) Re-Investment Plan.  The
basic idea is that an investor can purchase shares of a company directly
from that company without paying any commission.  This is most commonly
done in a traditional DRIP by having all dividends paid on shares
immediately used to purchase more of the same shares (i.e., the
dividends are reinvested).  Most plans also allow the investor to
purchase additional shares directly from the company every quarter. 
Thus the two names for DRIP: Dividend/Direct Re-Investment Plan.  But
note the "re" in re-investment: most DRIPs do not provide a way for an
investor to buy the first share. 

DRIPs offer an easy, low-cost way for buying common stocks and
closed-end mutual funds.  DRIPs are also a great way to invest a small
amount each month (dollar-cost averaging).  Since most of us try to set
aside a little each month, this can work extraordinarily well.  Yet
another good use of a DRIP is to give a small amount of stock as a gift. 
You may not want to set up a brokerage account for your niece, but you
may want to give her 10 shares of Mattel.  A DRIP account (structured as
a UTMA, see the article elsewhere in the FAQ) helps a minor benefit from
stock ownership and lets someone make additional purchases relatively

When you sell shares that were acquired via a DRIP, your cost basis is
simply the sum of the amounts you invested plus your reinvested
dividends.  But because you have four small purchases per year, at
different prices, for as long as you own the stock, the actual
calculation of your cost basis can quickly become an accounting
nightmare.  A program like Quicken or Microsoft Money can make this a
lot easier for you.  (There's no reason the broker can't do it for you
since they have all the data, but no broker I know does.) Of course if
the DRIP is structured as a retirement account, a sale is not a taxable
event, and you don't need to calculate the cost basis.  That leads
nicely to the next caveat.  In order to participate in a DRIP inside an
IRA, the DRIP sponsor has to be willing to serve as IRA custodian.  Some
will, some won't.  That information is available in the DRIP prospectus,
from the company's IR department, or the transfer agent. 

Traditional DRIPs are available as company-sponsored plans and from
large brokerage houses.  These two arrangements are both similar and

Company-sponsored DRIP
     In this arrangement, once you have purchased at least one share,
     dividends paid on all holdings are used to buy new shares.  That
     first share must be registered in your name, not in street name.  A
     common feature is that you can make additional purchases each
     quarter at little or no additional cost (i.e., no commission or
     fees).  When you sell the shares, the company buys the shares back. 
     Note that a company-sponsored DRIP might be run by the company
     directly, or by a bank.  The latter arrangement tends to lead to
     fees that quickly become onerous for small investors (more later). 
     Many companies sponsor DRIPs; lists are available through NAIC and
     some brokerages. 
Brokerage-house DRIP
     In this arrangement, you pay a commission to buy the original
     shares in your brokerage account (even retirement accounts), and
     the brokerage buys new shares with the dividends paid by the stock
     at no additional charge.  Thus, your investment accumulates a
     little at a time with no commission.  When you sell the stock, they
     sell the full shares (for a commission) and give you cash in lieu
     for the fraction.  Many brokerage houses offer this arrangement
     today, including (just to name a couple) Charles Schwab and

Brokerage-house DRIP arrangements are pretty simple when compared to
company-sponsored DRIPs.  The remainder of this article focuses on
company-sponsored DRIPs. 

Once you've found a company with a DRIP, check out the plan terms. 
Usually the transfer agent or company's investor relations (IR)
department will send you a copy of the plan information (the company's
IR department may be more responsive).  Two transfer agents, American
Stock Transfer and Trust ( ) and Chase Mellon ( ) have extensive plan info available online. 
Although most of the information is available there, always verify any
details that are important to you with the transfer agent or IR
department before investing. 

Here is a partial list of the things to check in the terms and
conditions of a DRIP.  Some DRIPs are exactly and only that, a Dividend
Reinvestment Plan.  If you intend to send in additional investments,
make sure that the plan allows optional cash payments.  Also, some DRIPs
only accept contributions on a quarterly basis (when the dividend is
paid) or even annually or semi-annually.  Plans that allow optional
investments at least monthly are much more convenient.  Some DRIPs
charge you up to $5 (or more) per contribution.  If you are interested
in one of those companies, then you may do just as well with a discount
brokerage account at $8/trade.  Still, if you want to give stock to a
child or family member who doesn't have a brokerage account, paying
$5/purchase through a DRIP may not be a bad idea.  Finally, check
whether the company issues new shares for your contribution or buys on
the open market.  Issuing new shares dilutes shareholder value and is
therefore less appealing than buying on the open market. 

Let's say the terms and conditions seem fair, and you want to get
started.  So you need that first share and it must be registered in your
name.  Once the shares are bought and issued to you, you then have to
get enrolled on your own.  To purchase the first share at modest cost,
you have several options, as follows. 
   * If you have a brokerage account, you can just buy a few shares and
     have the certificate issued (shares have to be in your name, not
     held in street name in a brokerage account).  This may or may not
     be a low-cost approach.  At Fidelity, a limit purchase order costs
     you a $30 commission, and it's $15 to have a certificate issued. 
     If you have a Vanguard brokerage account, you can buy the stock for
     a $20 commission, then have them issue the certificate for free. 
     Several brokerage houses (A G Edwards and Dean Witter, for example)
     offer a special commission rate for purchases of single shares. 
   * Many clubs and other organizations will help you buy the first
     share for a very reasonable charge.  Naturally they all have web
     sites; a partial list appears at the bottom of this article. 
   * A handful of companies sell their stock directly to the public
     without requiring you to go through an exchange or broker even for
     the first share.  In that case, just get a copy of the form from
     the IR department or transfer agent and send in a check.  These
     companies are all exchange listed as well, and tend to be

Last but certainly not least, you may have asked yourself why all
companies don't sponsor direct investment plans.  The short answer is
that it costs them too much.  And now for the long answer.. 

Most companies, most of the time, aren't selling stock at all.  For one
thing, issuing new shares requires registration with the SEC, at least
of the shelf variety, and that definitely costs money.  Years ago, when
postage, supplies, and all the rest weren't so costly, a lot of
companies went ahead and did the necessary shelf registration for a
Dividend Reinvestment and Stock Purchase Plan, for the benefit of those
who already had at least a few shares registered in their own names, so
that those shareholders could increase their holdings over time.  A
DRIP/SPP is a company-sponsored benefit for the shareholders, pure and

In recent years, legal fees have skyrocketed, postage alone has gone to
33c for an envelope in which to send a statement of account which costs
a bunch more to print than it used to, and the clerks and accountants
needed to keep track of such a program have also gotten a lot more
expensive.  DRIP fees have gone up in existing DRIPs and there have been
very few companies actually setting up their own new DRIPs, most with
some kind of fee structure. 

Many of these are designed much more for the purpose of generating fees
for the several large banking institutions that run them than for the
purpose of facilitating really small investors' interest in acquiring
fixed dollar amounts of stock.  Let's face it, when they take $15 just
to open an account, insist on minimum investments in the mid-three to
low-four digit range, and then demand huge percentage fees every time a
dividend gets reinvested, a small investor gets a pretty bad deal. 
Always (always) check the plan terms to make sure that you can't do
better with a DRIP arrangement at a discount brokerage house. 

Here is a list of DRIP resources, including sources of information as
well as companies that will help you buy shares at very low cost. 
   *, a service of Netstock Direct, lets you make
     automatic periodic investments in over 4,000 companies and 68 Index
     shares for just $4 per transaction.  This is sometimes called
     dollar-based investing, because you set the dollar amount to be
     invested rather than the number of shares.  Like any other DRIP,
     you can own partial shares.  The company bundles the orders from
     members and makes bulk purchases once a week.  The commission to
     sell shares is $16 for market orders and $20 for limit orders.  The
     following "ShareBuilder" link will take you to their web site.  If
     you use the link and sign up with them, Chris Lott, the compiler of
     The Investment FAQ, will earn a small commission. (referral)
   * PortfolioBuilder lets you make unlimited automatic repeat purchases
     of over 550 stocks.  Your investments are made in dollar amounts,
     not shares, allowing for the purchase of fractional shares.  Fees
     are $150 annually (unlimited purchases that year), or $15 monthly
     (unlimited purchases that month), or just $3 for a single
   * First Share is a buying club that helps investors obtain a single
     share so they can participate in DRIPS.  The annual membership fee
     is $24.  Members receive a membership handbook containing
     information about direct investing, transferring shares and
     registration of shares.  For more information about First Share,
     call 800-683-0743, +1 719-783-2929, or visit their web site.
   * StockPower offers StockClick, a product that allows investors to
     enroll in a direct stock purchase plan, purchase and sell stock,
     and manage company stock online.
   * The Moneypaper offers lists of DRIPs, an enrollment service, and
     several publications.  You can buy their Guide to Dividend
     Reinvestment Plans, including a list of over one hundred companies
     that offer DRIP's ($9).  Call them at 800-388-9993 or visit their
     web site.
   * The Rothery Report from Norman Rothery includes a list of companies
     that offer DRIPs and SPPs, compiled from a variety of publications,
     with special emphasis on Canadian companies.
   * The DRIP Advisor provides information and advice on Dividend
     Reinvestment Programs.
   * Buying Stocks Without a Broker by Charles B.  Carlson
     This book lists 900 companies/closed end funds that offer DRIPS. 
     Included is a profile of the company and some plan specifics. 
     These are: if partial reinvestment of dividends are allowed,
     discounts on stock purchased with dividends, optional cash payment
     amount and frequency, fees, and approximate number of shareholders
     in the plan. 

--------------------Check for updates------------------

Subject: Trading - Electronically and via the Internet

Last-Revised: 8 Sep 1998
Chris Lott ( contact me )

Many brokerage houses offer an electronic communications path for
placing orders on the equities and options markets.  In the past many
services offered dial-up access, but with the Internet reaching ever
larger numbers of people, access today is primarily via the 'net and
secure HTTP connections.  Some of the services offer both, which can be
a big advantage if "www" translates into "world-wide wait" for you. 

The primary motivation for using one of these services is lowering
commissions.  Competition among the on-line brokerages has become
intense, and rates have dropped as low as $8 per trade.  The only caveat
is that many on-line brokerages require a significant cash balance, even
as much as $10,000, before you can place trades. 

Here's a few web resources with more information:
   * The Securities Industry Association offers a brochure for investors
     titled Online Investing Tips .  Although it has only about 5 short
     pages of information, the file is over 1Mb, and you will need a
     copy of the free Adobe Acrobat reader to view it.  It's available
     from this page:
   * The links page on the FAQ web site about trading has links to many
     brokerage houses.
   * If you'd like to compare the response times of the web brokers,
     visit Keynote Systems and look for the Keynote Web Watch of broker

--------------------Check for updates------------------

Subject: Trading - Free Ride Rules

Last-Revised: 12 Jul 1997
Contributed-By: Karl Denninger (karl at, Timothy M.  Steff (tim

When trading stocks, a "free ride" describes the case when you buy a
security at 10 and sell it a day later (or an hour later) at 12, without
having the free funds to cover the settlement of the trade at 10.  This
activity is prohibited by the exchanges (e.g., NYSE Rule 431 forbids
member organizations from allowing their customers to day-trade in cash
accounts).  If you trade in a cash account, you must be able to settle
the trade, even if you would take the profit from it in the same day. 


Buy 1000 XXX at $10 on 7/10
     Requires $10,000 free cash available to settle the trade. 
Sell 1000 XXX at $15 on 7/11
     It's a day later, and you will get $15,000 from the sale, but you
     still must be able to settle the original purchase without the
     proceeds of the sale for the first trade to be legit. 

The rule on free rides should in no way be interpreted as a prohibition
on "day trading" (i.e., trading very rapidly in and out of a stock). 
You can "day-trade" as much as you want, provided that you can settle
the trade.  The short answer is that you must use a margin account if
you want to day-trade. 

Being able to settle the trade means that you either have sufficient
cash in your account to pay for the shares, or sufficient reserve in
your margin account to cover the shares.  Note that equity trades settle
3 market days after execution.  Therefore, the window on short-term
trading is not one day but rather three; i.e., any close of a position
before settlement occurs would run into the same issue. 

If you use cash, note that in a cash account you can spend a dollar only
once.  That is to say if you start the day in cash, you can buy stock
and sell that stock -- and then are done trading for the day.  If you
start in stock you can sell it, spend the cash for another position,
sell that position and then you are done. 

If you use margin, keep in mind that your broker is allowed to delay the
credit for your sale until settlement if they so choose, keeping you
from using those funds for three days.  If they are a market-making firm
or are selling their order flow they will likely obstruct your intra-day
and short term trading since it cuts into their bottom line.  To
day-trade using a margin account, you need a broker that uses NYSE
day-trading rules for margin.  Chances are your broker will have no idea
what you are talking about if you ask about this. 

Unlike stocks, options settle the next day, which is both good and bad. 
Option trading basically requires that the funds be there before you
place the trade, unless you like wiring funds around (and paying for the
privilege of doing so). 

--------------------Check for updates------------------

Subject: Trading - By Insiders

Last-Revised: 20 Oct 1996
Contributed-By: John R.  Mashey (mash at

Insider trading refers to transactions in the securities of some company
executed by a company insider.  Although a company insider might
theoretically be anyone who knows material financial information about
the company before it becomes public, in practice, the list of company
insiders (on whom newspapers print information) is normally restricted
to a moderate-sized list of company officers and other senior
executives.  Smart companies normally warn all employees to be careful
when they trade, "just in case".  The U.S.  Securities and Exchange
Commission (SEC) has strict rules in place that dictate when company
insiders may execute transactions in their company's securities.  All
transactions that do not conform to these rules are, in general,
prosecutable offenses under US securities law. 

This article offers a primer on the rules that govern insider trading. 
It focuses on a common insider's mechanism, namely stock options.  While
I make no claim to be an expert on this, I was an officer for a few
years at a company that was private and went public, but that was in
1992, so a few rules may have changed since then. 

Newspapers and other sources publish data about trades executed by
insiders.  These sources include the following. 
   * publishes a column called "Insider Focus" that offers
     information about people's insider transactions:
   * The SEC
   * Thomson Market Edge In general, interpreting the data taken
solely from any of these sources is difficult.  To do a thorough job,
you need the last couple years of annual reports so you can read the
fine print about executive compensation, special loans, extra covenants
about non-sale of stock around IPO, merger, acquisitions, etc.  In fact,
the insider-trading sections of newspapers can be very misleading if you
don't know how to interpret them.  Here are some examples that show why. 

Insider purchases and sales are closely watched, for better or worse. 
If you see insiders buying a lot of stock on the open market, this might
be worth investigating as a BUY signal ...  although insiders are often
wrong.  Another example is insider sales.  If you see insiders in fairly
young companies selling stock, either by selling very cheap stock
they've had a while, or by same-day exercise of a stock option and
selling the resulting stock, this rarely means very much. 

The list of stock still owned strangely doesn't mean very much either. 
That is, sometimes readers get very excited if they see that Joe Blow,
CEO, has sold 10,000 shares and now owns 0.  What is not obvious from
the paper is whether our friend Joe has no options left, is cashing out,
and about to leave.  However, Joe might have vested options on a million
shares, and has thus sold 1% of his stock to buy a new house. 
Obviously, the imputed meanings are rather different

The timing of sales also means relatively little.  Silicon Valley
financial advisors tell people to sell some stock every year for tax
reasons.  (More on this later in this article.) Normally, there are at
most 4 times during a year when an insider can sell stock anyway, and it
is easy for other events to knock this down to 1-2, or even 0.  I've
heard of cases where people got stuck for 2 years post-IPO not being
able to sell any stock. 

Now it's time for some detailed explanations. 

If you are a founder of a company, or even an early employee, you will
likely get some stock options, or own stock at minuscule prices (i.e.,
like $.10/share on stock you hope will be worth at least $10 at IPO.) I
don't know how the rules are now, but they used to strongly encourage
actual purchase of some of that stock, at least 2 years in advance of a
potential IPO, in order to have stock that could get favorable capital
gains handling when sold 6 months after IPO.  [When a company is
founded, of course, no one has the foggiest clue of the likely increase
in value ...  although there are many hopes :-)]

When you get closer to IPO, stock option pricing gets closer to an IPO
price, which is usually adjusted via splits or reverse-splits to be in
the $10-$30 range. 

Many companies continue to grant stock options after IPO, although the
prices are of course much higher, which tends to force some different
strategies.  From tax-treatment, it is advantageous to spread this out,
as only a certain amount per year gets the favorable Incentive Stock
Option (ISO) treatment, any above gets a Non-Qualified Option treatment. 

Silicon Valley companies use stock options extensively, and usually,
broadly across employees, not just for executives.  [Which is why the
Valley went berserk with the proposed law that required charging the
bottom line for the "expected future value of stock options" :-) If
anyone can predict such a thing, they are really smart ...  but even
worse, it would have discouraged broad use of stock options, which would
have been truly sad.]

If you have been in a high-tech startup, or even fairly early in, it is
likely that much of your net worth exists in stock ownership and options
of that company.  It is far more complicated, and takes longer than
you'd expect, to get that money out without giving it to the IRS :-) [I
do first-in-first-out on option exercises ...  I'm still working on some
I got in 1985...]

It is especially difficult to get money out if you are an insider, given
SEC rules, tax laws such as alternate minimum taxes, and lawsuit issues. 
Company officers must be especially careful about lawsuit issues, and
should ask the lawyers about extra rules that aren't laws but offer some
insurance against lawsuits. 

Insiders usually do no trades in month 1 and month 3 of a quarter for
the following reasons.  (This leaves insiders just 4 months per year.)
During month 1, no trades are permitted until the quarterly report
appears, plus a few days for market to digest the results. 
Theoretically, by the beginning of month 3 you know how the quarter will
be.  This may be actually true in some businesses, but not others.  In
some parts of the computer business, an awful lot of business is booked
during month 3, and shipped in the last 2 weeks, so people quite often
have no idea at this time whether they'll make the numbers or not.  This
is especially true for high-end machines (like supercomputers, where
pure-supercomputer companies have occasionally had crazed fluctuations
because some $20M machine got held up a week).  Right now, the
government shutdown and its effects on buying and export licenses is a
bit strange.  Similar weirdnesses go on, for example, in some retail
businesses, where the Christmas season is crucial. 

Insiders should avoid trades when in possession of material information
that might affect the stock, and is not yet public, at least partly
because it might or might not happen.  For instance, somebody might be
negotiating a merger or some really major sale, and the lawyers will
tell you that you shouldn't trade then, to avoid lawsuits.  This may
knock out some of the 4 months, and may be difficult to predict a year
in advance; that is, it is personally dangerous to say: "I expect to
sell stock 9 months from now." Don't count on it. 

Insiders may make no trades when forbidden by covenants that are part of
IPOs or merger deals.  There is usually a minimum of a 6-month block
after an IPO, and probably 3 after a merger. 

I don't know if this rule is still around, but insiders do not usually
both buy and sell their stock in within the same 6 months.  I think the
rule has been mellowed to allow purchase of options and sell them off,
but there used to be a terrible trap where you (a) sold some stock (b)
then, slightly less than 6 months later, were reminded that you had
options expiring.  You exercised the options ...  and blam some computer
at SEC nails you for illegal trading.  [Years ago, advisors mentioned
some horror stories, whose details I forget, but whose import stuck.]

When considering the rules mentioned above, plus some other rules about
tax-treatment on pre-IPO stock options, the whole mess might be
paraphrased as: "You are in a maze of twisty little rules, all alike."
But in general, the rules (explicit and implicit) strongly discourage
insiders from trading (mixtures of buying and selling) their own stock
very often; since insiders usually have stock options, that means they
mostly sell. 

Finally, some executive employment contracts have some really
complicated agreements, often involving loans made the company to the
executive to buy stock (so they can buy it when they aren't allowed to
sell any to get the money to buy it with), but also placing restrictions
on buying or selling stock. 

Further complicating the picture for an ousider trying to interpret the
moves of insiders, financial advisors tell people that, no matter how
well they think the stock will do over the long run, they should sell
some % of what they have left every year.  They advise this for
diversification, so they have the cash available, and to spread it out
to lessen the effects of the alternative minimum tax.  We once had a
"class" in this, and the recommended percentage was 10%, but that was
years ago, and was not a hard rule, just a general idea. 

Unlike "regular" people, if an insider needs some money quickly, s/he
cannot call their broker and sell some stock in the company on the spur
of the moment.  In fact, they cannot even be guaranteed that a window of
opportunity to do so will necessarily be predictable.  It may be that
with the changes to stockholder lawsuit rules, this will get a little
more rational; as it has been, lawyers have recommended extreme paranoia
regarding lawsuits, for good reason.  (So, what insiders do is use
existing money, or quite often, borrow money with the options as
security ...  which has often caused people trouble later on.)

Now on to the mechanics of exercising options as an insider.  When you
exercise an option (i.e., purchase the stock), you can do one of two
things.  First, you might do a same-day exercise, that is, purchase the
stock and immediately sell it, keeping the difference, and of course,
incurring a normal tax liability on the difference between option price
and exercise price.  Non-qualified option treatment forces this.  Or,
you might purchase the stock and keep it for a year, then sell it, thus
getting more favorable capital-gains treatment (at least sometimes) on
any gain.  Of course, in doing so, you are subject to later price
fluctuations.  If you are an insider, note that you may not be allowed
to sell when you'd like to, as described above. 

So if the current stock price is $20, and you have 10,000 options, you
might go either route.  If your option price is $.10, you might buy
shares and hold them, i.e., spend $1000.  But if your option price is
$10 and you want to buy and hold the shares, then you need to come up
with $100,000.  The only way to get that might be to sell some shares
you already own.  If what you have is vested options, then you might
exercise some, and sell less, thus keeping some shares.  This gets
tricky, as you have to sell enough to cover the purchase, cover the tax
liabilities, AND get some actual cash out! I'll continue with the
example, assuming you want to buy and hold the shares.  You get $200K
(sell 10,000 shares @ $20), pay $100K (exercise the options @ $10),
leaving $100K.  Probably approximately 40% goes to IRS and (here)
California, leaving $60K in cash to actually do something with. 

Bottom line: founders often actually own lots of stock, sometimes so do
early employees.  But, for many insiders (and in fact, not just legal
insiders, but other officers and actually, any employees who have
significant stock positions and/or legal advice that restricts the
timing of sales), the natural state of affairs gets to be (as the
absolute cost of options goes up):

   * Have a bunch of vested options that account for a big chunk of
     one's net worth. 
   * Do same-day exercise once or twice a year. 
   * Actually own zero shares. 

And these are basically driven by SEC rules, legal advice, and tax laws,
not by short-term price fluctuations.  [Note: anyone in high-tech
investing who doesn't expect short-term stock price fluctuations ...  is
crazy :-)]. 

Thus, moderate sales by insiders ...  simply don't mean much.  It takes
work to know whether or not a sale is substantial.  For instance, an
executive may have an employment contract that includes an $X loan
(where I've heard of $X in the millions), where they moved to the area,
wanted to buy a nice house, and the deal is that within N months of
being allowed to exercise options, they are required (or encouraged by
interest on the loan) to do so.  This means that they'd better sell off
enough stock to cover the loan, and the taxes incurred from selling the
stock.  The only way to figure this stuff out is to backtrack through
the annual reports and read the fine print. 

OF COURSE, there have been cases where some insider sold a ton of stock
and should have known better...  but by-and-large, the pattern in young
high-tech companies is that insiders gradually sell over time to move
more of their net worth into more diversified holdings and be able to
enjoy it :-)

A slightly different pattern shows up in more-established companies
where stock options are not as widespread, insiders were not founders or
early employees.  Here, there are often key executives who do not have
large stock positions (either owned or vested options), and they may
decide their stock is undervalued and buy a bunch on the open market. 

You can get lists of reported insider trades at Barron's Online (free,
but registration is required).  Visit their site at

--------------------Check for updates------------------

Subject: Trading - Introducing Broker

Last-Revised: 31 Mar 1997
Contributed-By: Craig Harris

An Introducing Broker (IB) is a futures broker who delegates the work of
the floor operation, trade execution, accounting, etc.  to a Futures
Commission Merchant (FCM).  In this relationship, the FCM maintains the
floor operation and the IB maintains the relationship with retail
clients.  This is efficient because the work of a floor operation vs. 
the work of maintaining relationships and meeting the needs of retail
customers have different requirements. 

Another way to think of an IB is that of a segmented firm.  The IB is
not a middleman, but is in a partnership with the clearing firm.  The
clearing firm manages the floor and back office ops, and the IB is free
to concentrate on his/her customers and their trading. 

Several myths concerning IBs need debunking.  First of all, the notion
that an introducing broker is a "middleman" or that fees or commissions
are necessarily higher is wrong.  It's also wrong to say that an IB is a
branch office.  Yes, an IB may have branch offices, but an IB is not a
branch office of a FCM.  The IB is in a business partnership with an
FCM, each handling their own piece of the work. 

When it comes to ordering, if you are trading through an IB, it need not
be any less efficient than trading with a vertically oriented firm that
does everything.  When you call an IB with an order, s/he can relay that
order directly to the trading floor, or even give clients direct access
to the floor themselves.  If you call one of the big, vertically
integrated firms your order is likely to take as many or more steps than
it would with an IB. 

In terms of commissions, an IB may maintain a low overhead and that lets
him/her charge reasonable fees while maintaing a lot of support and
specialized service that a big discount firm simply can't provide. 
There's more to trading than commissions, although most novices don't
understand that. 

I would say that the bottom line in choosing a broker depends on several
   * The type of trading you do
   * The level of assistance and support you require
   * Your ability to watch the markets all day Pick someone you are
comfortable with.  Make sure you know who the clearing firm is.  Call
the NFA and ask about any complaints or the disciplinary history of the
firm.  Don't ever let yourself fall victim to a high pressure sales
pitch; that is in fact illegal.  There are a lot of brokers out there,
take your time and make sure that the one you choose is a good fit for
you.  There are plenty of good brokers out there. 

There is one wrinkle, however.  Your trades may experience price
improvement -- or may not -- depending on the large brokerage firm that
executes the trades you submit via your introducing broker.  See the
article on price improvement in this FAQ for more details. 

--------------------Check for updates------------------

Subject: Trading - Jargon and Terminology

Last-Revised: 23 Feb 2000
Contributed-By: Ed Krol (e-krol at, Brook F.  Duerr, Art
Kamlet (artkamlet at, Bob Grumbine (rgrumbin at, Chris
Lott ( contact me ), Arthur Gibbs, Jason Hsu

Some common jargon that you should understand about trading equities is
explained here briefly.  See other articles in the FAQ for more detailed
explanations on most of these terms. 

AON, "all or none"
     A buy or sell order with this designation loses normal order
     priority if the amount of shares available doesn't match or exceed
     the order size.  There may be some specialized circumstances where
     it could be useful, such as late in the day on a GTC entry (to
     avoid a fractional fill such as 100 shares of a 1000 share order,
     with resulting doubling of total commissions when the rest of the
     order fills the following morning). 
blue-chip stock
     A valuable stock that has proven itself; i.e., has been around for
     many years and has made piles of money.  Examples are IBM, GE,
     Ford, etc.  The name derives from the chips used in poker, blue
     always being the most valuable. 
bottom fishing
     Purchasing of stock declining in value, or of stocks that have
     suffered drastic declines in their prices. 
     Mutual fund companies give volume-based percentage discounts in the
     load fee charged to purchase shares.  A breakpoint is the level of
     investment, like $100,000, required to qualify for a discount. 
     The term was first used around 1622 to mean an agent in financial
     transactions.  Originally, it referred to wine retailers - those
     who broach (break) wine casks. 
call money rate
     Also called the broker loan rate, this is the interest rate that
     banks charge brokers to finance margin loans to investors.  The
     broker charges the investor the call money rate plus a service
     charge.  Investors who buy on margin will pay this rate. 
day order
     Order to buy/sell securities at a certain price that expires if not
     executed on the day it is placed. 
diluted shares
     A way of characterizing the number of outstanding shares that a
     publically held company could have.  The diluted shares measure is
     the sum of the company's normally outstanding shares, the shares
     that would be outstanding if every warrant & stock option were
     exercised, and the shares that would be outstanding if every
     security convertible into the stock (e.g., certain preferred
     shares) were converted.  This is sometimes used when computing
     earnings per share numbers.  A larger number of outstanding shares
     means lower earnings per share, rather obviously; this is known as
     "dilution of earnings" or computation of "fully diluted" earnings. 
DNR, "do not reduce"
     This is usually assumed unless you specify otherwise, but different
     brokers may have different practices and some may require you to
     specify DNR if you want it.  What it deals with is how the order is
     to be/not adjusted when dividends or other distributions occur. 
     For example a $1/share dividend on a stock for which you have
     entered an order DNR brings the price closer to your bid or takes
     it further away from your offer.  Without the DNR specification, on
     the ex-dividend date your order price is reduced by the amount of
     the distribution. 
elves index
     Louis Rukeyser's index of the opinions on the general stock market
     for the next 6 months.  He polls 10 analysts, the same ones every
     week, to ask what they think the general trend will be, namely
     bullish (+1), neutral (0), or bearish (-1).  The index range is -10
     to +10. 
FOK, "fill or kill"
     This means do it now if the stock is available in the crowd or from
     the specialist, otherwise kill the order altogether.  I never have
     found a situation to make use of that designation.. 
going long
     Buying and holding stock. 
going short
     Selling stock short, i.e., borrowing and selling stock you do not
     own with the intention of buying it later for less. 
GTC, "good till cancelled"
     Order to buy/sell securities at a certain price (a limit order);
     the limit order stays in the market until you call specifically to
     cancel it.  Some brokers restrict the length of time a GTC can
     remain open to "end of same month", "no more than 30 days" or some
     such thing, but with most it becomes a permanent part of the book
     until it gets executed or you cancel. 
MIT, "market if touched"
     Frequently used in the commodity futures pits.  I seem to recall it
     being available on exchange-traded stocks as well, but I've never
     been such a hotshot as to use the designation *as such*.  Instead,
     when I see serious overhead resistance at some point and have
     sufficient reason to want to unwind my position, I'll respond with
     a limit order below the resistance to close out my position. 
     Similarly, when I see serious support and want to get into a
     position, I'll respond with a limit order above the support to gain
     entry.  What I don't want to be doing is chasing the stock wildly
     (what market orders tend to do) just because some specific price
     got touched. 
MKT, "at the market"
     It doesn't matter how much you have to pay to buy nor how little
     you get on a sale, just do it now . 
overbought [oversold]
     Judgemental adjective describing a market or stock implying That
     people have been wildly buying [selling] it and that there is very
     little chance of it moving upward [downward] in the near term. 
     Usually it applies to movement momentum rather than what the
     security should cost. 
over valued, under valued, fairly valued
     Judgmental adjectives describing that a market or stock is
     over/under/fairly priced with respect to what people believe the
     security is really worth. 
     Uptick means the next trade is at a higher price than the previous
     trade.  Meaningful for the NYSE and AMEX; not so meaningful for OTC
     markets (NASDAQ).  Certain transactions can only be executed on an
     uptick (e.g., shorting). 
     Downtick means the next trade is at a lower price than the previous
     trade.  See uptick. 
plc  An abbreviation of Public Limited Corporation.  This means that the
     company is not American, where "Inc." is used instead.  PLC is used
     by companies in many different countries, including Great Britain,
     South Africa, Australia, Hong Kong, etc. 
     tender (v), to provide, to offer for delivery.  Frequently used as
     a short version of "tender offer," which is a public invitation
     extended to shareholders of a company by an organization that
     wishes to buy the company (i.e., a bid to take control of the
     company).  Following a tender offer, shareholders who have accepted
     the offer surrender ("tender") their shares in exchange for
treasury shares
     Shares taken from the company treasury (not the US Treasury!). 
     Often occurs in the context of discussions about how companies
     fulfill share purchases within DRIP accounts. 
     When an investment banker brings a company to market in an IPO. 
     The banker agrees to purchase so many shares of ABC corp at $XX per
     share, less fees, and will resell them to the public immediately. 
     However, the banker does not go it alone; just like an insurance
     company, the banker often seeks others to share risk.  The
     companies that participate are collectively termed the
     underwriters, since the job of the subsidiary investment bankers is
     to lessen the banker's exposure to the risk that he cannot sell all
     the shares he agreed to purchase.  The group is collectively
     referred to as the underwriting syndicate. 
For more definitions of terms, visit these on-line gloassaries of
investment and finance-related terms:
   * InvestorWords
   * The Washington Post's Business Glossary

--------------------Check for updates------------------

Subject: Trading - NASD Public Disclosure Hotline

Last-Revised: 15 Aug 1993
Contributed-By: vkochend at, yozzo at

The number for the NASD Public Disclosure Hotline is (800) 289-9999. 
They will send you information about cases in which a broker was found
guilty of violating the law. 

I believe that the information that the NASD provides has been enhanced
to include pending cases.  In the past, they could only mention cases in
which the security dealer was found guilty.  (Of course, "enhanced" is
in the eye of the beholder.)

--------------------Check for updates------------------

Subject: Trading - Buy and Sell Stock Without a Broker

Last-Revised: 27 Sep 1993
Contributed-By: Franklin Antonio, Henry Chan Desu (henryc at

Yes, you can buy/sell stock from/to a friend, relative or acquaintance
without going through a broker.  Call the company, talk to their
investor relations person, and ask who the Transfer Agent for the stock
is.  The Transfer Agent is the person who accomplishes the transfer,
i.e., by issuing new certificates with the buyer's name on them.  The
transfer agent is paid by the company to issue new certificates, and to
keep track of who owns the company's stock.  The name of the Transfer
Agent is probably printed on your stock certificates, but it might have
changed, so it is best to call and check. 

The back of the certificate contains a stock power, i.e., those words
that say you want the shares to be transferred.  Fill out the transferee
portion with the desired name, address, and tax id number to be
registered.  Sign the stock power exactly as the certificate is
registered: joint tenancy will require signatures from all the people
listed, stock that was issued in maiden name must be signed as such,
etc.  In addition to signing, you must get your signature(s) guaranteed. 
The signature guarantee is an obscure ritual.  It is similar to a notary
public, but different.  The people who can provide a signature guarantee
are banks and stock brokers who are members of an exchange.  Now, your
stock broker might not be too happy to see you and help you when you are
trying to avoid paying a commission, so I suggest you get the guarantee
from your bank.  It's very easy.  Someone at the bank checks your
signature card to see if your signature looks right and then applies a
little rubber stamp.  Also, if you have the time, have the transferee
fill out a W-9 form to avoid any TEFRA withholding.  W-9 forms are
available from any bank or broker. 

Then send it all to the transfer agent.  The agent will usually
recommend sending securities registered mail and insuring for 2% of the
total value.  For safety, many people send the endorsement in a separate
envelope from the stock certificate, rather than using the back of the
stock certificate (if you do this, include a note that says so.) SEC
regulations require transfer agents to comply with a 3 business day
turn-around time for 90% of the stock transfers received in good
standing.  In a few days, the buyer gets a stock certificate in the
mail.  Poof!

There is no law requiring you to use a broker to buy or sell stock,
except in certain very special circumstances, such as restricted stock,
or unregistered stock.  As long as the stock being sold has been
registered with the SEC (and all stock sold on the exchanges, NASDAQ,
etc.  has been registered by the company), then the public can buy and
sell it at will.  If you go out and create yourself a corporation
(Brooklyn Bridge Inc), do not register your stock with the SEC, and then
start selling stock in your company to a bunch of individuals,
advertising it, etc, then you can easily violate many SEC regulations
designed to protect the unsuspecting public.  But this is very different
than selling the ordinary registered stuff.  If you own stock in a
company that was issued prior to the time the company went public,
depending on a variety of conditions in the SEC regulations, that stock
may be restricted, and restricted stock requires some special procedures
when it is sold. 

In brief: I do not believe that the guy who offers on the net to sell
people 1 share of Disney stock is violating any rules.  Just for full
disclosure: I'm not a lawyer. 

--------------------Check for updates------------------

Subject: Trading - Non-Resident Aliens and US Exchanges

Last-Revised: 29 May 2002
Contributed-By: Chris Lott ( contact me ), Enzo Michelangeli (em at

It is perfectly legal for non-resident aliens to trade equities on
exchanges in the United States using US brokerage houses directly.  (A
"non-resident alien" (NRA) is the US government's name for a citizen of
a country other than the US who also lives outside the US.) The current
surge in availability of on-line brokerage services has effectively
eliminated the problems of different time zones and high telephone
charges, and has made it really easy for people living outside the US to
trade on US exchanges.  This route is generally far cheaper as compared
to using any bank or brokerage house in the foreign country, and
therefore very attractive to many people. 

Of course there are certain formalities concerning tax treatment of such
accounts, and these formalities must be clarified with the brokerage
house when the account is opened.  Individuals who are not US citizens
must complete a W-8 form, which is a certificate of foreign status, and
return it to the brokerage house. 

The specific rules of how these accounts are taxed are described in IRS
Publication 515 (Withholding of tax on non-resident aliens) and IRS
Publication 901 (Tax treaties).  The tax treaty is especially important. 
If the individual's country of residence has an agreement (tax treaty)
with the US government, those rules apply.  For example, residents of
Germany should not have any tax withheld on interest or capital gains,
only for dividend payments.  However, if the individual's country of
residence has no agreement with the US, then the individual should
complete the 1001 form (exemption form), and no tax will be withheld at

I'm fairly certain that US citizens and green-card holders living abroad
are not required to fill out either of these forms, since these
individuals are required to report their world-wide income to the US
annually.  And none of this applies to bona fide residents of the US,
regardless of citizenship, who are automatically subject to the US
taxation laws. 

To avoid overseas telephone charges, the internet brokerages are clearly
the most attractive option.  Most large brokerage firms accept foreign
clients, although some brokerage houses that offer trading via the
internet still require their customers to be US residents. 

The following brokers once accepted non-resident aliens as customers:
Ameritrade, Datek, NDB, J.B.  Oxford, and Schwab. 

Various instruments sold by the US Treasury are also available for
purchase by NRAs.  NRAs can buy, hold, and sell normal Treasury
instruments through the TreasuryDirect program, and will not be charged
any tax as long as they file a Form W-8BEN.  However, the NRA must first
get an individual tax identification number (ITIN) by submitting a Form
W-7, which is required for opening a TreasuryDirect account.  Second,
the account holder should really have an account at a US bank to allow
for direct payment of purchases and direct credit of interest and sales
proceeds.  Finally, note that US Savings Bonds are not available to

--------------------Check for updates------------------

Subject: Trading - Off Exchange

Last-Revised: 20 June 1999
Contributed-By: John Schott (jschott at

Anyone can trade stocks off the current set of stock exchanges, if only
on a person-to-person deal.  This is not a far cry from the original
trading under the Buttonwood tree in New York in the 18th century. 
Today, over 20% of the total volume on stocks traded on the NYSE and
NASDAQ exchanges occurs off the official exchanges.  However, the
dealing is often on the 'non-exchanges' (often called electronic
communication networks or ECNs).  INSTINET is perhaps the best known of
several ECNs now functioning.  Most of these operations are members-only
operations that function both during and after the normal exchange
hours.  All are electronic - that is, non-physical exchanges.  Almost
all are direct, in that there are no intermediaries such as specialists
and market makers as on the NYSE and NASDAQ, respectively.  So they
function much like two people meeting in a person-to-person deal.  One
sells, the other buys.  This sort of trade is efficient and economical
in that no intermediaries need to paid, but because there are no
intermediaries, there is much less liquididy than the traditional
exchanges where a third party can serve as a volume buffer.  Thus ECNs
are ideally suited for the large block, sophisticated trader who wants
efficient execution with a minimal distruption in the trade price that
would occurr with public trading. 

In todays internet world, several firms are planning to open such
off-exchange trading to the public.  Much of the focus is toward after
hours trading.  But once started, there is no limit to providing
24-hour, 7-day access.  Perspective particiants range from Schwab to new
startups.  The SEC promises that some of the organized off-exchange
operations can qualify as official exchanges.  It was recently reported
that Datek's Island ECN had filed with the SEC to be recognized as an
official exchange. 

One computerized system is even designed to provide total annomity:
neither the buyer or seller or the operator of the computer system knows
the identity of the two participants until after the system puts the two
in contact. 

--------------------Check for updates------------------

Subject: Trading - Opening Prices

Last-Revised: 26 Feb 1997
Contributed-By: Chris Lott ( contact me ), John Schott (jschott at

The previous day's close, as well as any after-hour trading in a
security may have significant effects on the opening price, but that
isn't the whole story.  Here's a quick summary of how the process for
determining the opening price works. 

The basic problem is that the closing price from the previous trading
day is no longer a valid indicator of a stock's perceived value.  News
may have appeared since the previous close, there may have been trading
on foreign exchanges that open before US domestic exchanges, and there
surely has been a flow of new and changed orders since the previous

On the NYSE and ASE, the specialist determines the opening price by
looking at his/her "book." The specialists are supposed to select the
one price that clears out the maximum number of orders; i.e.  by looking
at the buy and sell offers and choosing a single price will execute the
most orders (shares).  But it is possible that today's book contains no
orders from yesterday - or at least none that might affect the opening. 
So the specialist may have to make an educated guess to kick off initial

As a multi-market maker exchange, NASDAQ's computerized system opens
differently.  Market makers perform a two stage round-robin opening. 
First, each posts a single bid and asked price pair.  This price can
signal each firms view of the security, its current desire to buy or
sell, or it may indicate that a firm is out of calibration with others
in the market.  After all have seen the first round, each firm may
revise their postings once and trading starts as the executions flow to
"best" postings.  And off the day's trading goes. 

You may read about "gaps" in the opening price, or that trading in a
security began late.  This commonly happens when news that was released
after the previous market close impacts a security's price.  The opening
price in these cases differs sharply from the previous day's close,
either higher or lower.  For example, a company may release unexpectedly
good earnings early in the morning just before the market opening.  If
there is a potential price impact expected, the firm, its
specialist/market makers, or the exchange itself may delay the opening
to allow the news to reach as many people as possible before an opening
is made. 

An extreme example of what a specialist may have to deal with happened
in February 1997.  Mercury Finance (MFN) closed around 15 and opened the
next day near 1 1/2 due to extremely bad news overnight.  (I am ignoring
what might have happened in after hours trading - but that would have
some effect.) Some poor souls might not have heard the bad news and left
open their old buy or sell orders at 14-15.  The NYSE specialist could
potentially have opened the stock at $14, taken out those orders and
then done the next trades at 1 1/2 (or where-ever it did open: 1-3/8 or
1-5/8).  But looking at the books, he eventually decided on a delayed
opening, allowing people time to assess the news and adjust open and new
orders accordingly.  Once a pattern of orders emerged, the opening
occurred according to normal procedures.  An unrevised open buy order
from yesterday executed at todays far lower price...  An inattentive
market-price seller from yesterday would get today's sharply reduced
price, too. 

--------------------Check for updates------------------

Compilation Copyright (c) 2005 by Christopher Lott.

User Contributions:

Gerri Pisciotta
My employer accidentally advised the company handling the 401k investment that I had been terminated, when in fact I had not. As a result, withdrawals discontinued from my pay and I missed a couple years of contributions. Since I never withdrew from the plan, is my employer liable for making up these contributions? If I made a lump sum catchup contribution,could they do the same?
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Truly lots of awesome tips!
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