SUMMARY - article
The article discusses the suspension of two Canadian Imperial Bank of Commerce investment advisors of profiting from insider information on four M&A takeovers. The information had been passed on from a former partner at Davis Ward Phillips & Vineberg. The potential profit of these trades was estimated around $3 million Canadian. The news of the suspension caused share prices to decrease by 2.3%. Two employees of TD Waterhouse were also accused of illegally trading. The insider trading enforcement record has been previously criticized due to its failure to secure convictions.
WHY INFO ASSYMETRY NEEDS TO ME MINIMIZED (taken from midterm exam)
The main issue at hand is the problem of information asymmetry. In this case, insiders had an unfair advantage in the market to shareholders. When the market is not considered to be a level playing field, estimation risk increases and investors are inclined to withdraw from the market or to bid down the share price, which was the case here. In either case, the result is less capital is allocated to deserving companies. To encourage investment, the government must intervene and introduce or improve regulations or change accounting standards to require a greater degree of disclosure.
INTEREST GROUP THEORY (ch 13)
Interest group theory can be applied to this case. There are a variety of different interest groups who have much at stake in the outcome of this situation. The shareholders are the primary reason why more regulations may be imposed, or why existing regulations may be improved. If shareholders are unhappy with a seemingly unfair market, they will invest less, causing less capital to be distributed, with the result that the firms will not get the funding they need to grow their businesses. Reducing adverse selection also improves the functioning of capital markets and the public benefits (page 445). However, those involved in management and in smaller businesses may dislike the idea of more regulation imposed on them, and may have incentive to lobby against more governance. The political authority will make the final decision based on what it stands to gain from each scenario.
INCREASING AND IMPROVING REGULATIONS – to secure convictions – “internal failure” cost
As noted in the article, the primary concern with this situation is the court’s inability to secure convictions of the offenders. The intricate details of problems within the court system are a legal matter, so there is little that the field of accounting can do after insiders behave unethically or break the rules.
The difficulty of securing convictions may stem from the high court costs associated with pursuing these cases. It seems that the solution is to invest in prevention measures to curb the problem, rather than relying on the courts. This comes in the form of adapting accounting standards in order to deter insider trading.
CHANGING ACCOUNTING STANDARDS (ch 12, page 444) – a “prevention” cost
The process of changing accounting standards should be considered in the light of decision usefulness, information asymmetry reduction, economic consequences, and other criteria used in the standard setting process.
Requiring companies to disclose potential takeovers more readily in their financial statements serves as a way to prevent inside trading. With less information hidden from the public, the importance of ethics of employees and management is decreased. Further, changing these accounting standards would be much less costly than trying insider traders in court. The rules regarding insider trading on takeover information are currently described in principle-based standards (page 492) that rely on the application of professional judgment. Due to the nature of inside trading, rules cannot be described within a specific set of rules. Requiring the disclosure of takeovers would supplement the current principle-based standard and leave less room for questionable professional judgment.
A takeover would be considered proprietary information, and thus will affect the future cash flows of a company. Disclosure may also impede on a company’s ability to gain a competitive advantage by forcing it to disclose too much before deals have been made. However, such a change would increase decision usefulness for investors because it would allow them to grasp more of each firm’s prospects.
