Does Procurement Inadvertently Facilitate Insider Trading?

Have you considered the potential for insider trading violations and the ensuing lawsuits that could arise from access to procurement information? Perhaps this hasn’t even entered your mind. With increasing data availability (spend data, supplier risk/management information, demand data) at the fingertips of procurement professionals and others in the organization, the opportunity to access information that could be used to provide an “advantage” in the capital markets has never been greater. Traditionally, such information (if available at all) was available solely to company “insiders” who could only trade within certain windows (and with other restrictions placed on them). In this multi-part Spend Matters Plus analysis, we explore the growing potential of procurement-related information to create the opportunity for insider trading information.

Insider Information: All Around Us

What could anyone possibly do with procurement information? Consider this list of data points:

• Changes in inventory turns combined with absolute volume can provide a good idea of how much you are selling and how efficiently you are shipping. Conversely, if your turns are increasing and/or volumes falling it tells a bleaker picture — especially to someone who knows the historical baseline, projections and expectations.
• Key supplier performance information, which includes any scandals brewing, any violations cropping up (child labor or other labor violations and abusive practices) and disasters (critical warehouses and production facilities being wiped out) can have a material impact on stock market performance.
• Demand planning (i.e., forecast sales numbers) can provide insight into whether a firm is expected to hit or miss targets. These can help forecast a relative clear short-term outlook, but many of the “purer” buy-side stats can also be just as informative (some of which are disclosed in earnings calls as well). However, demand-planning data is nearly always contained within a company (except those suppliers that have access to it as well).

From a trading perspective, just about all of the above types of information is useful input for a day trader to capitalize on. Some of the numbers are, of course, likely to be guarded more carefully than others. However, we can assume that in a Fortune 500 company, it is likely hundreds of individuals (if not thousands) that have access to this type of information, as it is necessary to manage procurement and supply chain operations as well as on the facility/plant/warehouse level.

But perhaps even more important, as companies roll out better, significantly more capable procurement tools with powerful aggregation and analytics of vast data sets — including external risk data (not merely the traditional D&B Paydex kind, but also geopolitical and other non-financial risk data from providers like riskmethods and Resilinc), even CSR issues (depending on how heavily a company leverages this in their brand building) — and also make this information available to a large set of stakeholders, it becomes interesting to think about the increased legal exposure.

Regulatory Statutes – Be Aware

Earlier, we considered how organizational behavior of some companies could hold them back in this area. Specifically, one area is being overly secretive about how much information is shared with stakeholders — an issue you can read more about in our Is The CEO The Only One With Need To Know? Information Clash Brewing article. That research brief is more centered on intellectual property and has more to do with balancing the potential for loss of valuable business data to the marketplace and competitors, with the need to ensure that users have sufficient and timely information in order to make the right decisions before it is too late.

In this brief, we are looking at a harder issue to guard against: regulatory violations and the wrath of various federal agencies. As we see in practically all fields, once the regulatory camel has its nose in the tent, it doesn’t tend to go away. This has been the case with the Foreign Corrupt Practices Act, where excessive prosecutorial reliance on settlements out of court has not helped clear the mist around what is actually in scope and what isn’t, similarly with Insider Trading legislation, where what Congress passed and what bureaucrats have since “finessed” over the years has lead to significant scope creek and business uncertainty.

There is an interesting court case (United States v. Newman and Chiasson) where the government recently lost trying to pin insider-trading charges on traders Todd Newman and Anthony Chiasson. Mondaq states that the court’s decision has “overturned insider-trading convictions of two remote tippees by (i) holding that a tippee must know that the insider tipper received a personal benefit for providing the tip and (ii) clarifying or narrowing (depending on one’s interpretation) the definition of what constitutes an actionable personal benefit.”

Regardless of how this unfolds (the government has filed for a rehearing and might pursue SCOTUS remedies on appeal), it points to an interesting (in a scary way) situation for procurement people. Could you be taken to court on insider trading violation charges?

Learning From KYC

Normally, I think of insider trading as someone with non-public insights into a company’s financials (usually a publicly-traded company, but not necessarily limited to those as we will see), who then acts on this information for personal gain, either directly, or via friends, family, etc.

Here is how a traditional Fortune 100 financial firm with a focus on the securities business handles this: Let’s set aside many of the checks and balances around their staff and internal activities (FINRA, FASB, SEC, etc.) and just look at how they handle their clients – people with brokerage accounts and/or 401(k), IRAs, etc. The key words here are “Know Your Client,” or KYC. The checklist for this area covers, among other items, the following:

• Is the client a qualified aka accredited investor (a watershed event regarding regulations)?
• Is the client an executive in any company (with 5% or more equity)? Note that this F100 firm applies this rule to ownership in any firm, not just publicly-traded ones.
• Is the client a politically exposed person (i.e. either in office, or related to a political office holder)?
• Where are sources of the client’s money/wealth coming from?

The information above helps guide the securities firm in monitoring their exposure to potential shenanigans by the client (trading before the clock, i.e. before the market knows about something of material impact), or by their own financial advisors (trying to trade equities between clients – this is where privately owned equities carry exposure), or if possible, by people related to the persons. Of course, for every check and balance, a devious mind can come up with a workaround (including eating napkins).

As our analysis continues, we will change tracks and examine what this means for procurement. We could think of this as a motivator to create a “Know Your Trading Partner” program.