As DraftKings stock has cratered in recent months, a topic has been broached numerous times on social media.
But last week on the company’s 2021 fourth-quarter earnings call, DraftKings CEO Jason Robins fielded the question for the first time in a formal setting. Toward the end of the hour-long call, J.P. Morgan analyst Joe Greff had the temerity to put Robins on the spot.
JG: Most of my questions on the business have been asked and answered. But why aren’t insiders buying the stock? And will insiders buy the stock?
Perhaps catching Robins off-guard, the line notably went silent for a pause before the DraftKings CEO responded.
JR: We have had several insiders buy the stock … many members of our board.
JG: Outside of directors, I’m talking about inside executives.
While Robins provided a convincing response, his answer was still rife with complexity. Invoking an obscure regulation from the U.S. Securities and Exchange Commission, Robins emphasized that DraftKings insiders were limited in their buying power by the Section 16b rule, more commonly known as the short-swing profit rule.
Despite New York‘s record opening month of mobile sports betting for DraftKings and other sportsbook operators, stocks across the space remain near 52-week lows. After falling 20% last Friday on profitability concerns, DraftKings’ share price fell to a fresh 12-month low of $16.56 early this week.
Explaining the short-swing profit rule
The rule, which is part of Section 16(b) of the Securities Exchange Act of 1934, essentially prevents company insiders from using non-public material information to profit on any short-term gains in the company’s stock price. Under the rule, company insiders are required to return any profits to the company from the purchase and sale of company stock, if both transactions occur within a six-month period.
The rule applies to any company insider who owns more than 10% of a class of the company’s stock. For instance, if a C-level executive buys 100 company shares at $5 each, then sells the shares at $6, the executive would make a profit of $100. Instead of keeping the $100 profit for his own personal gain, the executive must return it to the company under the rule.
At first, a Twitter user believed that Robins conflated the regulations on profit taking with a separate rule from the IRS, known as the “wash-sale rule.” In that rule, if an investor sells a security at a loss, and then he or she repurchases it within a period of 30 days, the initial loss cannot be claimed for tax purposes. Robins, as well as several other DraftKings insiders, have exercised company options in recent months available to them through executive compensation plans.
“I think as long as there’s options to be exercised, that would probably be the first stop for most executives,” Robins said in response to Greff’s question. “But I can’t speak for everyone else. Also, as you know, there’s wash rules.”
Since the short-swing profit rule is often described within the context of larger wash rules, Robins cannot be faulted for the confusion. But shortly after the call, the Twitter user took exception with Robins’ response, while making reference to the IRS wash-sale rule. Robins responded soon after with a link to an Investopedia page on the short-swing profit rule to clarify any misconceptions.
He made up some rubbish that they couldnt buy because of the wash rule which doesnt add up as its a 30 day rule ..
— Dean Swift (@shearer991) February 18, 2022
Executive compensation programs
In 2000, the SEC established Rule 10b5-1, which allows company insiders to establish a plan to receive a predetermined number of shares at a certain time. On Feb. 22, Robins received a net of 5,850 shares of DraftKings Class A common stock in the form of restricted stock units, according to an SEC filing. Restricted stock units are a form of compensation given to employees through a vesting schedule.
On Aug. 11, 2020, Robins was granted 185,396 restricted stock units, vesting quarterly over a four-year period through 2024.
“Based on 10b5 programs that have not been active the last few months but were active within the six-month time frame, it’s not possible for executives to buy shares right now. But we can certainly exercise options and we have been,” Robins said on the call.
Over the period in question, the highest sale price of a security will be compared with the lowest sale price to determine if an insider has received a profit. Any shareholder can bring a lawsuit against the company to recover short-swing profits, according to Latham & Watkins LLP, a multinational law firm.
Following DraftKings’ Feb. 18 earnings’ call, Greff maintained a neutral rating on DraftKings while pointing to long-term profitability concerns, as well as the lack of insider buying from company executives. If there are indications that in-game betting will be well-received by new U.S. customers, DraftKings could accelerate its growth, Greff noted. On the other hand, if new states legalize at a slower pace than expected, it will reduce the present value of DraftKings’ cash flows, he indicated.
Based on stock prices last year, if DraftKings’ management purchased shares at current levels, wash rules could come into play, according to an industry analyst. There are also indications that when company insiders pay taxes on the vesting of restricted stock units, one top DraftKings executive views it as a way of buying stock, Sports Handle has learned.
DraftKings surged more than 11% on Thursday to close at $21.83 a share. The company is still down more than 65% from last March’s high of $74 a share.
Although DraftKings projects a full-year 2022 adjusted loss in the range of $825-$925 million, the company believes it can swing to profitability by the fourth quarter of 2023. Analysts are expected to receive further indications of DraftKings’ long-term strategy on March 3 at the company’s annual Investor Day presentation.