Assessing the likely effects of alleged inside information

In a highly publicised prosecution being brought against the chairman of an ASX listed entity, our experts were asked to assess the findings of the prosecution’s expert, which were proposed to be put before the court in a potential jury trial.

Greg Houston, Sarah Turner and Alyse Corcoran reviewed the opposing expert’s analysis of the likely effect of the alleged inside information on the price of the ASX entity’s shares. They found that the analysis and conclusions suffered from four critical deficiencies.

First, the prosecution’s expert did not assess the likely effect of the inside information by reference to market expectations of the company’s future cash flows. Rather, the analysis focused on an historic comparison between the inside information and the company’s known performance for the same period in the prior year. In adopting this approach, the prosecution’s analysis eschewed the long-standing financial principle that the price of an efficiently-traded security reflects the present discounted value of the future cash flows expected to be generated by the underlying asset.

Second, the prosecution’s expert did not recognise that, had the company made the alleged inside information available to the market, it would also have released all other, relevant information. Such other relevant information had the potential to mitigate the likely price effect of the more limited set of information that was said to be known only to insiders.

Third, the valuation methods adopted for the purpose of assessing the likely effect of the inside information were inconsistent with mainstream financial theory and involved a misuse of those methods.

Finally, the expert’s application of those valuation methods was highly conditional upon quantitative assumptions or contentions made without explanation or reasoning. For example, no explanation was given as to why the inside information would have caused an investor to expect the company to experience as reduction in ongoing earnings that was equal to the current year’s shortfall.

Our work assisted in ensuring the prosecution expert’s analysis was withdrawn and a satisfactory outcome achieved for the respondent, underlining that the analysis of inside information must draw from mainstream financial theory, consider all available information and adopt sound assumptions.

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