Views on improving the integrity of global capital markets
08 August 2013

Shades of Gray: SAC Capital Reignites Debate on What Is Insider Trading

Posted In: Insider Trading

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.

About the Author(s)
Glenn Doggett, CFA

Glenn Doggett, CFA, was a director of professional standards for CFA Institute. His responsibilities included providing member guidance in applying the ethics and standards of practice policies, supporting related educational and public awareness activities, and working with the Standards of Practice Council of CFA Institute on its initiatives. He was a co-host of the free, live, interactive webinars used by CFA Institute to promote ethical decision making and global best practices. Previously, Mr. Doggett, as a member of the CFA Institute Financial Reporting Policy Group, represented membership interests regarding reporting and disclosures initiatives, including XBRL. Prior to joining CFA Institute, he worked in the financial information sector with SNL Financial, where he focused on the real estate and energy industries, directing the development and maintenance of a financial data storage system. Mr. Doggett holds a BA in economics from the University of Virginia. He was awarded the CFA charter in 2006 and is a member of CFA Society Virginia.

2 thoughts on “Shades of Gray: SAC Capital Reignites Debate on What Is Insider Trading”

  1. Peter Jarvis says:

    This is a gray area indeed. That underlying talks were taking place earlier is no secret. Is trying to find out and discern whether they are being reopened – is that illegal?
    The courts will choose but when expert advice and expert views on upcoming business combinations becomes an illegal source of inquiry one must ask whether research is illegal.

    Alternatively if the information given by Aggarwal was illegally obtained and distributed is it really practical to charge those who come into possession of that information? Once information is broadly distributed (and 14 analysts is a pretty broad group as that information will travel quickly) is it realistic to pretend it’s not out there. As well is the resumption of negotiations necessarily material and not discernible?

    When BCE in Canada was put into play in late 2007 analysts staked out their offices to see who went in and out and identified when the surprise board meeting was called by the limos that arrived and their occupants. The stock spiked immediately but it was just the start of negotiations. Would that behaviour be seen as illegal behaviour?

  2. Glenn Doggett, CFA says:


    Thank you for your comment. There are differences between conducting thorough research and distributing material nonpublic information. The ability for analysts to conduct their research of companies to develop a mosaic basis for their recommendation is not in question.

    CFA Institute has and will continue to advocate for analysts to utilize all legitimate forms of information gathering available to them (e.g. expert networks, channel checking, monitoring activity outside a firm’s corporate office). Analysts should not be prevented from using this information just because others do not have it (or are not willing to get it) and the information is likely to impact the value of the firm.

    However, information that is material and nonpublic, provided directly from a source that is credible and who has a duty to not disclose the information, would not be considered acceptable to use in this mosaic. CFA Institute will vigorously advocate for strong rules and regulations to prevent such activity from being acceptable within the capital markets.

    When individuals and firms trade on information that is obtained, not through rigorous and thorough research, but through channels that violate duties to other parties, the overall confidence in the fairness of the markets is eroded.

    CFA Institute will not attempt to judge whether Aggarwal’s actions were in compliance with the current rules and regulations, as we can only comment on how such actions related to the Code and Standards required of all our members. We would expect all charterholders to know that the distribution of material nonpublic information in any format is not acceptable. In the future, we would hope that not only CFA charterholders, but all analysts would follow the ethical principles outlined in the Code and Standards as well.

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