How can someone worth (reportedly) $700m risk everything over $30,000? Greed or stupidity are two nouns that spring to mind.

In 2001, Martha Stewart was America’s sweetheart. A domestic goddess with an impressive media/entertainment empire to match. But on December 27, Martha’s stock broker informed her that the price of ImClone’s shares was about to plummet because it failed to get approval for its experimental drug. She owned 4,000 shares which she promptly sold, to avoid a loss. Problem was, this information wasn’t made public to the market until the day after Martha sold her shares. Whilst she avoided losing $45,673, it cost her 5 months in prison, 5 months of home confinement and a $30,000 fine.

Insider Trading

In Australia, trading (buying or selling, or causing someone else to buy or sell shares) using inside information is prohibited. Inside information is any information, including deductions, conclusions and inferences, that is not generally available to the market. By way of example; if you buy shares in a company after a friend who works for them tells you something critical eg a material new client, new mineral deposit, new contract etc, and it hasn’t been disclosed on the ASX –you are skating a fine line and possibly “inside”.

To help prevent cases of insider trading, publicly listed companies have an obligation to disclose price sensitive information (continuous disclosure). The market has to be fully informed, and not selectively disclosed. A good example of this was when Newcrest was fined $1.2m last year by the regulator (ASIC) for sharing price sensitive details with a group of analysts rather than the broader market. They released draft information to analysts at a conference, which was still to be approved by management and not announced to the broader market.

Companies also need to ensure that information they disclose is accurate; and not misleading or deceptive. Andrew Forrest and Fortescue Metals were investigated by the regulator in 2004, when it was alleged they told the market some crucial contracts were binding, but were only an agreement to agree.

Why all the fuss?

There is a wide range of justifications for preventing insider information.

• The first is fairness. All investors should have access to the same information about a company.
• The second is ensuring the people in positions of trust within a company are not making profits from inside information. If CEO’s and management were able to make profits off all the information that they where privy too, shareholders would likely lose out in the end.
• Economic efficiency – the price of a stock should be a reflection of its real long-term value. This would be distorted if investors didn’t all have the same information about the stock or its company.
• The last is reputational risk – the damage that actual or alleged insider trading has on the standing of the corporation. If investors are aware that people are making unfair profits on a stock, they will be less likely to want to invest in that stock. Therefore this affects the company’s ability to attract and maintain investment in the long term.

Front Running

The principles behind insider trading also apply to fund managers, stockbrokers, or anyone who knows of a big order about to be executed on the market. Front running is where employees of a fund manager personally purchase a stock because they know that their fund is about to purchase the same stock. Why? Because the increased demand from the fund’s investment will increase the value of the shares the employee has obtained. The same goes for sales of shares.

Investment firm IOOF is currently working to clear itself from front running and insider trading allegations. While no wrong-doing has currently been proven, the allegations are enough to call the ethical standards and practices of the firm into question.

Nine Network’s punch up

David Gyngell is (in)famously known for his punch up earlier in the year with friend James Packer. He is also the recently listed Nine Network (NEC) CEO. In 2013 Gyngell received a cash bonus of $2.5m for helping to list NEC, a $10m shareholding, $4.5m of performance rights, and an annual fixed remuneration of $2m (source BRW).

NEC listed at $2.05 in December 2013, and has fluctuated between $2.39 and (more recently) $1.40. It was his personal share trading in the sale of $1.5m of shares in May which pricked ASIC’s interest. It seemed rather timely that he sold this stock just weeks before a significant profit downgrade. Gyngell argues that he complied with NEC’s share trading policy, having the approval of his Chairman to sell 731,707 shares between May 13-15. He also argues that he only knew of the April advertising numbers (which is when the stock was performing), and not the information released 2 weeks later (which showed a softness in numbers) prompting the downgrade.

ASIC’s spotlight on NEC and Gyngell will be uncomfortable for those involved as ASIC tries to sort out who knew what and when. Rightly or wrongly, and irrespective of the answer in the examples mentioned, any allegations hurt the individual and companies concerned, as it leaves a perception of poor governance standards and ethics.