3.2) Integrity of Capital Markets II (A): Material non-public information Flashcards
What is standard 2?
II. Integrity of Capital Markets
What does sub-standard 2(A) material non-public information state?
- Those who possess material non-public information that could affect the value of an investment must not act or cause others to act on the information.
When is information material and non-public?
Info is material if its disclosure would affect the price of a security or if it would affect an investor’s investment decision.
Info is non-public until it has been made
available to the marketplace (not just industry insiders).
What does mosaic theory suggest?
Mosaic Theory states that reaching an investment conclusion through perceptive analysis of public information combined with non-material non-public info is not a violation of Standard II(A).
Hence, what issues does one consider when implementing material non-public information? (4)
Therefore, the issues to consider are the:
- substance and specificity of info
- reliability of the source
- strength of the link to the price of the security and
- time value of the info (material info may become non-material over time).
What are some examples of material non-public info?
- Examples of material non-public info: earnings; M&As; significant asset changes; patents & licences (new, rejected etc.); mgt changes; significant supplier and
customer changes; significant legal issues; financial position, cashflow issues etc
What are the recommendations for members to comply with material non-public information? (4)
- If info is material non-public, encourage source company to disseminate it widely.
If not possible, report to internal supervisory function and do not trade on it. - Do not knowingly induce company insiders to disclose material non-public info.
- Keep records of sources of info as proof and save all research.
- An influential analyst’s opinions may affect a security’s price but not being a full insider the analyst does not need to make reports etc. known to all.
What are the recommendations for firms to comply with material non-public information? (4)
- Monitor and limit proprietary trading while a firm is in possession of material nonpublic info. However, prohibiting all proprietary trading while a firm is in possession of this info may be inappropriate as it may send a signal to the market.
- Supervision of interdepartmental communication in multi-service companies (e.g. investment and corporate finance). Implement “Chinese walls” between relevant departments.
- Internal info barriers (“fire walls”) to ensure info only goes to those who need it.
- Companies should provide same info to all and not discriminate (e.g. exclude
analysts who have written bad reports on them in the past).
Example 13: Grant Phillips, the CFO of
Working Smart Ltd., is informed by the
company’s controlling shareholder,
Brilliant Investments, that it will accept a
tender offer for its shares in the company.
The tender offer is at a premium of 20%
to the current share price. Phillips
mentions this information to his friend Ian
Charters who in turn tells his father-inlaw, Thomas Banks. Banks likes to “play”
the stock market and immediately buys
R10,000 worth of Working Smart’s shares.
Who (if anybody) has violated Standard
II(A)?
Solution: This information is clearly
material and non-public. As an insider,
Phillips should not have told his friend.
Also, Banks should not have traded based
on his inside knowledge.
Example 14: Mr Hendricks, the husband
of the CFO of Quantam Holdings, tells his
friend Mr Ross that he is concerned about
his wife, who is experiencing high stress
levels because of serious cashflow
problems at work. Upon hearing about
this, Mr Ross immediately phones his
broker with instructions to sell his
R200,000 worth of shares in Quantam
Holdings. Has Standard II(A) been
violated?
Solution: Yes. This information is material
and non-public. Mr Ross is in breach of
Standard II(A). Even though he knew that
there was a major risk of him losing a
substantial amount of money if he
retained his shares, he should not have
traded based on material non-public
information.
Example 15: Prakesh Govender is an equity analyst at Manchester Asset
Management. Govender has conducted an in-depth study of the published
financial statements of the various players in the building material industry.
Having spoken to various building experts and visited several building material
stores, Govender draws the conclusion that Blue Wild’s new store concept will
give it a strong competitive advantage in the market. Based on this, he writes
a report for Manchester’s clients in which he rates Blue Wild a “Buy” and
predicts that its earnings in the coming year will be up by at least 20%. Is
Standard II(A) been violated?
Solution: No. Govender used material public information (published financial
statements), in combination with non-material non-public information
(industry expert opinions) to come to his conclusions. This is an application of
the Mosaic theory, which is allowed under Standard II(A).
Example 16: Helen Green is a junior analyst at Morgan Jones. During the
morning meeting at Morgan Jones, a senior fund manager, Zondo Mkhize,
announces that he will, over the next month, be buying a large amount of
GloGold Mining, a small cap stock, for the large balanced fund he manages.
Knowing that Mkhize’s buying is likely to push the price of GloGold up
substantially over time, Green phones her brother and suggests to him that he
should buy Glogold shares as soon as possible. Does Green’s phone call violate
Standard II(A)?
Solution: Yes. Green is causing somebody to trade on information that is nonpublic, but material, as it is likely to affect the share price or impact on the
rational investor’s investment decision.
