The following guidelines originate from the Disclosure Committee of the Insider Trading Directorate of the Financial Services Board
Guidelines for Recipients of Information
Preamble
This advisory note covers all recipients of corporate information, ranging from the sophisticated users to those less sophisticated. It is important to bear their sophistication in mind when evaluating how the recipients can react and should react to the information supplied by the issuers.
Investment professionals (including, but not limited to analysts, fund managers and investment advisors) are widely and appropriately, seen as the more sophisticated and knowledgeable of these recipients, and thus these guidelines are primarily directed at these professions. However, the term “recipients” has been specifically chosen, since it is not practical to exclude people because of title or job description, nor because of the size of their sphere of influence, for example, widely publicised financial journalists.
Furthermore, it is not useful to limit the scope of these guidelines to specific rules and practices since this will reduce its application and the understanding thereof will be unnecessarily restricted.
Need for awareness
There are a number of compelling reasons why both issuers and recipients need to be aware of where the boundaries relating to inside information lie. Unfortunately, these limits are not always definitive and have to be approached on a case-by-case basis, often having to rely on the informed judgement of those handling and receiving the information. These include:
- There is a global trend towards the application of high ethical standards and control of the issuing, dissemination and use of sensitive information. A compelling case has been made that good ethics results in good business and good business attracts investment. Indeed, many large international investors are not prepared to invest in countries where the ethics and practices are questionable.
- There are numerous laws and rules dealing with inside information and how it is to be handled, which are often country and exchange specific. Transgression of these can result in severe censure, fines and even prison sentences.
- Good analysis of financial information has immense positive benefits for the transparency of markets, foreign investment and the economy in general. If the fear of censure and the uncertainty of how to treat information causes issuers to unduly withhold information, society in general will be unfairly prejudiced. This provides persuasive reasons for clarifying the issues.
- Widely and speedily disseminated information is a characteristic of transparent and efficient markets. Such markets enjoy greater investor confidence and participation, combined with more accurate pricing and smaller spreads between buyers and sellers prices.
Discussion of terms
It is not possible to provide definitions with regard to the terms below, since the value of the information will vary according to factors such as the audience, the context of disclosure, timing and the recipient’s individual circumstances.
Inside information, or as it is often termed, price-sensitive information, has to be both material and non-public. The opposites of these terms provide a useful illustration of what is not inside information.
Public information is seen as having been widely distributed and disseminated to the interested parties to whom the information has value. To become public, information has to be disseminated so that it is available to investors generally. Thus, disclosure to a select group of analysts or publication in a limited distribution journal does not constitute sufficient distribution. Such limited distribution is typically termed “selective disclosure”.
Immaterial information is not in itself valuable and would not be perceived to be of worth in the hands of an investor. In contrast, material information is generally understood to be important in the price formation process of a security and would influence the decision of a reasonable investor.
The Value of Analysis
The work performed by analysts contributes significantly to the price formation process and the efficiency of markets, which in turn has substantial benefits for the economy and society in general. Fairer and more efficient disclosure and dissemination of information, of whatever nature, is intended to improve the overall analytical function and the broad-ranging benefits that result.
The United States Securities and Exchange Commission noted the value of analysts as follows:
“[Analysts] are in the business of formulating opinions and insights – not obvious to the general investing public – concerning the attractiveness of particular securities. In the course of their work, analysts actively seek out bits and pieces of corporate information not generally known to the market for the express purpose of analysing that information and informing their clients who, in turn, can be expected to trade on the basis of the information conveyed. The value to the entire market cannot be gainsaid; market efficiency in pricing is significantly enhanced by such initiatives to ferret out and analyse information, and thus the analysts work redounds to the benefit of all investors”.
The Mosaic Theory
Analysts use their skills to dissect, reassemble and interpret information and disseminate this to their clients. To achieve this, analysts make use of all the sources of information that they are able to access and through deductive reasoning arrive at conclusions with regard to the economy, industries and individual securities. It is widely accepted that in this process analysts may use material and immaterial public information and non-public immaterial information. Through this process, termed the mosaic theory, an astute analyst may arrive at a conclusion that has the equivalence of material non-public information. This conclusion is the result of good analysis and not as a result of the possession of inside information unfairly gained. However, to protect himself the analyst needs to record and retain the records of his sources and the deductive logic used. These may be required to validate and verify the conclusion.
Clearly, the acquisition of inside information and the development of, with the benefit of hindsight, a mosaic theory-type structure does not protect the analyst from allegations of the possession and use of inside information.
Confidential and Special Relationships
Certain activities such as corporate finance and legal work with an issuer of information will result in the recipients of this information becoming willing insiders. These people have been drawn into a special and confidential relationship with the issuer and must respect this position. A relationship of trust has been established. During the period of this relationship, the recipients of the inside information may not use it or disclose it to others without committing an offence. The information may only be used once it has been made public.
Analysts may be drawn into this relationship by virtue of their skills. This is sometimes referred to as “looking over the wall”, referring to the “firewall” or “information barrier” that exists within the firm. This activity must be controlled and monitored by the compliance officer or department within a firm.
Examples of Inside Information
By definition, inside information has to be both material and non-public. Both the issuers and recipients need to be aware of the significance of the information that they are handling and how to react if unintentional disclosure occurs. Typical examples of material information are:
- The passing of a dividend or a forthcoming declaration
- Mergers and takeovers
- Change to the corporate structure
- Corporate actions
- A debt default
- Substantial increases or declines in earnings, particularly when they are meaningfully different from the market consensus
- Substantial mineral finds or the proving thereof
- Regulatory approval for a product or drug or merger
- Share repurchase programs
- Company officers buying or selling shares.
A good test of materiality is whether, if the information were widely disseminated, the share price would react. Would a reasonably well-informed investor consider the information to be material? (Consider your position as both a buyer and seller).
What to do when presented with material information
An issuer could wrongfully disclose material non-public information either on purpose or inadvertently. In the event of purposeful disclosure to an individual or a select group, this is clearly wrong and both the issuer and recipients, if they use the information, risk severe censure. Issuers should be aware of the sensitivity of the matter and immediately institute damage control via broad public dissemination of the information. The recipients may not use the information or further distribute it until it has become public.
Inadvertent disclosure of non-public material information is a more complex matter. If the issuer realises that he has disclosed inside information in error, an appropriate route would be to immediately embargo the information and without delay make arrangements for public disclosure. Again the recipients may not use, pass on or act on the information until it has become public.
Although an officer of the company should be aware of what inside information is, the recipient, particularly if they are a sophisticated user such as an analyst, should also be aware of their obligations in this respect. Analysts need to be conscious of whether the information is material and check if it has been made public. If the information has not been made public, the analyst should explain the need to do this and the issuer has an obligation to consider public dissemination. Possibly the issuer and recipient/s should also discuss whether the information is indeed of a material nature, since one does not want to obstruct a free flow of non-material information and prevent honest application of the mosaic theory.
The recipient who is in possession of inside information should encourage the issuer to make this public, but in any event abstain from trading, dissemination or tipping others.
Closed Periods
For the purposes of inside or price-sensitive information, so-called closed periods have no relevance, since the same definitions and logic is applied to the information at all times. Closed periods are essentially defined by the issuer’s internal policy and are in essence designed to restrict the activities of the corporate officers of the issuer. Closed periods should not be used as an “excuse” for corporate officers not to see analysts, since the guidelines with regard to information are applicable at all times.
August 2001