The Joint Venture Call and the Pension Fund Order
On Tuesday at 10:40 a.m., the CFO of a listed mining company-a long-standing client-calls his salesman: 'We sign a joint venture with a Chinese state buyer on Friday. Keep this to yourself, but you should position your clients before the disclosure.' The salesman runs a discretionary model portfolio. At 11:00 he buys 200,000 shares for the model portfolio and, at 11:05, buys 30,000 shares in his wife's account. At 11:15 the institutional desk receives a 1.5 million-share buy order from a pension fund. Expecting the order to move the price, the salesman buys 20,000 shares for his own account at 11:18 and only enters the pension fund order at 11:25. The joint venture is disclosed on Monday before the open, and the stock opens 18% higher. Compliance later sees the personal-account trades and the order timestamps.
1. Separate the salesman's conduct into distinct violations, identify the elements of each, and state the SRC provisions most likely engaged.
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1. Insider trading. Elements: the CFO is an insider with material, non-public information-the joint venture-obtained by virtue of office; the salesman is a tippee who knew or should have known it was confidential; he traded before disclosure, for the model portfolio and for a related account. SRC Sec. 23 prohibits insiders and tippees from trading or tipping on material non-public information. Materiality is shown by the 18% opening move: a reasonable investor would consider the deal important. The wife's account is a related account; failure to pre-clear compounds the breach.
2. Front-running. Trading ahead of the pension fund's 1.5 million-share order to profit from its expected price impact. No issuer information is needed; the wrong is breach of the duty of loyalty and fair dealing to the client and the firm. SRC Sec. 24 (manipulative or fraudulent devices) and Sec. 26, plus PSE fair-dealing rules, are engaged. 'Front-running' is a label, not a separate statutory offence. Entering the pension order only after his own trade is the core proof.
3. Personal-account dealing. Both personal purchases breached pre-clearance and holding rules. The model-portfolio trade may also exceed the discretionary mandate if the stock was outside it.
2. What should the firm have had in place, and what should it do now with the client relationship, the trades and the records?
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Prevention. A restricted list naming the mining company as soon as the CFO call was received; mandatory internal reporting of non-public information; information barriers between the relationship side and the desk; pre-clearance and holding periods for personal and related accounts; order-timestamp surveillance; and a rule that client orders are entered immediately on receipt.
Now. Preserve telephone recordings, chat logs, order tickets and personal-account statements. Suspend the salesman's personal trading and client contact pending investigation. Prevent him from contacting the CFO to 'fix' the story. Consider rescinding the personal trades, disgorging profits, and reporting to the SEC and the PSE. Assess whether the pension fund's order was disadvantaged and remediate if so, without disclosing other clients' information.
The CFO client. Internally restrict the stock and escalate. The firm may need to cease dealing for that client and, if appropriate, report the insider's conduct to the SEC. Do not tip the CFO that a report is being considered.
Accountability. Supervisors who missed the timestamps and the related-account trading should be reviewed.
3. Would your analysis change if the CFO's information had already been publicly rumoured in a newspaper? Explain.
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It changes the emphasis but does not eliminate the problem. The test is whether the information was generally available and reliable. A newspaper rumour is not the same as disclosed facts; confirmation by the CFO would still be material to a reasonable investor, and his duty of confidence remains. If the rumour was specific, widely disseminated and already priced in, the insider-trading case weakens because the information may be immaterial or already public. If the rumour was false and the CFO knew the truth, trading on the truth is still insider trading.
The front-running analysis is unaffected: it depends on the pension fund's order, not on issuer information. The personal-account and pre-clearance breaches also stand.
Document the assessment contemporaneously: what was public, when, from what source, and how the price reacted. Do not accept the salesman's after-the-fact claim that 'everyone knew' without evidence.