Related-Party Transactions: A Beginner's Red-Flag Checklist

Introduction

Related-party transactions are business deals between a company and people or entities that have a close relationship with the company, like executives, major shareholders, board members, or their family and companies they control. These transactions can be perfectly legitimate, but they also create opportunities for conflicts of interest and, in some cases, misuse of company resources.

Why should you care about related-party transactions when you evaluate a company? Because they affect transparency, governance, and ultimately the risk profile of your investment. Spotting red flags quickly helps you avoid companies where insiders are benefiting at the expense of outside shareholders.

In this article you will learn what related-party transactions are, where to find them in SEC filings, how to tell when they’re normal versus concerning, and a practical red-flag checklist you can apply in minutes. Ready to learn what to look for?

• Related-party transactions are deals between the company and insiders or entities with a close relationship to insiders.
• You'll find disclosures in the annual report, proxy statement, and Form 8-K, often under "Related Party Transactions" or "Transactions with Related Persons."
• Some related-party deals are routine and harmless, like executive loans with board approval. Others become red flags when they lack disclosure, involve high amounts, or follow weak approval processes.
• Use a short checklist: check disclosure location, transaction size, pricing fairness, approval process, frequency, and counterparty independence.
• Watch for patterns: repeated small questionable transactions may add up, and sudden increases in related-party activity often need deeper review.

What are related-party transactions?

Related-party transactions are any transfers of resources, services, or obligations between a company and a related person or entity. Related parties include executives, directors, principal shareholders, family members, and businesses they control. These deals can be sales, purchases, loans, leases, guarantees, or management services.

Not every related-party transaction is bad. For example, an executive renting a small office to the company at market rent can be fine. Problems arise when insiders gain undue advantage or when the company does not fully disclose the terms. The key questions are whether the deal is fair to the company and whether independent oversight existed.

Where related-party transactions appear in filings

Related-party disclosures show up in a few standard places in U.S. public-company filings. Knowing where to look saves time when you’re doing quick due diligence.

Annual Report on Form 10-K

The Form 10-K often includes a section called "Related Party Transactions" or similar language in the "Notes to the Financial Statements". The 10-K is a good starting point for historical patterns because it covers the full fiscal year.

Proxy Statement (DEF 14A)

The proxy statement is especially useful because it explains transactions that involve directors or executive officers and explains how those transactions were approved. If you want to know whether independent directors reviewed a deal, check the proxy.

Form 8-K and Other Filings

Material related-party deals may trigger Form 8-K disclosure when the company needs to tell investors about a significant event. Transactions can also appear in credit agreements and notes to the financials. Search filings for terms like "related party," "related person," "intercompany," and specific insider names to speed your search.

When related-party transactions are normal vs concerning

Some industries naturally have more related-party activity. Family-owned firms, conglomerates with many subsidiaries, and joint ventures often involve related parties. The presence of related-party transactions alone is not a reason to avoid a company.

You should get concerned when transactions have one or more of these features: poor or missing disclosure, large dollar amounts relative to company size, non-market pricing, lack of independent board approval, or patterns that benefit insiders consistently. Ask whether the deal favors the company or the insider.

Normal examples

• Reimbursements of reasonable expenses to a director for travel and lodging, fully documented and approved.
• A director-owned supplier that wins a competitive bid and provides market-rate goods or services, with independent approval and documentation.
• Loans to directors with market interest rates, collateral, and board oversight, disclosed in filings.

Concerning examples

• Large cash transfers to a company owned by an executive without board approval or a written contract.
• Below-market pricing on major sales that shift profit to a related entity.
• Repeated short-term contracts with the same insider-controlled vendor without competitive bids.

Red-Flag Checklist you can apply in minutes

Use this compact checklist when you open a company's filings. Each check takes a minute or two and lets you decide whether the related-party activity needs deeper review.

1. Locate the disclosure - Search the 10-K and proxy for "Related Party" or "Transactions with Related Persons." If you can’t find a clear disclosure, that’s an immediate red flag.
2. Check dollar amounts and scale - Compare the transaction size to total revenue or assets. Million-dollar deals in a $10 million company are much more material than in a $50 billion firm.
3. Assess pricing and terms - Look for statements about whether terms are market-based. If the filing doesn't say, ask why not. Unclear pricing is a concern.
4. Look for independent approvals - Good governance includes independent director review or a committee approval. If insiders approved their own deals, proceed cautiously.
5. Watch frequency and pattern - One-off transactions may be fine. Repeated deals with the same related party can indicate dependency or favoritism.
6. Search for conflicting roles - If a director or senior executive is on both sides of the deal, that’s a conflict that requires strong disclosure and independent oversight.
7. Check for post-period announcements - If material related-party deals are announced in an 8-K soon after year-end, verify whether they appeared in the prior 10-K or proxy. Late disclosure can be suspicious.
8. Scan auditor and legal notes - Read the notes to the financial statements for auditor language or legal contingencies related to these transactions. Auditor concern is a strong signal.

Real-world examples and how to read them

Concrete scenarios make this easier to apply. Below are practical examples you can map to the checklist. You'll see how to think through what you find.

Example 1: Hypothetical small-cap supplier deal

Imagine $SMPL, a small manufacturing company with $40 million in sales. The company reports a $3 million purchase from a supplier owned by the CEO’s brother. The disclosure says the transaction was negotiated at market rates but does not say whether bids were solicited or if independent directors approved it.

Quick checklist application: the amount is material for the company, disclosure lacks competitive-bid evidence, and independent approval is unclear. This should trigger a deeper look: seek prior years' disclosures, ask whether bids were solicited, and check the board committee minutes if available.

Example 2: Large conglomerate with normal related dealings

Consider $BIGC, a diversified conglomerate with $50 billion in revenue. A subsidiary leases office space from a company owned by a long-time director. The lease is market rate and was approved by an independent committee. The amount is small relative to the conglomerate’s scale.

Here the checklist points to a normal arrangement. The disclosure is transparent, the approval process is robust, and the dollar impact is immaterial to the parent company. You would treat this as routine unless you see a pattern of self-dealing.

Example 3: Public scandal where related-party activity mattered

In several high-profile cases, related-party transactions were central to allegations of fraud or mismanagement. One public example involved a company where insiders shifted revenue and contracts to entities they controlled, which contributed to misstated financials and investor losses.

The lesson is that related-party transactions can hide transfer pricing, circular sales, or off-balance arrangements. If you find opaque disclosures, reconcile them with revenue and cash flow trends to see whether the numbers match reality.

How to dig deeper if you find red flags

If the checklist raises concerns, take a few practical steps to learn more. Most of these can be done without industry expertise.

• Read prior-year filings to identify changes in related-party activity over time.
• Search news and regulatory databases for the insider names and the related entities to see prior relationships or litigation.
• Compare the reported pricing to market benchmarks when possible. For example, contract rates for common services or lease comps can provide context.
• Check the auditor’s report and any audit committee statements for mentions of related-party transactions or disagreements.

If you still have unanswered questions, note the company’s investor relations contact and consider asking a direct question. Public companies are obligated to answer investor queries in many jurisdictions, and the response or lack of it can be informative in itself.

Common Mistakes to Avoid

1. Assuming any related-party transaction is fraudulent - Not all related-party deals are harmful. Avoid throwing out companies for minor, well-documented arrangements. How to avoid: use the checklist to judge governance, scale, and disclosure.
2. Overlooking cumulative impact - Small transactions can add up. How to avoid: add related-party totals over several years and compare them to revenues and cash flow.
3. Ignoring approval process - Focusing only on dollar amounts misses whether independent directors or committees reviewed the deal. How to avoid: always check the proxy and relevant committee disclosures.
4. Relying on vague language - Phrases like "market terms" without supporting details can be meaningless. How to avoid: look for concrete terms, comparables, or evidence that competitive bids were sought.
5. Not checking post-period events - Material related-party activity can show up after fiscal year-end. How to avoid: check recent 8-Ks and news releases for timely disclosures.

FAQ

Q: How common are related-party transactions?

A: Very common. Many companies have at least some related-party transactions, especially family firms, conglomerates, and companies with complex ownership. The key is how those transactions are disclosed and governed.

Q: Can related-party transactions be approved by management?

A: They can be proposed by management, but best practice is for independent directors or an independent committee to review and approve material deals. Insider approval without independent oversight is a red flag.

Q: Should I avoid companies with any related-party deals?

A: Not necessarily. You should evaluate the nature, size, pricing, and approval of the deals. Many are routine and fair. Use the checklist to decide if the specific transactions merit concern.

Q: Where can I find more information if a filing is unclear?

A: Look at prior filings, the proxy statement, 8-Ks, auditor notes, and public news. You can also contact investor relations with specific questions. If disclosure remains vague, consider that lack of transparency is a valid concern.

Bottom Line

Related-party transactions are a normal part of corporate life, but they deserve your attention because they can reveal conflicts of interest, weak governance, or worse. With a few minutes and this red-flag checklist you can quickly separate routine arrangements from those that require deeper review.

Next steps: when you research a company, search the 10-K and proxy for related-party disclosures, compare amounts to company size, check for independent approvals, and watch for patterns over time. If the answers are unclear, dig into prior filings and public records, or reach out to investor relations.

At the end of the day, transparency and independent oversight are the best signals you can look for. Use this checklist regularly and you'll get better at spotting where insiders may be getting preferential treatment and where your attention is most needed.