II-A：Material Nonpublic Information

（1）Acting on Nonpublic Information

  • Frank Barnes, the president and controlling shareholder of the SmartTown clothing chain, decides to accept a tender offer and sell the family business at a price almost double the market price of its shares. He describes this decision to his sister (SmartTown’s treasurer), who conveys it to her daughter (who owns no stock in the family company at present), who tells her husband, Staple. Staple, however, tells his stockbroker, Alex Halsey, who immediately buys SmartTown stock for himself.

  • Comment:

    • treasurer：司库; 财务主管; (俱乐部或组织的)会计; 出纳
    • The information regarding the pending sale is both material and nonpublic.
    • Staple has violated Standard II(A) by communicating the inside information to his broker.
    • Halsey also has violated the standard by buying the shares on the basis of material nonpublic information.

      （2）Controlling Nonpublic Information

  • Samuel Peter, an analyst with Scotland and Pierce Incorporated, is assisting his firm with a secondary offering（二次发行） for Bright Ideas Lamp Company. Peter participates, via telephone conference call, in a meeting with Scotland and Pierce investment banking employees and Bright Ideas’ CEO. Peter is advised that the company’s earnings projections for the next year have significantly dropped. Throughout the telephone conference call, several Scotland and Pierce salespeople and portfolio managers walk in and out of Peter’s office, where the telephone call is taking place. As a result, they are aware of the drop in projected earnings for Bright Ideas. Before the conference call is concluded, the salespeople trade the stock of the company on behalf of the firm’s clients and other firm personnel trade the stock in a firm proprietary account and in employees’ personal accounts.

  • Comment:

    • Peter has violated Standard II(A) because he failed to prevent the transfer and misuse of material nonpublic information to others in his firm.
    • Peter’s firm should have adopted information barriers to prevent the communication of nonpublic information between departments of the firm.
    • The salespeople and portfolio managers who traded on the information have also violated Standard II(A) by trading on inside information.

      （3）【IMP】Selective Disclosure of Material Information

  • Elizabeth Levenson is based in Hanoi and covers the Vietnamese market for her firm, which is based in Singapore. She is invited, together with the other 10 largest shareholders of a manufacturing company, to meet the finance director of that company.

  • During the meeting, the finance director states that the company expects its workforce to strike next Friday, which will cripple productivity and distribution. Can Levenson use this information as a basis to change her rating on the company from “buy” to “sell”?

  • Comment:

    • Levenson must first determine whether the material information is public.
    • According to Standard II(A), if the company has not made this information public (a small group forum does not qualify as a method of public dissemination), she cannot use the information.

      （4）Determining Materiality

  • Leah Fechtman is trying to decide whether to hold or sell shares of an oil-and-gas exploration company that she owns in several of the funds she manages. Although the company has underperformed the index for some time already, the trends in the industry sector signal that companies of this type might become takeover targets.

  • While she is considering her decision, her doctor, who casually follows the markets, mentions that she thinks that the company in question will soon be bought out by a large multinational conglomerate and that it would be a good idea to buy the stock right now. After talking to various investment professionals and checking their opinions on the company as well as checking industry trends, Fechtman decides the next day to accumulate more stock in the oil-and-gas exploration company.

  • Comment:

    • Although information on an expected takeover bid may be of the type that is generally material and nonpublic, in this case, the source of information is unreliable, so the information cannot be considered material.
    • Therefore, Fechtman is not prohibited from trading the stock on the basis of this information.

      （5）Mosaic Theory

  • Jagdish Teja is a buy-side analyst covering the furniture industry. Looking for an attractive company to recommend as a buy, he analyzes several furniture makers by studying their financial reports and visiting their operations. He also talks to some designers and retailers to find out which furniture styles are trendy and popular. Although none of the companies that he analyzes are a clear buy, he discovers that one of them, Swan Furniture Company (SFC), may be in financial trouble. SFC’s extravagant new designs have been introduced at substantial cost. Even though these designs initially attracted attention, the public is now buying more conservative furniture from other makers.

  • Based on this information and on a profit-and-loss analysis, Teja believes that SFC’s next quarter earnings will drop substantially. He issues a sell recommendation for SFC. Immediately after receiving that recommendation, investment managers start reducing the SFC stock in their portfolios.
  • Comment:
    • extravagant：[ɪkˈstrævəɡənt] 奢侈的; 铺张浪费的; 挥霍的; 过分的; 放肆的; 不切实际的; 无节制的; 过于昂贵的
    • Information on quarterly earnings data is material and nonpublic.
    • Teja arrived at his conclusion about the earnings drop on the basis of public information and on pieces of nonmaterial nonpublic information (such as opinions of designers and retailers).
    • Therefore, trading based on Teja’s correct conclusion is not prohibited by Standard II(A).
  • Roger Clement is a senior financial analyst who specializes in the European automobile sector at Rivoli Capital. Because he has been repeatedly nominated by many leading industry magazines and newsletters as a “best analyst” for the automobile industry, he is widely regarded as an authority on the sector. After speaking with representatives of Turgot Chariots — a European auto manufacturer with sales primarily in South Korea — and after conducting interviews with salespeople, labor leaders, his firm’s Korean currency analysts, and banking officials, Clement analyzed Turgot Chariots and concluded that：
    • (1) its newly introduced model will probably not meet sales expectations
    • (2) its corporate restructuring strategy may well face serious opposition from unions
    • (3) the depreciation of the Korean won should lead to pressure on margins for the industry in general and Turgot’s market segment in particular
    • (4) banks could take a tougher-than-expected stance in the upcoming round of credit renegotiations with the company.
  • For these reasons, he changes his conclusion about the company from “market outperform” to “market underperform”. Clement retains the support material used to reach his conclusion in case questions later arise.
  • Comment:
    • To reach a conclusion about the value of the company, Clement has pieced together a number of nonmaterial or public bits of information that affect Turgot Chariots.
    • Therefore, under the mosaic theory, Clement has not violated Standard II(A) in drafting the report.
  • John Doll is a research analyst for a hedge fund that also sells its research to a select group of paying client investment firms. Doll’s focus is medical technology companies and products, and he has been in the business long enough and has been successful enough to build up a very credible network of friends and experts in the business.
  • Doll has been working on a major research report recommending Boyce Health, a medical device manufacturer. He recently ran into an old acquaintance at a wedding who is a senior executive at Boyce, and Doll asked about the business. Doll was drawn to a statement that the executive, who has responsibilities in the new products area, made about a product: “I would not get too excited about the medium-term prospects; we have a lot of work to do first”. Doll incorporated this and other information about the new Boyce product in his long-term recommendation of Boyce.

  • Comment:

    • acquaintance：熟人; (与某人)认识，略有交情; (对某事物的)了解; 相识; 认识的人; 泛泛之交
    • Doll’s conversation with the senior executive is part of the mosaic of information used in recommending Boyce.
    • When holding discussions with a firm executive, Doll would need to guard against soliciting or obtaining material nonpublic information.
    • Before issuing the report, the executive’s statement about the continuing development of the product would need to be weighed against the other known public facts to determine whether it would be considered material.

      （6）Analyst Recommendations as Material Nonpublic Information

  • The next day, Clement is preparing to be interviewed on a global financial news television program where he will discuss his changed recommendation on Turgot Chariots for the first time in public. While preparing for the program, he mentions to the show’s producers and Mary Zito, the journalist who will be interviewing him, the information he will be discussing. Just prior to going on the air, Zito sells her holdings in Turgot Chariots. She also phones her father with the information because she knows that he and other family members have investments in Turgot Chariots.

  • Comment:

    • When Zito receives advance notice of Clement’s change of opinion, she knows it will have a material impact on the stock price, even if she is not totally aware of Clement’s underlying reasoning.
    • She is not a client of Clement but obtains early access to the material nonpublic information prior to publication. Her trades are thus based on material nonpublic information and violate Standard II(A).
    • Zito further violates the Standard by relaying the information to her father. It would not matter if he or any other family member traded; the act of providing the information violates Standard II(A). The fact that the information is provided to a family member does not absolve someone of the prohibition of using or communicating material nonpublic information.

      （7）【IMP】Acting on Nonpublic Information

  • Ashton Kellogg is a retired investment professional who manages his own portfolio. He owns shares in National Savings, a large local bank. A close friend and golfing buddy, John Mayfield, is a senior executive at National. National has seen its stock price drop considerably, and the news and outlook are not good. In a conversation about the economy and the banking industry on the golf course, Mayfield relays the information that National will surprise the investment community in a few days when it announces excellent earnings for the quarter. Kellogg is pleasantly surprised by this information, and thinking that Mayfield, as a senior executive, knows the law and would not disclose inside information, he doubles his position in the bank. Subsequently, National announces that it had good operating earnings but had to set aside reserves for anticipated significant losses on its loan portfolio. The combined news causes the stock to go down 60%.

  • Comment:

    • Even though Kellogg believes that Mayfield would not break the law by disclosing inside information and money was lost on the purchase, Kellogg should not have purchased additional shares of National.
    • It is the member’s or candidate’s responsibility to make sure, before executing investment actions, that comments about earnings are not material nonpublic information. Kellogg has violated Standard II(A).

      （8）【IMP】Materiality Determination

  • Larry Nadler, a trader for a mutual fund, gets a text message from another firm’s trader, whom he has known for years. The message indicates a software company is going to report strong earnings when the firm publicly announces in two days. Nadler has a buy order from a portfolio manager within his firm to purchase several hundred thousand shares of the stock. Nadler is aggressive in placing the portfolio manager’s order and completes the purchases by the following morning, a day ahead of the firm’s planned earnings announcement.

  • Comment:

    • There are often rumors and whisper numbers before a release of any kind. The text message from the other trader would most likely be considered market noise.
    • Unless Nadler knew that the trader had an ongoing business relationship with the public firm, he had no reason to suspect he was receiving material nonpublic information that would prevent him from completing the trading request of the portfolio manager.

      （9）【IMP】Using an Expert Network

  • Mary McCoy is the senior drug analyst at a mutual fund. Her firm hires a service that connects her to experts in the treatment of cancer. Through various phone conversations, McCoy enhances her understanding of the latest therapies for successful treatment. This information is critical to Mary making informed recommendations of the companies producing these drugs.

  • Comment:
    • McCoy is appropriately using the expert networks to enhance her evaluation process. She has neither asked for nor received information that may be considered material and nonpublic, such as preliminary trial results.
    • McCoy is allowed to seek advice from professionals within the industry that she follows.
  • 【IMP】Tom Watson is a research analyst working for a hedge fund. To stay informed, Watson relies on outside experts for information on such industries as technology and pharmaceuticals, where new advancements occur frequently. The meetings with the industry experts often are arranged through networks or placement agents that have specific policies and procedures in place to deter the exchange of material nonpublic information.
  • Watson arranges a call to discuss future prospects for one of the fund’s existing technology company holdings, a company that was testing a new semiconductor product. The scientist leading the tests indicates his disappointment with the performance of the new semiconductor. Following the call, Watson relays the insights he received to others at the fund. The fund sells its current position in the company and buys many put options because the market is anticipating the success of the new semiconductor and the share price reflects the market’s optimism.

  • Comment:

    • deter：阻止; 威慑; 制止; 使不敢
    • relay：
      • vt. 转发; 转播(电视或广播讯号); 转送(信息、消息等); 播放; 接转
      • n. 中继设备; 接力赛; 接班的人(或动物); 轮换者
    • Watson has violated Standard II(A) by passing along material nonpublic information concerning the ongoing product tests, which the fund used to trade in the securities and options of the related company.
    • Watson cannot simply rely on the agreements signed by individuals who participate in expert networks that state that he has not received information that would prohibit his trading activity.
    • He must make his own determination whether information he received through these arrangements reaches a materiality threshold that would affect his trading abilities.

      II-B：Market Manipulation

      （1）Independent Analysis and Company Promotion

  • The principal owner of Financial Information Services (FIS) entered into an agreement with two microcap companies to promote the companies’ stock in exchange for stock and cash compensation. The principal owner caused FIS to disseminate e-mails, design and maintain several websites, and distribute an online investment newsletter — all of which recommended investment in the two companies.

  • The systematic publication of purportedly independent analyses and recommendations containing inaccurate and highly promotional and speculative statements increased public investment in the companies and led to dramatically higher stock prices.

  • Comment:

    • The principal owner of FIS violated Standard II(B) by using inaccurate reporting and misleading information under the guise（伪装; 外表; 表现形式; 外貌）of independent analysis to artificially increase the stock price of the companies.
    • Furthermore, the principal owner violated Standard V(A) – Diligence and Reasonable Basis by not having a reasonable and adequate basis for recommending the two companies and violated Standard VI(A) – Disclosure of Conflicts by not disclosing to investors the compensation agreements (which constituted a conflict of interest).

      （2）Personal Trading Practices and Price

  • John Gray is a private investor in Belgium who bought a large position several years ago in Fame Pharmaceuticals, a German small-cap security with limited average trading volume. He has now decided to significantly reduce his holdings owing to the poor price performance. Gray is worried that the low trading volume for the stock may cause the price to decline further as he attempts to sell his large position.

  • Gray devises a plan to divide his holdings into multiple accounts in different brokerage firms and private banks in the names of family members, friends, and even a private religious institution. He then creates a rumor campaign on various blogs and social media outlets promoting the company.
  • Gray begins to buy and sell the stock using the accounts in hopes of raising the trading volume and the price. He conducts the trades through multiple brokers, selling slightly larger positions than he bought on a tactical schedule, and over time, he is able to reduce his holding as desired without negatively affecting the sale price.

  • Comment:

    • John violated Standard II(B) by fraudulently creating the appearance that there was a greater investor interest in the stock through the online rumors.
      • fraudulent：[ˈfrɔːdʒələnt] 欺诈的; 欺骗的
    • Additionally, through his trading strategy, he created the appearance that there was greater liquidity in the stock than actually existed. He was able to manipulate the price through both misinformation and trading practices.

      （3）【IMP】Creating Artificial Price Volatility

  • Matthew Murphy is an analyst at Divisadero Securities & Co., which has a significant number of hedge funds among its most important brokerage clients. Some of the hedge funds hold short positions on Wirewolf Semiconductor. Two trading days before the publication of a quarter-end report, Murphy alerts his sales force that he is about to issue a research report on Wirewolf that will include the following opinions:

    • quarterly revenues are likely to fall short of management’s guidance,
    • earnings will be as much as 5 cents per share (or more than 10%) below consensus, and
    • Wirewolf’s highly respected chief financial officer may be about to join another company.
  • Knowing that Wirewolf has already entered its declared quarter-end “quiet period” before reporting earnings (and thus would be reluctant to respond to rumors), Murphy times the release of his research report specifically to sensationalize the negative aspects of the message in order to create significant downward pressure on Wirewolf’s stock — to the distinct advantage of Divisadero’s hedge fund clients. The report’s conclusions are based on speculation, not on fact. The next day, the research report is broadcast to all of Divisadero’s clients and to the usual newswire services.
  • Before Wirewolf’s investor-relations department can assess the damage on the final trading day of the quarter and refute Murphy’s report, its stock opens trading sharply lower, allowing Divisadero’s clients to cover their short positions at substantial gains.

  • Comment:

    • sensationalize：大肆渲染; 故作耸人听闻地夸张
    • refute：反驳; 驳斥; 批驳; 否认
    • Murphy violated Standard II(B) by aiming to create artificial price volatility designed to have a material impact on the price of an issuer’s stock.
    • Moreover, by lacking an adequate basis for the recommendation, Murphy also violated Standard V(A)–Diligence and Reasonable Basis.

      （4）Personal Trading and Volume

  • Rajesh Sekar manages two funds — an equity fund and a balanced fund — whose equity components are supposed to be managed in accordance with the same model.

  • According to that model, the funds’ holdings in stock of Digital Design Inc. (DD) are excessive. Reduction of the DD holdings would not be easy, however, because the stock has low liquidity in the stock market. Sekar decides to start trading larger portions of DD stock back and forth between his two funds to slowly increase the price; he believes market participants will see growing volume and increasing price and become interested in the stock. If other investors are willing to buy the DD stock because of such interest, then Sekar will be able to get rid of at least some of his overweight position without inducing price decreases. In this way, the whole transaction will be for the benefit of fund participants, even if additional brokers’ commissions are incurred.

  • Comment:

    • Sekar’s plan would be beneficial for his funds’ participants but is based on artificial distortion of both trading volume and the price of the DD stock and thus constitutes a violation of Standard II(B)

      （5）【IMP】”Pump-Priming” Strategy

  • ACME Futures Exchange is launching a new bond futures contract. To convince investors, traders, arbitrageurs, hedgers, and so on, to use its contract, the exchange attempts to demonstrate that it has the best liquidity. To do so, it enters into agreements with members in which they commit to a substantial minimum trading volume on the new contract over a specific period in exchange for substantial reductions of their regular commissions.

  • Comment:

    • The formal liquidity of a market is determined by the obligations set on market makers, but the actual liquidity of a market is better estimated by the actual trading volume and bid–ask spreads. Attempts to mislead participants about the actual liquidity of the market constitute a violation of Standard II(B).
    • In this example, investors have been intentionally misled to believe they chose the most liquid instrument for some specific purpose, but they could eventually see the actual liquidity of the contract significantly reduced after the term of the agreement expires.
    • If the ACME Futures Exchange fully discloses its agreement with members to boost transactions over some initial launch period, it will not violate Standard II(B).
    • ACME’s intent is not to harm investors but, on the contrary, to give them a better service. For that purpose, it may engage in a liquidity-pumping strategy, but the strategy must be disclosed.

      （6）【IMP】Creating Artificial Price Volatility

  • Emily Gordon, an analyst of household products companies, is employed by a research boutique, Picador & Co. Based on information that she has gathered during a trip through Latin America, she believes that Hygene, Inc., a major marketer of personal care products, has generated better-than-expected sales from its new product initiatives in South America.

  • After modestly boosting her projections for revenue and for gross profit margin in her worksheet models for Hygene, Gordon estimates that her earnings projection of US$2.00 per diluted share for the current year may be as much as 5% too low. She contacts the chief financial officer (CFO) of Hygene to try to gain confirmation of her findings from her trip and to get some feedback regarding her revised models. The CFO declines to comment and reiterates management’s most recent guidance of US$1.95–US$2.05 for the year.
  • Gordon decides to try to force a comment from the company by telling Picador & Co. clients who follow a momentum investment style that consensus earnings projections for Hygene are much too low; she explains that she is considering raising her published estimate by an ambitious US$0.15 to US$2.15 per share. She believes that when word of an unrealistically high earnings projection filters back to Hygene’s investor-relations department, the company will feel compelled to update its earnings guidance. Meanwhile, Gordon hopes that she is at least correct with respect to the earnings direction and that she will help clients who act on her insights to profit from a quick gain by trading on her advice.

  • Comment:

    • boutique：精品店; 时装店; 礼品店
    • By exaggerating her earnings projections in order to try to fuel a quick gain in Hygene’s stock price, Gordon is in violation of Standard II(B).
    • Furthermore, by virtue of previewing her intentions of revising upward her earnings projections to only a select group of clients, she is in violation of Standard III(B) – Fair Dealing. However, it would have been acceptable for Gordon to write a report that
      • framed her earnings projection in a range of possible outcomes
      • outlined clearly the assumptions used in her Hygene models that took into consideration the findings from her trip through Latin America
      • was distributed to all Picador & Co. clients in an equitable manner
      • virtue：[ˈvɜːrtʃuː] 美德; 优点; 德行; 长处; 优秀品质; 高尚的道德; 良好习惯; 用处; 正直的品性
      • equitable：[ˈekwɪtəbl] 公平的; 公正的; 公平合理的

        （7）Pump and Dump Strategy

  • In an effort to pump up the price of his holdings in Moosehead & Belfast Railroad Company, Steve Weinberg logs on to several investor chat rooms on the internet to start rumors that the company is about to expand its rail network in anticipation of receiving a large contract for shipping lumber.

  • Comment:

    • Weinberg has violated Standard II(B) by disseminating false information about Moosehead & Belfast with the intent to mislead market participants.

      （8）Manipulating Model Inputs

  • Bill Mandeville supervises a structured financing team for Superior Investment Bank. His responsibilities include packaging new structured investment products and managing Superior’s relationship with relevant rating agencies. To achieve the best rating possible, Mandeville uses mostly positive scenarios as model inputs — scenarios that reflect minimal downside risk in the assets underlying the structured products. The resulting output statistics in the rating request and underwriting prospectus support the idea that the new structured products have minimal potential downside risk.

  • Additionally, Mandeville’s compensation from Superior is partially based on both the level of the rating assigned and the successful sale of new structured investment products but does not have a link to the long-term performance of the instruments.
  • Mandeville is extremely successful and leads Superior as the top originator of structured investment products for the next two years. In the third year, the economy experiences difficulties and the values of the assets underlying structured products significantly decline. The subsequent defaults lead to major turmoil in the capital markets, the demise of Superior Investment Bank, and the loss of Mandeville’s employment.

  • Comment:

    • demise：[dɪˈmaɪz] n. 死亡; 消亡; 终止; 倒闭; 失败; 逝世; 一命呜呼 v. 让位; 遗赠
    • Mandeville manipulates the inputs of a model to minimize associated risk to achieve higher ratings. His understanding of structured products allows him to skillfully decide which inputs to include in support of the desired rating and price. This information manipulation for short-term gain, which is in violation of Standard II(B), ultimately causes significant damage to many parties and the capital markets as a whole.
    • Mandeville should have realized that promoting a rating and price with inaccurate information could cause not only a loss of price confidence in the particular structured product but also a loss of investor trust in the system. Such loss of confidence affects the ability of the capital markets to operate efficiently.

      （9）Information Manipulation

  • Allen King is a performance analyst for Torrey Investment Funds. King believes that the portfolio manager for the firm’s small- and microcap equity fund dislikes him because the manager never offers him tickets to the local baseball team’s games but does offer tickets to other employees. To incite（煽动; 鼓动） a potential regulatory review of the manager, King creates user profiles on several online forums under the portfolio manager’s name and starts rumors about potential mergers for several of the smaller companies in the portfolio. As the prices of these companies’ stocks increase, the portfolio manager sells the position, which leads to an investigation by the regulator as King desired.

  • Comment:
    • King has violated Standard II(B) even though he did not personally profit from the market’s reaction to the rumor.
    • In posting the false information, King misleads others into believing the companies were likely to be acquired. Although his intent was to create trouble for the portfolio manager, his actions clearly manipulated the factual information that was available to the market.