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An event based approach for quantifying the effects of securities fraud in the IT industry

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Abstract

Detecting the incidence and impact of illegal insider trading is a difficult process since access to the actual trading records of insiders that overlap precisely with fraudulent events is difficult. This paper provides a case study of a specific IT stock in Canada that was successfully prosecuted in the Canadian court system for market manipulation and illegal insider trading violations. The study provides a quantification of the impact of insider trading activities by the President directly through his own account or through accounts under his control, and illustrates the impact of some off-exchange transactions by the impugned parties. Overall, the costs of the insider trading violations are quite high, given the significant wealth effects produced by the events surrounding this case.

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Notes

  1. Cour du Québec, No: 500–61–204,220-058, July 31, 2008.

  2. See http://www.kugler-kandestin.com/areas_class_jitec.html Class Action Léveillé -vs- Jitec Inc., now designated as Advantage Link Inc. & al.

  3. Altavista’s assets reported at the time of the acquisition were $6,447,000; it reported a net loss over its previous fiscal year of $1,264,000, as shown in the 2000 Crosbie Mergers & Acquisitions in Canada database. Altavista’s mining assets were transferred into a new company, called Strateco Resources Inc., and the shares distributed to Altavista shareholders. Altavista shares were consolidated on a 4-for-1 basis. Altavista issued 49 million new common shares to Jitec shareholders. Jitec became a wholly-owned subsidiary of Altavista. Altavista then changed its name to Jitec Inc. Jitec’s reported assets as of December 31, 1999 of $2,442,421.

  4. Canada NewsWire, June 19, 2000.

  5. See Exhibit P-93. Canada News Wire reports that the issuance of 49 million new shares

    provided Jitec with net proceeds of $ 9,339,186 in additional capital. See Canada News Wire November 29, 2000.

  6. Canada NewsWire, November 29, 2000.

  7. See e.g. J. Ritter and I. Welch (2002) In their Table 1, they show that average first day returns rose from 7.4% in the 1980s to 11.2% in the early 1990s, to 18.1% in the mid 1990s, and to 65.0% in 1999 and 2000.

  8. The sample is described in section 6.2. The first day average return for the high-tech group within the sample is 39.92%. For the non high-tech group it is 18.95%.

  9. Jitec’s closing prices for the next three trading days were: $4.70 (July 27), $6.55 (July 28). and $8.10 (July 31). On these days, trading in Jitec represented on average 23% of all shares traded on the Montreal Exchange. More Canada News Wire, June 19, June 20, and June 25 are almost identical in content. They all make the claim that: “Jitec Inc. is a leader in the Thin-Client branch of information technology, which many industry giants regard as the new wave in information systems. This market represents a potential of $25 billion to $35 billion, and Jitec Inc. is the only company offering a global solution in this particular field.”

  10. The abnormal return is defined as Jitec’s first day return less the IPO Benchmark return for the year 2000: (204% -56.1%) = 147.9%.

  11. The abnormal increase in market value can be attributed to the misleading information calculated as the product of the Jitec abnormal return (Jitec Return – Benchmark IPO return for 2000) and the value of the shares prelisting (the number of shares issued multiplied by the subscription price: 247.9%*53,845,242*$1.25 = $166,852,944).

  12. The total value of Laliberté’s share position that includes the free shares and the shares held in escrow at this price is $422,375,142.

  13. Canada NewsWire, November 29, 2000.

  14. Canada NewsWire, June 19, 2000: “According to company projections, revenues should start to soar in the third quarter of 2000, due to the huge potential of the niche targeted by Business Computing Advantage(TM).”

  15. Canada NewsWire, May 22, 2001.

  16. Ibid. In the company’s press release on June 19, 2000, Laliberté states: “Being listed on the stock exchange will allow Jitec to maintain the technological leadership of Business Computing Advantage(TM) and rapidly complete the deployment of this new, revolutionary computer service on a national and international scale. Jitec will also enjoy greater visibility among financial institutions and investors.”

  17. King (2009) shows a significant increase in the dollar value of net purchases disclosed by insiders (both directors and major shareholders) prior to the takeover announcement for the cases in which insiders are more likely to be informed about an upcoming bid. As he states: “This large increase undisclosed insider buying suggests that insiders do not fear prosecution and are trading in violation of insider trading regulations.”

  18. Brown and Warner (1985) also show that the detection of significant abnormal returns is robust to the estimation method.

  19. This was an involuntary announcement in order for the firm to comply with the demand of the Exchange to provide clarification on its previous press releases. The exchange had suspended Jitec shares from trading at the open of trade on October 16th until it provided clarification on its previous press releases. Trading was not reinstated on the company’s stock until October 18, 2000.

  20. Confirmed on this issue by Mr. Justice Wagner of the Superior Court on April 28, 2009, C.S.M. C.S.M. 500–36–004807-080 and 500–36–004651-082.

  21. Indeed, the considerable insider selling on this day, which represents trading on adverse information that is counter to the press release to avoid a further loss seems to have had a significant impact to counter the ostensible “no news is good news” content represented by this announcement. The effects of insider selling in Jitec are examined in section 5. An adverse reaction to this ostensible “no news is good news” announcement is also consistent with the “dog that did not bark” theory posited by Marin and Olivier (2008), that there is more to be learned from the absence of an action (for Jitec, it should have been the issuance of a material and truthful news announcement) than from its presence.

  22. The equal weighted index is used rather than the value weighted index as the proxy for the market portfolio, as in King (2009). During this period, the value weighted index gives a large weight to Nortel Networks, which was near its peak (trading at over $100 per share and representing about 1/3 of the TSX index). The results are very similar when one uses value weighted index as the proxy for the market portfolio.

  23. The dates that the Montreal Exchange suspended Jitec trading were October 16th and October 17th, 2000.

  24. CMVQ decision 2000-C-0692. Shareholders fortunes continued to plummet on a path that led to the extinction of the company as a publicly traded entity. On November 21st, the shares of Jitec fell to $1.38. Laliberté subsequently resigned as president CEO and director of the company and agreed to pay back $865,000 in advances that the company’s board had not approved. In addition, he agreed to pay back within six months $1.2 million related to Jitec’s previous retail stores’ inventory and accounts. Laliberté subsequently defaulted on this agreement, as was reported by the company on March 15, 2001, when the directors requested a trading halt on the company shares. Trading resumed on June 14, 2001, and Jitec’s shares closed that day at $.50. Jitec’s board then approved a name change for the company to Advantage Link Inc. (Ticker symbol AVK CN, CUSIP 00762P102). On October 1st, 2001 the company’s listing was changed to the Canada Venture Exchange. On March 15, 2002, with the company’s shares trading at $.16 it announced that it was proceeding to sell Laliberté’s block of 10,315,157 common shares. As stated by the company (CanadaNewsWire, March 18, 2002) the “proceeds of the sale will be used to acquit Mr. Benoit Laliberté’s debts to the company and that to the company’s knowledge, Laliberté will no longer hold any common shares in the capital stock of the company.” On December 13, 2002, a Cease Trade Order was issued by the by the CVMQ due to the failure of the company to file its quarterly financial statements. On June 23, 2003, it was delisted from the Venture Exchange.

  25. We also use both MSCI0IT equal and value weighted portfolios and get statistically similar results.

  26. This negative reaction is consistent with Kryzanowski’s (1978) findings of a negative reaction on reinstatement of allegedly manipulated stocks in Canada.

  27. This combines the abnormal market impacts of Press Release 1 and Press Release 2.

  28. Adjusted return is the return over CFMRC equal weighted index. Results include IPO initial returns are qualitatively similar.

  29. Results include IPO initial returns are qualitatively similar so are not reported for brevity.

  30. See F. Black and M. Scholes (1973), “The Pricing of Options and Corporate Liabilities,” Journal of Political Economy 81, (1973), pp. 637–59.

  31. The amount of the latter settlement was $9.85 million. See http://kklex.com/class-actions/securities-class-actions-vs-avantage-link-inc-formerly-jitec-inc-et-als/

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Acknowledgements

The authors would like to thank the seminar participants at the conference held by CFA–FAJ-Schulich Conference in April 2012 and Entrepreneurship, the Internet, and Fraud Conference in May 2016. Financial support from SSHRC to Switzer and Wang is gratefully acknowledged. Switzer would like to further acknowledge the support from the Autorité des Marches Financiers.

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  1. Finance Department, John Molson School of Business, Concordia University, 1455 De Maisonneuve Blvd. W., Montreal, Quebec, H3G 1M8, Canada

    Lorne N. Switzer

  2. Department of Management and Organizational Studies, University of Western Ontario, London, ON, Canada

    Jun Wang

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Correspondence to Lorne N. Switzer.

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Switzer, L.N., Wang, J. An event based approach for quantifying the effects of securities fraud in the IT industry. Inf Syst Front 19, 457–467 (2017). https://doi.org/10.1007/s10796-017-9753-3

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