Flipping ESPP Shares

Good economics but not a good idea.

One way to participate in your company's ESPP allows you to make a profit with hardly any risk at all. Some advisors recommend this practice, but I believe it's an abuse of the benefit.

Flipping

The approach is usually called flipping. You buy shares at a discount through the ESPP and sell them immediately after the purchase. Not all companies with ESPPs permit an immediate sale, but at most companies you can sell the shares a day after your purchase, or perhaps a few days later if there is a delay in transferring the shares into your account.

Many of these plans provide a discount, which can be as great as 15%. In addition, many plans have a "lookback" provision that allows the discount off the stock price at the beginning of the offering period if that price is lower than the price at the end of the offering period. That means you may be buying shares even more than 15% below their current value. Selling the shares immediately after the purchase — "flipping" the shares — locks in your profit, except in the extremely unusual situation where the stock price happens to fall more than 15% in the short period of time between your purchase and sale.

What's wrong with flipping?

If your employer doesn't prohibit flipping, and it's perfectly legal, why shouldn't you do it? The answer is that it's an abuse of the benefit provided by the ESPP. The plan is designed to provide an advantageous way for you to acquire stock in the company where you work. That's good for the company, because workers who own stock care more about how well the company performs, and as a result the workers perform better. More broadly, it's good for the economy when workers and companies perform better. Congress created special tax rules for these plans, and your company decided to adopt the plan, with a clear purpose in mind.

When you flip shares from an ESPP, you defeat that purpose. You never gained meaningful ownership of the shares. Except for the day or so between the purchase and the sale, you didn't care whether the stock price went up or down, because you would still end up buying the shares at a 15% discount (or whatever discount your company provides). The company provided the discount so you would own shares, and you responded by taking the discount without accepting the ownership.

As I said, there's no law against flipping. Most companies permit the practice because they don't want to interfere with decisions about how to manage your investments. Yet participating in the plan with no intention of holding the shares isn't a proper use of this benefit. If everyone at your company used this approach, there's a good chance the company would terminate the plan. And if workers at many companies overwhelmingly took this approach, there's a good chance Congress would do away with the tax provisions that make these plans possible.

What about stock options?

You may be aware that in many cases I recommend immediate sale of shares acquired by exercising stock options. That's different. Stock options are rarely issued at a discount. Furthermore, when you hold a stock option, you have an equity interest in the company even before you exercise the option. During the entire holding period, which is often four years or more, you care whether the stock price goes up or down. Stock options serve their purpose of making you care about (and profit from) changes in the stock price even if you sell the shares immediately after exercising the option. Selling shares immediately after exercising a stock option isn't an abuse because it doesn't defeat the purpose the company had in granting the stock option.

What's proper?

If flipping shares isn't proper, it's fair to ask how long you should hold ESPP shares before selling them. Here is what seems proper to me. You should be participating in the ESPP because you want to make an investment, and you should hold the shares for a period of time that is consistent with that purpose. How long would you hold shares if you bought them without a discount, through your broker? That depends on your investment philosophy, but if we're talking about genuine investing, not trading, the time period will certainly be measured in months or years.

You could run into some unexpected event that makes you bail out of the stock sooner. I don't see any problem there. To me, the issue boils down to a question of your intent at the time you chose to participate in the ESPP. If you went into it without any intention of holding the shares, you're a flipper. You may make a tidy profit from the practice, but you're abusing the plan in a way that may end up spoiling this benefit for the people who want to use it properly.