12/01/2010

Federal Probe Prompts Compliance Reviews

The SEC's latest insider-trading investigation has hedge fund managers working overtime to calm worried investors and drill their employees on compliance procedures.

After news broke last week that federal investigators had raided three hedge fund firms and served subpoenas on two others, fund managers across the industry were flooded with calls and e-mails from their shareholders. Had the manager received a subpoena or otherwise been contacted by the SEC? Does he do business with any of the firms targeted by the probe? Does the firm have an adequate compliance framework?

Despite being on high alert, most managers remained confident in their trading strategies and continued to rely on their regular research channels, both inside and outside their firms. A key focus of the insider-trading probe is on independent research networks that sell proprietary stock analysis to hedge funds.

"People are at work," said a lawyer whose client had received a subpoena. "It would be irresponsible to say, 'I'm not going to invest in securities,' when that is your mandate."

Still, many managers are taking steps to ensure their investment staffers are extra careful when it comes to handling information about the companies they invest in. Among other things, they are reviewing their compliance procedures and conducting refresher courses for employees.

"People don't want to make mistakes," one industry lawyer said.

For example: Staffers are being reminded that if they receive an e-mail from a source containing questionable information about an investment, they shouldn't delete it. Instead, they should report it to the firm's compliance officer.

"If someone lobs you something that looks or smells like you shouldn't have it, you have to deal with it," another lawyer said. "It's out there, and if someone in the firm winds up trading that stock - even if they didn't see it - that can cause problems."

Irwin Latner, a hedge fund lawyer with Herrick Feinstein in New York, said independent research firms have become an increasingly important source of information for larger hedge fund firms that can afford paying the high fees.

"When it comes to the [research] networks, chief compliance officers need to get more forensic and dig deeply into how [the networks] are being used," Latner said. "Even if a firm is not the focus of an investigation, there is reputational damage that goes to the core of a firm's existence."

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