Tag: Insider Trading

Do Hedge Funds Create Criminals?

Lynn Stout takes the recent charges against arrest of Raj Rajaratnam, founder of the Galleon Group, and the recent raids on expert networks as an indictment of the entire hedge fund industry. She makes the mistake of using a few bad apples to state the whole industry is corrupt. The vast majority of hedge funds operate completely in compliance with the law and ethical obligations. You would not say the entire energy industry is corrupt because of the failures of Enron.

The expert networks Stout mentions are not your classic cases of insider trading. The involved parties were trying to get information about how a company is doing. By getting access to orders for computer chips you can make some estimates about how many computers a company is producing. Depending on the type of information, some should have been protected and some is just business intelligence.

After all, there is nothing wrong with looking at satellite photos of a shopping center to see how many cars are in the parking lot. Compare the photos from year to year and you may have a good indication of whether sales are up or down.

There is plenty of evidence demonstrating that bad environments contribute to bad behavior. That is backbone for compliance. Create an environment where there is more pressure to follow the rules than to break the rules.

Stout lays out three social signals that have been repeatedly shown in formal experiments to suppress pro-social behavior:

Signal 1: Authority Doesn’t Care About Ethics.
Signal 2: Other Traders Aren’t Acting Ethically.
Signal 3: Unethical Behavior Isn’t Harmful.

Signal 1 is the classic call for a tone from the top. Signal 2 is the classic call for corporate culture. Signal 3 is the classic call for regulatory (and criminal) enforcement.

No. Hedge funds do not create criminals. Unethical work environments create criminals. It’s a problem not just at hedge funds, but every industry.

Lynn Stout is the Paul Hastings Professor of Corporate and Securities Law at the UCLA School of Law and the author of Cultivating Conscience: How Good Laws Make Good People.

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Do Prosecutions Stop Insider Trading?

We generally assume that the prosecution of crime acts as a deterrence to others who may think about committing the crime. One of the key factors in fraud is opportunity. If the wrongdoer thinks they can not get away with the violation, they are less likely to commit the violation.

At least that is the theory. Social scientists have been looking at this strategy for a long time, with sometimes mixed results. My guess is that the deterrent effect will vary from crime to crime and deterrence strategy to deterrence strategy.

What about insider trading?

The UK’s Financial Services Authority has published a metric on insider trading. They look at the level of abnormal pre-announcement price movements (APPMs) in the share price of a company.

“The level of APPMs for the takeover data set has remained stable over the past few years including for 2009. The level of APPMs for the FTSE 350 data set remained at a low level in 2009.”

The data does not show any improvements. The data set is on the small side so it is hard to judge significance. The FSA program is also new. The program begin during a period of great turmoil in the financial markets.

On the other hand, the FSA’s new enforcement activity of criminal prosecutions and large fines did not affect the amount of abnormal pre-announcement price movements. If this robust enforcement activity is supposed to have a deterrent effect, it does not obviously appear in the data.

Perhaps robust enforcement activity catches more bad guys but does not reduce the bad activity.

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The SEC Drinks Its Own Champagne

The SEC has named its first chief compliance officer: Kathleen Griffin.

She will be tasked with oversight of employee securities transactions and financial disclosure reporting. The creation of a compliance program to prevent insider trading came from last year’s insider trading scandal at the SEC. The Office of the Inspector General reported that “the Commission lacks any true compliance system to monitor SEC employees’ securities transactions and detect insider trading.”

Ms. Griffin will have her hands full. From the SEC OIG Report:

The current disclosure requirements and compliance system are based on the honor system. and there is no way to determine if an employee fails to report a securities transaction. There are no spot checks conducted and the SEC does not obtain duplicate brokerage account statements. In addition. there is little to no oversight or check;ing of the reports that employees file to determine their accuracy or even whether an employee has reported at all. Moreover. different SEC offices receive each of those reports and do not routinely share that information with each other.

It’s good to see the SEC drinking its own champagne and hiring someone to focus on their own internal compliance issues. (Doesn’t “drinks its own champagne” sound better than “eat its own dog food.”)

Since the announcement came on April 1, I thought it was an April Fool’s Day joke. Why would the SEC hire the comedian Kathy Griffin? Clearly, I was being overly cautious about my news intake. I was not alone in this confusion and I’m sure will not be the last to draw the comparison between the two.

I’m sure Kathleen’s comments to the SEC employees will be less controversial than Kathy’s comments at the Emmy Awards.

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Mark Cuban and Insider Trading

The Wall Street Journal reported that the SEC filed insider trading charges against Mark Cuban (owner of the Dallas Mavericks basketball team): SEC Charges Mark Cuban With Insider Trading. You can read the full text of the complaint against Mark Cuban.

According to the complaint, Cuban owned 600,000 shares in Mamma.com Inc.  (now called Copernic Inc.), whose shares are trded on NASDAQ. Cuban was told of an upcoming PIPE transaction. News of the transaction would likely have a substantial negative impact on the stock of the company. On the day prior to the announcement, Cuban sold all of his shares in the company and avoided losses in excess of $750,000.