Question

Anthony Johnson is a marketing executive with a substantial investment portfolio that he has built over the years from savings. He owns shares in National Savings, a large local bank. A close friend and golfing partner, John Stansfield, 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, Stansfield mentions that National will surprise the investment community in a few days when it announces excellent earnings for the quarter. Johnson is pleasantly surprised by this information, and thinking that Stansfield, as a senior executive, knows the law and would not disclose any illegal inside information, he doubles his position in the bank's shares. Subsequently, National announces that it had good operating earnings but had to set aside reserves for anticipated significant losses on its loan portfolio in the next quarter. The combined news causes the stock to go down (instead of up) almost 20%.

did Anthony Johnson and/or John Stansfield violate any of the ethical rules? Explain why or why not.

Answer 1

Information on earnings for prospective quarter ( National will surprise the investment community in a few days when it announces excellent earnings for the quarter ) may impact price of a concerned share materially and hence is a sensitive information. Further, the information on earnings was unpublished yet, hence making it an Unpublished Sensitive Information (UPSI).

• As John Stansfield has accepted employment in National Savings, he has undertaken a legal obligation to shareholders' to put the shareholders' interest before his own, in matters related to the corporation. Being a senior executive / officer ,  he was an insider and breached his fiduciary duties to shareholders by disclosing sensitive information to Anthony Johnson . Irrespective of whether the other person traded or not, the behavior of John Stansfield would be deemed unethical.

• On the other hand,,Anthony Johnson made trade on the basis of unpublished sensitive information ( UPSI) , thus getting an unfair advantage over other shareholders. This violated transparency, the basic tenet of capital markets. When Statsfield passed on information,his fiduciary duty was imputed to Johnson and Anthony Johnson violated his duties when he traded based on unpublished sensitive information (UPSI).

Hence, it was unethical on Johnson's part to trade for gaining unfair advantage over rest of the market. Irrespective of whether the person made losses or profits on trade, the behavior would be deemed unethical.Not only unethical, this behavior is illegal in several countries including the US ( Section 16 (b) and Section 10 (b) of Security Exchange Act of 1934), the UK and India .Allowing this legally could have serious ramifications on capital markets.