It’s who you know. Not what you know

Friday 13 November 2020

Ethics case study 1: The insider information dilemma

Developments on the horizon

James Arzon works as a Pharmaceuticals Analyst in Global Research at Alpha Return Corp.  Over the past week James has been writing a report on Zip Pharma.  Zip has a strong reputation in the industry for its innovative and diligent research methodology.  However, in recent years, Zip Pharma has failed to receive FDA approval for several of its new treatments which has led to profit warnings and turnover in leadership at the firm.

Zip Pharma is in the process of developing a new drug that is expected to provide a revolutionary cure for a respiratory illness.  Company management have been actively publicising the drug’s benefits and their exciting plans for Zip Pharma on social media (leading to a sharp appreciation in Zip’s share price).

Overstating the facts – it’s time to sell

As part of his research, James calls one of his contacts at the World Health Organisation to discuss the drug.  His contact states that the chances of approval are being significantly overstated by Zip (due to some of the side effects documented in Phase 2 trials) and that FDA approval is extremely unlikely.  James reviews Zip Pharma’s recent statements and determines that earnings projections are overly reliant on the success of this drug.  

James drafts a sell recommendation for Zip Pharma, documenting the dependency on the success of this drug for the company’s future and that experts he consulted at the WHO do not think the drug will receive FDA approval.  James shares this report with his supervisor, Rohan Rigsby.  Rohan asks James to remove all statements about the WHO contact, calling them “speculative” and that they could invite legal action (since they are not official statements from the WHO).  James updates his report accordingly. 

It’s who you know, not what you know

James is close friends with Petra King, a colleague in the Wealth Management division at Alpha Return Corp. They often discuss broad themes within the pharmaceutical industry but James is very careful not to share specific views on a company or disclose whether a report will be positive or negative.  James mentions to Petra that he is currently researching Zip Pharma. 

Later that evening, James and Petra are out for dinner with their families and the respiratory illness comes up in conversation.  James forcefully states that no treatment will likely be available soon.  Following dinner, Petra conducts her own research and surmises that James’ view is informed by his research into Zip Pharma.  Zip is held in all of her client portfolios and has become an overweight position (given the recent price appreciation).  Given the likely impact negative news will have on the share price, Petra decides to eliminate the position across all client portfolios.  She documents her rationale for exiting the position: “Zip is up approximately 120% YTD and overweight.  Eliminating position to fund other opportunities.” 

Two days later James submits his report and the share price drops significantly. 

Rohan does not question James’ actions and Alpha’s Compliance Department does not investigate Petra’s trade. 


Watch members of CFA UK Ethics Steering Committee discuss the results of case study 1: The Insider Information Dilemma:


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