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What makes it insider trading?
FORTY-TWO financial institutions in Singapore were fined S$16.8 million by the Monetary Authority of Singapore (MAS) over the 18 months between July 2017 and December 2018. They were penalised for market abuse (e.g. insider trading), misconduct in financial services (e.g. mis-selling or circumventing business conduct rules) and money laundering-related control breaches.
MAS announced these details in March in its inaugural enforcement report and said it would be releasing subsequent reports every 18 months. Other enforcement actions in the report include S$698,000 in civil penalties in relation to two insider trading cases and one unauthorised trading case. According to the report, as at end-2018, there were 14 outstanding insider trading cases under review and investigation. These form 38 per cent of market abuse cases with the others being false trading, deception or fraud and corporate disclosure violations.
As a professional body, CFA Society Singapore and our members abide by the strict standards and code of conduct issued by CFA Institute, which provides clear guidelines against various types of unethical behavior, including insider trading.
What is insider trading?
The CFA Institute Standards of Professional Conduct states that members and candidates who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information. Acting on such information is considered insider trading. Information is "material" if its disclosure is likely to have an impact on the price of a security or if reasonable investors would want to know the information before making an investment decision.
A good example of material information would be the performance of a listed entity like Singtel or Hyflux ahead of the announcement of its full-year financial results. This includes information on mergers, acquisitions, legal disputes, innovative products and change to senior management, among others.
Information is "nonpublic" until it has been disseminated or is available to the marketplace in general (as opposed to a select group). After a listed company posts its financial results online and accompanies this with a press release distributed widely or a filing on Singapore Exchange to the marketplace, then it is reasonable to expect that the general investing public has received the information, thus rendering the financial results from nonpublic to public information.
If listed entities brief stock analysts on the company's financial performance ahead of the public, the analysts are deemed to be in possession of material nonpublic information. They must not trade or cause others to act on this information before the financial performance information becomes public.
Consequences of insider trading
Trading or inducing others to trade on material nonpublic information erodes confidence in capital markets, institutions, and investment professionals, by supporting the idea that those with inside information and special access can take unfair advantage of the general investing public.
Although trading on inside information may lead to short-term profits, in the long run, individuals and the profession as a whole suffers from such trading. Investors eventually will shy away from the capital markets because they perceive such markets to be "rigged" in favour of the knowledgeable insider.
Thus, measures to protect and promote a high level of confidence in market integrity are critical for markets to remain healthy and to flourish.
Today's case is adapted from newswire reports and original filing of 'SEC vs. Peter Cho, Dec 2018'.
Peter Cho, an accountant in a fund management company, lives next door to his fiancée Annie Wang, an investment banker, with a global bank. In view of the close proximity, Annie cautioned Peter that her work involves numerous confidential material and advised Peter not to divulge what he may pick up from Annie's work to anyone.
During a weekend, Peter overheard an acquisition deal which Annie was working on. He decided to buy small quantities of the derivatives of the target stock instead of the stock of the target company. The profit from the transaction would help defray expenses of the impending marriage. Both the derivative and the stock did not come under the restricted list of Peter's employer; and Peter was not yet married to Annie. Peter went ahead with the purchase but to his disappointment the transaction netted him a loss instead.
Peter's actions are:
A: Acceptable as he bought the derivatives instead of the stock
B: Acceptable as long as he does not divulge the acquisition information to others
C: Acceptable only because he suffered a loss
D: Not acceptable as he is merely engaged to Annie
E: None of the above
The CFA Institute Standard states that members and candidates who possess material nonpublic information that could affect the value of an investment must not act or cause others to act on the information. Peter was clearly in possession of material nonpublic information when he overheard Annie's conversation. Although Peter bought the derivatives instead of the stock, he is deemed to have acted upon the information.
It is also a clear violation of the Standard by acting upon the information although he did not cause others to act upon the information by not divulging the information to others.
Furthermore, Peter is a professional in the financial services industry. It is reasonable to assume that he would have known that acting upon the acquisition information he overheard is considered insider trading which will compromise market integrity and erode public confidence in capital markets.
Although the transaction did not yield a profit, the loss Peter suffered is irrelevant. The intent was clear. He wanted to profit from the transaction. And he acted upon it.
Being engaged to or a total stranger to Annie is again irrelevant. Peter came into possession of nonpublic material information and should not have acted upon it. Annie could have exercised tighter control on communication to maintain confidentiality. A firewall could have been erected between her work and personal life at home or on a holiday. While her investment actions would no doubt have been subject to close pre- and post-trade monitoring, she could have put up her fiancée portfolio for scrutiny.
When Peter came into possession of material nonpublic information, he should have communicated this to designated supervisory and compliance personnel in his company. The same has to be done on Annie's part. Peter must not take investment action on the information or knowingly engage in any conduct that may induce others to privately disclose material nonpublic information. Choice E is the only fitting answer.
This column has been adapted from content by CFA Institute and is printed here with permission from CFA Institute.
- The writers are CFA charterholders who volunteer with the Singapore society on advocacy issues with a view towards promoting financial literacy among retail investors and improving overall standards and integrity in the industry.