In our Age of Communication, confidential information is more easily exposed than ever before. Real-time communication tools and social media give everyone with Internet access the ability to publicize information widely, and confidential information is always at risk of inadvertent or intentional exposure. The current cultural emphasis on transparency and disclosure—punctuated by headline news of high-profile leakers and whistleblowers, and exacerbated in the corporate context by aggressive activist shareholders and their director nominees—has contributed to an atmosphere in which sensitive corporate information is increasingly difficult to protect. There is limited statutory or case law to guide boards and directors in this area, and there exists a range of opinions among market participants and media commentators as to whether leaking information (other than illegal insider tipping) is problematic at all.
Posts Tagged ‘Inside information’
In my paper, Financial Conglomerates and Chinese Walls, which was recently made available on SSRN, I examine the effectiveness of Chinese walls, or information barriers, in preventing financial conglomerates from misusing non-public information in their trading and other activities. In recent years, empirical evidence has shown that financial conglomerates’ Chinese walls fail in important contexts, allowing firms to trade using non-public information they garner from their clients. Nevertheless, Chinese walls continue to have the legal effect of allowing financial conglomerates to discharge the otherwise incompatible client duties they owe under agency law. These incompatible duties arise due to the inflexible application of agency law and to financial conglomerates’ organizational structure, under which firms act for numerous clients across a broad and diverse range of financial activities, accumulating vast quantities of non-public information in doing so. As agents, firms are duty-bound to disclose material information in their possession to clients, and yet to do so is to breach duties of confidence owed to other clients. Chinese walls help financial conglomerates to reconcile their otherwise incompatible duties.
In my paper, Insider Trading in the Derivatives Markets, recently made available on SSRN, I argue that the prohibition against insider trading is becoming increasingly anachronistic in markets where derivatives like credit default swaps (CDS) trade. I demonstrate that the emergence of credit derivatives marks a profound development for the prohibition against insider trading, problematizing conventional theory and doctrine like never before. With the workability of current rules subject to question, this paper advocates for a rethinking of the present regulatory framework for one better suited to modern markets.
Lenders use CDS to trade the risk of the loans they make. And, when they engage in such trading, they are usually privy to vast reserves of confidential information on their borrowers. From a doctrinal perspective, CDS appear to subvert insider trading laws by their very design, insofar as lenders rely on what looks like insider information to transfer the risk of a loan to another institution. Fundamentally, insider trading rules prohibit trading based on information procured at an unfair advantage by those in a privileged relationship to a company. And, increasingly, insider trading laws are taking a fairly broad approach in preventing misuse of confidential information by those who acquire this information through their special access or through deception. For example, Rule 10b-5(2) can ground a claim for insider trading where someone trades on information obtained through a relationship of trust and confidence. In the CDS market, lenders usually buy and sell credit protection based, at least in part, on information they obtain in their relationship with the borrower, one ordinarily protected by restrictive confidentiality clauses. From the doctrinal viewpoint then, old laws and new CDS markets appear to exist in a state of serious tension. Put differently, either this thriving market is operating outside or at the margins of existing law—or the law itself has not adapted to the existence of these markets.
In our paper, Managerial Incentives and Management Forecast Precision, forthcoming in The Accounting Review, we focus on one important characteristic of management forecasts—forecast precision—and examine how managerial incentives affect the choice of forecast precision. We choose to focus on forecast precision (or specificity, as it is sometimes referred to in the literature) for two reasons. First, precision is one of the most important forecast characteristics over which managers have a great deal of discretion. Managers can issue qualitative or quantitative forecasts, and the latter may take the form of point forecasts, range forecasts, or open-ended forecasts. More than 80% of the quantitative forecasts compiled by Thomas Financial are in the range format (i.e., estimates with explicit upper and lower bounds), and there is a large degree of variation in forecast width (i.e., the difference between the upper and lower bounds). One might even argue that managers have greater discretion over the precision of their earnings forecasts than over whether to provide forecasts in the first place (Hirst et al. 2008). Managers cannot always withhold information because it is part of their fiduciary duty to update and correct previous disclosures. Furthermore, withholding information can lead to considerable litigation risks and can cause great damage to a manager’s reputation (Skinner 1994). Second, forecast precision has a significant effect on market reactions to management forecasts. A number of theoretical papers, such as Kim and Verrecchia (1991) and Subramanyam (1996), argue that the magnitude of the market reaction to a disclosure is positively related to its precision, and empirical studies examining the impact of management forecast precision on stock returns and analyst forecast revisions provide support for this argument (e.g., Baginski et al. 1993; Baginski et al. 2007).
Investors who hire political intelligence firms to collect information from government sources should take notice of the Stop Trading on Congressional Knowledge (STOCK) Act, according to panelists at a recent American Bar Association event. The panel, which included Stephen Cohen of the SEC’s Division of Enforcement, gathered in the wake of recent scandals and increased government scrutiny of the political intelligence industry—in particular, the SEC’s investigation of Height Securities, a political research and advisory firm. According to The Wall Street Journal, on April 1, 2013, Height Securities alerted investors to a government decision to reverse funding cuts to certain health-care companies before the agency formally announced its decision. In the 18 minutes before the markets closed, investors traded the suddenly promising health-care stocks, making exorbitant profits.
The STOCK Act
Under the STOCK Act, investors who rely on material, non-public information obtained through government channels can be liable under the federal securities laws for insider trading. Irrespective of the Act, insider-trading laws prohibit trading in securities while in possession of material non-public information obtained in breach of a fiduciary duty. The Act explicitly expanded insider-trading restrictions to members of Congress and legislative branch employees, and made clear that a government employee owes a duty to the United States with respect to material non-public information derived from his or her position.
How should firms communicate with the capital market in advance of corporate events? If firm insiders receive some private information that their firm may perform poorly in the near future, should they inform investors about this adverse information as soon as possible, or should they wait to release this information? Further, is the manner of communication by firms related to their performance in the short or the long run?
A concrete example of the above situation is that of a firm contemplating a dividend cut in the future. Firm insiders may have received some private information about a potential decline in future earnings, or that the current level of dividends is unsustainable for some other reasons (e.g., a change in the competitive environment requiring it to retain more cash within the firm). Under these circumstances, should insiders release a statement to the market that they are reviewing the firm’s dividend policy, and indicating that there is a possibility of a dividend cut (in other words, “prepare” the market)? Or should they wait till they in fact decide to cut their firm’s dividends before making any announcement?
While there have been several theoretical as well as empirical analyses of dividend signaling (see, e.g., Bhattacharya (1979), John and Williams (1985), and Miller and Rock (1985) for theoretical models), unfortunately, there has been no systematic empirical analysis so far in the literature that provides guidance to decision makers regarding the right way to communicate adverse private information to the equity market. The objective of this paper is to fill this gap in the literature by providing the first empirical analysis of a firm’s choice between preparing and not preparing the market before a dividend cut and the consequences of market preparation.
This article concentrates on conflict of interest, secrecy and insider information of corporate directors in a functional and comparative way. The main concepts are loans and credit to directors, self-dealing, competition with the company, corporate opportunities, wrongful profiting from position and remuneration. Prevention techniques, remedies and enforcement are also in the focus. The main jurisdictions dealt with are the European Union, Austria, France, Germany, Switzerland and the UK, but references to other countries are made where appropriate.
On September 27, 2012, the Staff of the SEC’s Office of Compliance Inspections and Examinations published a summary of examinations conducted by the SEC, the NYSE and FINRA of information barriers and practices of nineteen broker-dealers, including six of the largest broker-dealers. FINRA’s examinations included a review of the practices of smaller broker-dealers that focus on PIPE transactions. The review focused on the information walls and other systems in place to ensure compliance with regulatory requirements related to the handling of material nonpublic information, or MNPI. Mishandling of MNPI may result not only in exposure to regulatory charges, but also to civil liability and reputational damage. While the report does not constitute an order or finding by the SEC, it provides valuable insight into the Staff’s views, which will likely be reflected in future examination reports (and possibly enforcement actions) by the SEC, FINRA and the NYSE.
The report cites a number of specific concerns, including: informal and undocumented interaction between groups having MNPI and internal and external groups that have sales and trading responsibilities; senior executives designated as “above-the-wall” receiving MNPI without being subject to any monitoring or restrictions despite their managerial responsibilities for business units involved in sales and trading; the lack of a review process to evaluate trading that occurred after MNPI was provided to sales, trading or research personnel for business purposes; and gaps in oversight coverage.
On June 28, 2012, the European Court of Justice (“ECJ”) issued an important judgment that will have a significant impact on the disclosure of non-public, price-sensitive information (so-called “inside information”) by public companies listed on stock exchanges in the European Union (“EU”). The decision clarifies the definition of inside information in cases where the circumstances relevant to the disclosure develop over time, potentially involving several intermediate steps. The ruling is the latest in a string of court decisions concerning the spectacular departure of Daimler’s CEO in summer 2005 and the company’s allegedly late disclosure of this event.
The issue before the ECJ was whether Daimler had met its obligation to timely disclose inside information. Under EU and German law, each issuer of securities is obliged to disclose inside information if (i) the information is sufficiently precise, (ii) relates to circumstances which are not publicly known, (iii) relates to one or more issuers of securities (or the securities themselves) and (iv) the information would likely have a significant effect on the price of the securities if it became publicly known. Future circumstances may also constitute inside information if they are sufficiently likely to occur. Issuers can temporarily delay disclosure if certain conditions are met.