Insider Trading: Does It Make You an Outsider?

Categories: Asset Manager Code of Professional Conduct, Insider Trading, Standards, Ethics & Regulations (SER)
Alexander Flatscher, CFA

Given our intense interest in high professional standards of conduct in the investment profession, we still find it disappointing when we come across the never-ending stream of news about market participants who do not behave according to the rules. That is because the market’s ability to sustain itself becomes questionable when participants don’t behave fairly. It is only when everyone in the market acts within the framework of rules and regulations — when there is integrity in the market — that it makes sense to participate. Without integrity, the honest may lose and the dishonest may win.

Just look at the problem of “front-running” in the Asia-Pacific region, which regulators in India are now trying to solve. Another important issue is insider trading which has also received increased media attention in Asia Pacific. This attention is both good, because regulators have continued to work against the resurgence of scandals, and bad, because this practice is still happening.

Readers of this blog certainly remember the news about leaked insider information on new share issues by employees of even the biggest Japanese security firms. This included information about listed companies such as Tokyo Electric Power, INPEX and Nippon Sheet Glass. There are cases when analyzing market price behavior based on readily available trading data suggests the possibility that insider trading has taken place. Nicholas Smith, a strategist at CLSA Asia-Pacific Markets who has written extensively on insider trading in Japan, estimated that share prices in 2011 typically fell for two weeks before a public issue, sharply lagging the rest of the stock market.

The Financial Services Agency (FSA, the main financial markets regulator in Japan), has not been passive about this development, and it is in the process of improving rules related to insider dealings (e.g., read publication of the report by the “Working Group on Insider Trading Regulations” of the Financial System Council). In an effort to regain investor confidence in Japan’s financial markets, the FSA is strengthening penalties for insider trading significantly as part of the reform plans.

Front-running and insider trading are just two examples of unethical behaviors that impact the integrity of the financial markets. Luckily, regulators are actively tackling related issues; this is welcome given the results of CFA Institute’s recent Global Market Sentiment Survey 2013, which confirmed that unethical behavior is a major concern for market participants.

Will improved regulations completely eliminate the practice of insider trading, front-running or other unethical behavior in the future? The answer is probably not. So, is it something that we have to live with? The answer again is no. As my colleague Bob Dannhauser, CFA, elaborated in his recent blog post, to the extent that the formal regulatory and legal systems are not wholly adequate to govern the conduct of those in the capital markets, self-regulatory initiatives and voluntary standards of conduct will inevitably be a feature of the investment management marketplace.

Thus, in the interest of financial market sustainability, CFA Institute recommends that institutions abide by a set of ethical principles—such as the CFA Institute Asset Manager Code of Professional Conduct. As a welcome by-product of internal commitment to an ethical culture, compliance with the Asset Manager Code of Professional Conduct is an effective signal to a firm’s clients of a firm’s commitment to high ethical standards. So far, more than 820 asset management firms globally have made this commitment and recognized the benefits, including offering asset owners a single uniform globally accepted standard of conduct by which to appraise managers. Even with increased local regulatory scrutiny of practices that compromise investor interests, investment managers in Asia Pacific should be taking the lead in adopting global best practices, even before regulation catches up.

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