CFA Institute’s Code of Ethics and Standards of Professional Conduct codify the ethical guidelines for the investment profession that are critical to maintaining the integrity of capital markets and investor trust. Members, candidates, and even firms make a commitment to uphold these standards as they help elevate ethical decision-making universally around the globe.
As investment professionals, we are certain to face important ethical decisions in our day-to-day activities. Some scenarios we encounter will be straightforward, while others may be more complex. No matter what circumstances we face, continuous learning remains imperative in an investment industry that continues to evolve with products undergoing innovation and a regulatory environment continuing to adapt.
For that reason, each week we will feature a sample case from CFA Institute’s Ethics in Practice Casebook. Each case is built upon a real-life example that may involve a regulatory matter or even a CFA Institute Professional Conduct investigation. At the end of the case is a multiple-choice question that addresses the ethical nature of the actions taken in that case.
This week’s case involves Standard II(A) Material Nonpublic Information.
Material and Nonpublic Info or Not?
Robles, a fund manager, visits the main manufacturing plant of a large international cement company. During his visit, the management of the company discloses that the company has purchased additional land and resources at this location that can easily be put to use for low-cost expansion in the future. Management claims that the expansion would result in a capital cost per unit of production nearly 30% cheaper than industry norms. Management tells Robles “confidentially” that the company may consider expansion when the global economic climate improves sufficiently to boost demand for their product. Based on this information, Robles buys stock in the cement company for the fund he manages. Did Robles act unethically?
A. Yes because Robles traded based on material nonpublic information
B. No because Robles did not trade on material nonpublic information
What do you think is the correct choice? Feel free to discuss in the comments below and make sure to check back later this week as we post the analysis. The completion of this case qualifies for 0.25 hour of Standards, Ethics, and Regulation (SER) credit.
[Update – 7/16/2020]
Welcome back! Here is the analysis of this case:
Analysis:
CFA Insitute Standard II(A): Material Nonpublic Information prohibits members who are in possession of material nonpublic information that could affect the value of an investment from acting on that information. Information is material if it would significantly alter the total mix of information currently available in such a way that the price of the security would be affected. The nature, specificity, exclusivity, and reliability of the source of the information helps determine materiality. Information is nonpublic until it has been disseminated or is available to the marketplace in general. There are three pieces of information that are described in the case that are relevant to Robles’s decision to trade: (1) the purchase of excess land and resources at the site of the company’s main plant, (2) the calculation that using this additional capacity would reduce the company’s production costs to less than industry norms, and (3) the company’s expansion plans. Are any of these three pieces of information material nonpublic information?
The first piece of information about acquiring additional production assets would likely be considered material. But it is not clear when the purchase occurred. Was it recent? Is the purchase in the public record? It is possible that the purchase is already publicly known, and the management’s disclosure to Robles is nothing new. It is also possible that the purchase just occurred or is imminent and has not been announced publicly, which would make the information nonpublic. The second piece of information about being to produce at much lower costs would be material information. But it is unclear whether this information is known only to the company. Certainly, confidential proprietary manufacturing cost calculations would be nonpublic, but astute analysts with knowledge of the industry may be able to easily make this type of evaluation. In that case, the information may not be confidential. Finally the third piece about the company’s expansion plans are very likely to affect the price of the company’s stock and would thus be material information. But again, the information is not specific enough. Management tells Robles that the company “may consider” expansion when the global economic conditions “improve sufficiently.” The possibility that the company “may consider” expanding is vague and ambiguous. When the economy “improves sufficiently” is also subjective and indefinite. Even if this information is disclosed “confidentially” only to Robles and is not publicly available, it is not clear that general plans about possible expansion at some unknown point in the future rises to the level of material information.
In sum, a portion of the information disclosed to Robles by company management has the potential to be material. It is unclear from the facts of the case that the information is nonpublic. An argument could be made either way. We would need more information to make a determination about whether Robles violated the prohibition against trading on material nonpublic information.
The facts for this case were submitted by Shreenivas Kunte, CFA Institute Director of Continuing Education and Advocacy, India, Asia-Pacific Region.
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