Special Topic Business Ethics Rutgers

Ronnee

FINRA 2060 Rule

Use of information obtained in fiduciary capacity: it prohibits brokers from using non-public information for personal gain.

FINRA 2090 Rule

Know your customer: Know who your customer is, know who can act for them, and keep their information accurate

NFA (National Futures Association)

Self-regulatory organization for the U.S. derivatives industry. Approved by CFTC, it protects investors and makes sure members follow the rules by fighting fraud, enforcing compliance, and watching the markets in real time.

The Securities Act of 1933

Focuses on governing securities issued by companies in the primary market 

The Securities Exchange Act of 1934 

Created the SEC, regulates securities trading on the secondary market, stock exchange markets and the participants involved to protect investors

The Investment Company Act of 1940 

Regulates the organization of companies, including mutual funds, that primarily engage in investing/reinvesting/trading securities and have their own securities offered to the public  

Investment Advisors Act of 1940

Regulates investment advisors

The SEC

Protects investors and keeps markets fair.

• Oversee SRO’s such as the national securities exchange, clearing agencies etc.

• Helps investors gain access to materially complete and accurate information about companies and the securities they offer and sell.

Sarbanes-Oxley Act 2002

Mandated reforms to enhance corporate responsibility, enhance financial disclosures, combat corporate and accounting fraud, created PCAOB

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

Aimed to prevent the excessive risk-taking that led to the financial crisis:

• Consumer protection

• Transparency-Enhance financial disclosures (investment industry)

• Trading restrictions, credit ratings, regulation of financial products

• Creating new registration and reporting requirements for private fund advisers

• Corporate governance and disclosure

Economic Growth, Regulatory Relief and Consumer Protection Act 2018

Exempted many US banks from the DFA’s banking regulations.

Law passed the House of Representatives and later that year Trump signed the partial repeal into law.

Investment Advisor (RIA)

Any person or firm that: 

• Provides advice or analysis about securities (stocks, bonds, mutual funds, ETFs, etc.) 

• Does so for compensation (fees, commissions, or other economic benefit)

• Is engaged in the business of providing such advice on a regular basis

Regulation of Investment Advisers

• Registration

• Fiduciary Duty

  • Full Disclosure of Material Facts 

  • Conflicts of Interest 

  • Disciplinary Events and Precarious Financial Condition

  • Suitable Advice 

  • Reasonable Basis for Recommendations

  • Principal Transactions and Agency Cross Transactions

  • Best Execution

  • Proxy Voting

• Compliance Obligations

• Advertising & Marketing 

• Inspections & Enforcement 

Exclusions - Is the advice a part of their business

• Banks and Bank Holding Companies, Lawyers, Accountants, Engineers and Teachers

• Publishers- if they provide only impersonal advice

• Credit Rating Agencies

• Government Securities Advisors

• Brokers and Dealers - excluded if advice is given

  • Solely incidental to the conduct of its business as a broker or dealer

  • Does not receive any special compensation for providing investment advice

Duty of Loyalty 

Advisers must put the clients interests ahead of their own 

Requires full disclosure of all material conflicts of interest so clients can give informed consent 
Ex. If an adviser receives compensation for recommending a fund, this must be disclosed clearly 

Duty of Care

Advisers must provide advice that is in the clients best interest, based on a reasonable inquiry into their objectives, financial situation, and risk tolerance

Requires advisors to have a reasonable basis for all investment recommendations and to monitor portfolios when agreed upon

Ex. Advising a retiree with low risk tolerance into highly volatile stocks would breach this duty

Certified Financial Planner (CFP)

A formal recognition of expertise in the areas of financial planning, taxes, insurance, estate planning, and retirement

• Designation is awarded to those who pass the exams

Stockbrokers 

Brokers must register with the SEC; they are licensed to make trades with securities exchanges 

They act as an agent for investors, executing orders, through exchanges or other venues 

agency capacity

Dealers

A person who will buy and sell securities on their own account

They have assets of their own that they sell 

Profit from the bid/ask spreads 

principal capacity

Broker/Dealers

A brokerage firm

• Broker is a registered representative of a broker-dealer

• Big Financial Advisory firms and Wealth Management firms can be dually resisted as investment advisors and broker-dealers

List of things they may offer:

• Wealth Management services

• College savings accounts/college planning advice

• Retirement accounts, including IRA’s and rollover accounts

• Insurance and annuity products

• Retirement accounts and cash management services for small business

• Money market funds and savings accounts

• Credit cards and loans

Regulation of Broker/Dealers 

Transition from suitability to Best Execution

Standards of Conduct: 

• Historically held to a suitability standard (recommendations must be suitable for the client, not necessarily in their best interest 

• Antifraud Provisions and FINRA Rule 2111: suitability applies to recommendations made to both retail and institutional investors

• It was enhanced in 2019 with Regulation Best Interest (BI) which goes beyond suitability obligations 

  • Disclosure, care obligation, conflict management, compliance

Payment for Order Flow (PFOF) defined in Rule 10b-10 1997 

• Requires broker-dealers to disclose on trade confirmations if they receive payment for order flow 

• It’s not an unethical practice

Barclays fined $2 million for best execution violations

• Barclays traded as principal against customer orders (took the other side).

• It didn’t seek better prices on other trading venues.

• When warned about the issue, it failed to review or change its routing process.

• Its internal system routed most trades to its own market, likely costing customers better execution and higher prices.

FINRA’s Central Registration Depository 

An online registration and licensing system that contains administrative and disclosure information about registered securities firms and brokers. The CRD system is Used by members of the securities industry, state and federal regulators and SRO’s. 

Available through FINRA BrokerCheck

• A free tool to research the background and experience of financial brokers, advisers and firms

Securities Industry Essentials (SIE) Exam

A FINRA exam for prospective securities industry professionals

• Introductory-level exam to assess a canditate’s knowledge of basic securities industry information, including concepts fundamental to working in the industry

Corporate Fraud

• Falsification of financial information

  • Accounting

  • Trading

  • Other Transactions

• Self-Dealing by corporate insiders

  • Insider Trading

  • Property Misuse

  • Tax Violations

Money Laundering

• Involves criminals turning “dirty” money “clean”

  • Hide and accumulate wealth

  • Avoid taxes and prosecution

• Involves three major steps

  • Placement

  • Layering

  • Integration

Rule 10b5-1 

Rule 10b5-1 lets insiders pre-schedule trades legally — as long as they set the plan before knowing inside info.

A written securities trading plan that provides a way for companies and corporate insiders to purchase and sell securities in their company when they have MNPI.

• Predetermined trades: specifies the purchase or sale of securities based on a formula, algo, or program.

• Non-MNPI adoption: The plan must be adopted at a time when the insider is not aware of MNPI

• Affirmative defense: If these conditions are met, the insider has a valid defense against insider trading allegations, even if they later trade while possessing MNPI

June 29, 2022, the WSJ reported results of its corporate insider trading
analysis

• 75,000 insider trades under rule 10b5-1 plans 

• 20% of insiders sold shares within 60 days of adopting their plan 

• These insiders made ~500 million more than if they had 3 months 

• Pattern: Quick sales often preceded stock price drops, suggesting possible misuse of MNPI 

Ontrak CEO Terren Scott Peizer

• He set up and used his rule 10b5-1 trading plans while he already possessed material nonpublic information (MNPI) - which violates the rule’s intent

• sentenced to 42 months in prison for insider trading, even though he used a Rule 10b5-1 plan

• He was ordered to pay $5.2 million fine and give up $12.7 million in illegal profits

Regulation on Short Selling 

• Locate & Borrow Requirement 

• Uptick Rule/ Alternative uptick rule

• Margin Requirements

• Reporting and Disclosure 

• Restrictions in Crisis Periods 

Albert H. Wiggin

Led to the birth of major securities regulations

• Shorted shares in Chase National Bank, where he was CEO (40,000 shares)

• Hid the trades using other family-owned companies

• Ran his company down, and after the 1929 crash, he legally made $4+ million

• There were no laws against insider trading at the time

SEC v. Texas Gulf Sulphur Co. (1970)

The court stated that anyone in possession of inside information must either disclose the information or refrain from trading

Dirks v. Securities and Exchange Commission 

The Supreme Court held hat those who receive inside information from an insider are liable if they had reason to believe that the tipper had breached a fiduciary duty in disclosing confidential information 

SEC vs. Materia

First introduced the misappropriation theory of liability for insider trading

United States v. Carpenter (1986)

Found liability for a trader who received information from a journalist rather than from the company itself

September 2021 SEC charged a quantitative analyst 

• The analyst had a front-running scheme which generated him illicit profits of over $8.5 million 

• He had non-public information about the size and timing of his employers orders and would trade ahead of the employers trades - the SEC detected suspicious patterns

Martha Stewart 

• December 2001, she sold nearly 4,000 shares of ImClone Systems, a biotech company 

• One day later the FDA announced it rejected ImClone’s new cancer drug, and the stock price plummeted 

• CEO Sam Waksal had learned that the FDA would reject the drug and told his family to sell their shares

• Martha Stewart’s broker at Merrill Lynch, Peter Bacanovic, tipped her off that Waksal was selling 

• Steward then sold her shares 

• Stewart was not convicted of insider trading directly, but she was:

  • Convicted of obstruction of justice and lying to federal investigators about why she sold the stock (she was trying to protect the broker but it backfired) 

  • She claimed she had a pre-existing sell order at a specific price — which investigators later found was false.

Reliance Industries 

• In 2007, RIL planned to sell a large block of RPL shares 

• Before the sale, some RIL executives used confidential non public information about the upcoming sale to trade derivatives (futures contracts) 

• These trades were designed to profit from the expected drop in share price after the sale became public 

• Once the block deal was announced the traders made huge profits off the drop 

• In 2021 the Securities and Exchange Board of India (SEBI) ruled that RIL and their executives had violated insider trading laws 

• Reliance Industries to disgorge ~$60 million in illegal gains plus interest

• Barred RIL and Mukesh Ambani from trading in derivatives for one year

Raj Rajaratnam Founder of Galleon Group 

• Exposed for running one of the largest insider trading networks ever uncovered 

• Between 2003 and 2009

  • Obtained confidential MNPI from insiders at companies like Intel, IBM, McKinsey, and Goldman Sachs

  • Traded on that information before public announcements, earning over $60 million in illegal profits

  • Built a network of informants, including corporate executives, consultants, and bankers, who fed him tips about mergers, earnings, and deals

• The FBI used wiretaps and found that Raj was discussing confidential information and planning trades on it

• In 2011 Raj was convicted of 14 counts of security fraud and conspiracy

• Sentenced to 11 years in federal prison

• Paid $150 million in fines and forfeitures

• Galleon Group shut down post-scandal

Christopher Collins and his Son

• US Congressman from New York and sat on the board of directors of an Australian biotech company - Innate Immunotherapeutics 

• His son, Cameron Collins, and Cameron’s fiancee’s father, Stephen Zarsky, were also involved in the case

• In June 2017, Collins. received MNPI from Innate - he learned that the company’s multiple sclerosis drug trial had failed 

  • He immediately told his son about the bad news before the news was public

  • Cameron sold his shares in Innate and tipped off Zarsky who did the same

  • They avoided losses of around $800,000 once the bad news became public

• In 2018, both Christopher and Cameron Collins were arrested and charged with insider trading and lying to the FBI

• In 2020 Christoper Collins was sentences to 26 months in prison, but was pardoned by Donald Trump later that year

  • Cameron and Zarsky also pleased guilty and received shorter sentences

Fox News

Fined $1 million in NYC settlement of sexual harassment allegation

In addition to the fine, the settlement, Fox agreed for the next 4 years to waive forced arbitration clauses in employee contracts related to workplace complaints brought under the city’s human rights law.

2016-2017

• Former anchor Gretchen Carlson filed a lawsuit against Fox News chief and CEO Roger Ailes alleging sexual harassment

• Star Commentator ill O’Reilly had paid five women millions to keep allegations of sexual harassment in the dark. Upon hearing the news advertisers suspended their segments and O’Reilly was fired

• Shareholders upset that multiple allegations were a sign of a company culture that allowed for sexual harassment

• After the renewed contract, Fox agreed to pay over $32 million to settle shareholder claims related to O’reilly and Ailes scandal

• Was clear fox covered up the sexual harassment

Lawsuit Against CBS Corp. 2019 

• CBS Corp. Executives sold more than $200 million in company shares before disclosing claims of sexual misconduct against former CEO Les Moonves and other network officials 

• The day after news became public, CBS shares fell 6% on heavy volume, their biggest one-day drop in 11 years. 

• NY Attorney General Letitia James secured $30.5 million settlement from CBS, Former CEO Leslie. Moonves for Insider trading and Concealing sexual assault allegations 

• CBS senior leadership knew about multiple allegations and intentionally concealed them from regulators, shareholders and the public for months 

• The investigation also revealed that another senior executive sold before allegation were public to make profit 

Front-Running

• Buy the stock before their employer would and sell after the employer bought and the price increased

German fund manager

• Pleaded guilty to front running investment decisions securing ~9 million in profit for himself

  • He bought and sold shared worth over ~$600 Million for his employer daily and knew the trades moved prices ~2 cents per share

  • He would trade for his personal account seconds before placing larger orders for the stock on behalf of his employer

  • He told the judge he started insider trading because he was very unhappy with his pay and decided to get back at his employer to make up what he thought he deserved

White collar crime 

Frauds committed by business and government professionals 

SEC and regulators tools

• Suspends trading for up to ten days

• SRO’s can also halt trading in circumstances where there is a significant imbalance in the volume of buy and sell orders in a security

The Poyais Scheme 1822

• Gregor MacGregor, “ King of Con-men”

• Time of low interest rates and cheap credit

• New companies were venture often related to assurance

• He found an uninhabited piece of land along the coast of Honduras and created a fake country called Poyais

• He created a sales pitch and book describing it

• He sold over $1 billion worth of Poyais bonds and warrants in London

• When investors arrived in Honduras they realized there was nothing there and it was a wasteland

• France was stricter than England and put an end to his scam, bondholders lost everything

Poyais land grants second life

• Someone desperate used the Poyaisian warrant as a collateral for a loan

• For a long time nothing happened, and then there is a price increase in Poyais, for no apparent reason

• The “poor friend” holds in hope of further price increases and eventually liquidates for a profit

• still highlights how speculative bubbles and false hope can drive markets, even for worthless assets

Hertz Background

Hertz had a history of bad decisions, their financial model relied on asset-fronted debt (debt owed tied to the value of leased vehicles). 

• By 2018 numerous management changes, cost reductions, market improvements, and the stock price increases 

• By 2020 the company is ~17 billion in debt 

• Covid hits and the stock price tanks to .56

• Hertz filed for bankruptcy in 2020 

• They delisted to OTC

• In 2021 they emerged from bankruptcy after getting funding (July)

• Trades in OTC under new ticker

• Price rallied over 500% in the first half of 2021 and rose to around 27.6

• Listed on NASDAQ - oct 2022 it hovered around 17.9

Bankruptcy Vs. Chapter 11 Bankruptcy

Bankruptcy: is a legal proceeding involving a person or business that is unable to repay their outstanding debts

Chapter 11 Bankruptcy: generally provides for reorganization, usually involving a corporation or partnership. The debtor proposes a plan of reorganization to keep its business alive and pay creditors over time.

Who is the Centra; figure in The Spider Network and what was his role

The central figure is Tom Hayes- former derivatives trader at banks like UBS and Citigroup, he became deeply involved in the LIBOR (London Interbank Offered rate) manipulation scandal by coordinating submissions to influence the benchmark for profit

What is LIBOR and why did it matter in the scandal 

LIBOR (London Interbank Offered Rate) is a daily interest rate benchmark used worldwide for loans, derivatives, mortgages and other products. Because it affected trillions of dollars in contracts, even small shifts in it could generate huge profits - making it a target for manipulation

What was the “Spider Network”

The “Spider Network” was a nickname for the network of traders, brokers, and bank staff who colluded with Tom Hayes to manipulate LIBOR submissions nudging them slightly higher or lower. They exchanged tips, coordinated across banks and used the benckmark ’s weakness for profit

How did the manipulation of LIBOR functionally operate inside banks? 

Traders with large derivatives positions would ask LIBOR-submitting banks or brokers to adjust the rate up or down to benefit their positions; because submissions were self-reported and not strictly based on actual transactions, the system was vulnerable to influence 

What role did culture and incentives within banks play in enabling the scam?

Massive bonuses, risk-taking, and deference to traders: banks prioritized profit over ethics, compliance was weak, and many insiders assumed the behavior was accepted— contributing to the rampant manipulation

What happened when the scam was revealed ?

After the 2008 crisis, regulators and journalists began probing anomalies in LIBOR; banks (like Barclays, UBS, Deutsche Bank) paid large fines.

Tom Hayes was prosecuted, convicted and sentenced to a long prison term as one of the few individuals held criminally responsible

What was unusual about Tom Haye’s personality and how did it contribute to the story?

Tom Hayes was a math prodigy, socially awkward, likely on the autism spectrum— obsessed with numbers and derivatives. His outsider status made him both effective and vulnerable → Effective: His analytical mind and outsider perspective made him great at spotting patterns and profits. Vulnerable: He didn’t understand internal politics or ethics boundaries — when the scandal broke, he was isolated and blamed.

What is the author’s investigative advantage in writing the book

David Enrich secured unique access to Tom Hayes and transcripts, emails, chats and internal communications from banks — enabling a detailed, first-hand account of how the manipulation was orchestrated