By DAVID MOON, Moon Capital Management
February 13, 2005
It's no secret that the way to make money in stocks is to buy low and sell
high. If you can repeat the process, that's great. But if you're running the
company and you know more about what's going on with the business than the
shareholders to whom and from whom you're buying and selling, that's a
That's what a group of shareholders are alleging has been going on at a
Nashville-based insurance company, Direct General Corporation.
Direct General provides auto insurance to drivers who can't get coverage from
standard carriers. Its customers are folks whose cars inexplicably keep running
into other cars. Direct allows these customers in "must carry" states like
Tennessee to get an automobile policy, albeit with an extremely high deductible
- as much as $2,000.
In 2003 Florida required that deductibles on these policies be lowered to
$1,000 and that effective policy benefits be increased from $8,000 to $10,000.
Most people would assume that this would have some impact on Direct. Its claims
expenses were about to increase. Direct could have taken a special charge or set
aside increased reserves. It could have increased its premiums, but that would
hurt sales of new policies. Direct had gone public only a month earlier; this
was not a good time for bad news. So Direct executives did nothing. Well, that's
not exactly true. They said nothing. But they sold $105 million worth of stock -
and only after selling the stock did they set aside extra reserves.
Last January 26, 15 months after the Florida law was changed, Direct finally
increased its loss reserves to reflect the increased payouts on the claims
related to these Florida policies. On the day of the announcement, Direct shares
declined 34 percent. In the 15 months between the Florida law change and the
time the company finally accounted for it, Direct insiders were able to sell 3.4
million shares at an average price of $30.68 a share. The stock currently trades
Last November the chairman tried to reassure investors. When Direct announced
that the executive vice president, Tammy Adair, and her family had sold an
additional $11.8 million of stock, chairman William C. Adair Jr. (Tammy's
father) said he remained "committed to Direct'" Over the next month, however,
insiders sold another $2 million of Direct stock, all before the 34 percent
decline on January 26.
When the Florida law was changed in 2003, Direct had been a public company
for barely a month. A skeptic might surmise that the insiders wanted to sell
their newly liquid stock and they didn't want some little issue like a change in
the profitability of their business in their biggest market to impede their
ability to cash out.
Direct enjoys a special relationship with the Adair family. Actually, it is
the other way around. In the last several years, Direct or its subsidiaries paid
$2.7 million to Tammy Adair's law firm prior to her joining Direct, the company
purchased real estate from the Adair family, sold salvaged vehicles to Tammy's
husband, hired her step-daughter to do auto body work and paid her sister
$130,000 for janitorial services. Chairman Adair's wife, Jacqueline, is the
chief operating officer.
Lawsuits are already afoot, with the likelihood of more to come. Only five
days after announcing the increased reserves and torpedoing the stock price,
Direct announced a $20 million stock buyback plan. Buy low. Sell high. Repeat,
as often as possible.
On Wednesday, company executives said the need for the increased reserves
only became apparent within the last few weeks - more than a year after the
change in Florida law. Otherwise, they said the lawsuits were without
merit and declined further comment on issues raised in the litigation.
Prior to joining the family insurance business, Tammy Adair was a defense
attorney. Her experience may come in handy.
David Moon is president of Moon Capital Management, a
Knoxville-based investment management firm. This article
originally appeared in the News Sentinel (Knoxville, TN).