The CFO's call before the profit warning
On Tuesday at 10:15 the chief financial officer of a HK$22 billion retailer - a long-standing investment banking client - calls Ben, an institutional salesperson, to discuss a possible share placement later in the year. Mid-conversation the CFO says: 'Between us, the board decided yesterday that interim profit will be down 35%. We announce before the open next Monday. Keep this to yourself.' The stock closed at HK$41. Ben's firm published a Buy rating on the stock last week with a HK$48 target. At 11:00 a hedge fund client, Atlas, calls: 'We want to add two million shares - what's your view on the retailer?' At 14:00 Ben's father, who holds HK$600,000 of the stock, calls for a share tip. Ben has not traded and has told nobody.
1. Is the CFO's statement inside information, and what is Ben's legal position once he has heard it?
Read the worked answer
The definition. Under SFO sections 270 (civil) and 291 (criminal), inside information is information that is specific and precise, not generally available, and which, if generally available, would be likely to materially affect the price of the securities. All three limbs are met: the board resolved yesterday, the profit impact is quantified at 35%, the announcement is scheduled for Monday, and the HK$41 price has plainly not absorbed it.
Ben's position. He is now a person in possession of inside information, and that status does not depend on having sought it. Once in possession he must not: deal in the shares for himself, the firm or any account he manages; counsel or procure another person to deal; or communicate the information to anyone else.
The source does not cure the recipient. The CFO's call is itself a communication of inside information and is the CFO's exposure; it does not give Ben a licence to use the information. Nor does the firm's published Buy rating help. The rating now rests on stale information, but correcting it by selective whispers would itself be a disclosure, and the stock cannot be dealt while the firm is in possession.
What it is not. This is not 'market colour' or a vague rumour - it is a board decision with a quantified number and a timetable, which is the classic insider-dealing fact pattern in enforcement cases.
2. What should Ben say to Atlas at 11:00 and to his father at 14:00, and what should happen inside the firm?
Read the worked answer
Atlas, 11:00. Ben cannot convey or hint at the information. 'No comment' delivered oddly, 'I would hold off for a week', 'maybe wait for the results' or 'I can't talk about that stock' are all capable of being communications. The safe course is to decline to discuss that stock and end the conversation. He should also not accept an order from Atlas in the stock, because execution would be dealing while the firm is in possession of inside information.
His father, 14:00. Refuse, plainly. Family relationships are not a defence, and tipping relatives is one of the most commonly prosecuted routes.
Inside the firm, immediately after the 10:15 call. Ben should have reported to compliance. Compliance should: place the stock on the restricted list; stop all principal, employee and discretionary dealing in it; restrict knowledge on a need-to-know basis and keep an insider list; decide at firm level whether research coverage should be suspended or the report withdrawn - a decision that cannot be taken by a salesperson as a selective signal; and consider reporting the matter to the SFC, which licensed corporations are expected to do where they suspect market misconduct.
The placement team. He must not brief them either. The information arrived in a placement conversation, and the deal team's knowledge is a separate compliance question, not a reason to widen the circle.
3. If Ben had told Atlas and Atlas had sold its holding, what would each party face, and what defences would be available?
Read the worked answer
Ben would be exposed for communicating inside information and for counselling or procuring a dealing. Atlas and its responsible officers would be exposed for dealing while in possession. The firm would face supervisory-failure allegations if compliance knew, or ought to have known, and did nothing.
Criminal route (s.291). On conviction on indictment, up to 10 years' imprisonment and a fine of HK$10 million.
Civil route (s.270, Market Misconduct Tribunal). Disgorgement of profits gained or losses avoided; a fine up to the greater of HK$10 million or three times the profit gained or loss avoided; disqualification orders up to five years; a cold-shoulder order up to five years; and cease-and-desist orders.
Regulatory route. SFC disciplinary action against the licensed corporation and the individual - reprimand, fine, suspension or revocation - plus a fitness and properness finding that ends the individual's career in the industry.
Defences. There is no useful one. A Chinese wall does not help a person who actually possesses the information. 'The client asked me', 'I made no money', 'it was already in the market', 'I only told one person' and 'he would have found out anyway' are not defences. The only real protection is not dealing and not communicating, and escalating to compliance immediately.