A recent article in the New York Times DealBook provided additional insights into insider trading charges against Sandeep Aggarwal for his role in tipping off an SAC Capital Advisors portfolio manager. It raises the question of when potential “inside” information becomes known to the market through the distribution of that information by research analysts. For a CFA charterholder, the Code of Ethics & Standards of Professional Conduct is clear: no one can act or cause others to act on such information.
According to the article, Aggarwal provided information about negotiations for a strategic partnership between Microsoft and Yahoo expected to help bolster Yahoo’s earnings by $500 million. (His source was a friend at Microsoft.) Previously, Mr. Aggarwal had issued a report stating there was a 50% chance of the two firms reaching an agreement.
The guidance for Standard II(A) Material Nonpublic Information in the Standards of Practice Handbook acknowledges “mergers, acquisitions, tender offers, or joint ventures” as types of information likely to be considered material. The investing public would be interested in having information related to a Yahoo-Microsoft partnership because of the potential effects on profitability of both firms. A charterholder receiving such confidential information is prohibited from taking trading actions on either firm or issuing recommendations for others to take any actions.
But Aggarwal did just the opposite of keeping the information to himself. According to the DealBook article, “Mr. Aggarwal spoke to approximately 14 traders or portfolio managers at various hedge funds about the resumption of negotiations.” He even acknowledged that a “senior guy at Microsoft had provided detailed information about developments between Microsoft and Yahoo.”
Two factors to weigh when determining if confidential information would be considered material are the source and the specificity. In recognizing that the information came from a “senior guy at Microsoft,” the source is not in question. Regarding specificity, the information was precise as to the timing of a possible agreement. Given these factors, a CFA charterholder would not be allowed to disclose the information in the manner undertaken by Aggarwal.
The “gray area,” according to the article, relates to a prior legal proceeding, United States v. Contorinis, in which the United States Court of Appeals for the Second Circuit ruled that “information is also deemed public if it is known only by a few securities analysts or professional investors.” The court determined the information is no longer confidential when this information is known by the market and “investors rely on the market to quickly reflect all available information in the value of a company’s securities.”
This does not mean that those with inside information can avoid charges just by telling a lot of other investors. According to the DealBook article, “in Contorinis, the court noted that a tip that provides additional reliability to existing information about the status of a transaction based on the source’s access to inside information may be material because it lessens the risk from uncertainty.” This is in line with CFA Institute guidance to charterholders.
We will follow this case as it works its way through the legal system. Should it necessitate updates to the guidance in the Standards of Practice Handbook, proposed changes will be forwarded to our Standards of Practice Council for consideration. In the meantime, we encourage members, candidates, and other interested parties to review the changes currently under consideration for the upcoming 11th edition of the Handbook.