If the Internal Revenue Service is the governmental agency most feared by Americans in general, then the U.S. Securities and Exchange Commission (SEC) is the agency most feared by Wall Street, in general, and by hedge funds in particular.

Illegal insider trading has been the SEC investigators’ priority target for decades and with the 2011 adoption of a bounty offered to whistle-blowers pursuant to Rule 21f of the Securities Exchange Act, the SEC has enhanced its ability to reach potential targets. As recently as June 3, 2014, a pair of whistle-blowers were awarded almost one-half million dollars each, one of 8 bounties paid since 21f’s implementation.

The Irony Is Palpable

Running a successful hedge fund requires keen insight—insight gained from a variety of sources. Geo-political events, market trends, corporate strategies, mergers, acquisitions, innovations, interest rates, unemployment, government policy shifts, inflationary trends and deflationary signals represent but a fraction of the information a hedge fund manager must consider when making an investment decision.

The information gathering process necessary to make sound investment decisions continually exposes hedge funds to the possibility of arousing the suspicion of regulators as it relates to insider trading. As a consequence, many hedge fund firms engaged the services of political intelligence companies. These enterprises, usually manned by former lobbyists and other political insiders, gather and sell information to investors of all stripes. This information is not secret, not classified; it is simply difficult for any single individual or firm to compile.

Ironically, many of these political intelligence firms, also reeling from regulatory pressure, are turning to computer algorithms which analyze public data, eliminating the need for any interaction with Congress or other policy makers. This makes it extremely difficult for regulators to build a case against them for insider trading because no direct link can be made between the intelligence firm and any individual.

Maneuvering Through the Minefield

To what degree the fund manager’s fiduciary responsibility to his investors is thwarted by the regulatory process is impossible to gauge. One thing, however, is certain; ambiguities in regulation and law have blurred the line between the legal and the illegal to such an extent that investment decisions are being made in the absence of information that might have been routinely accessed just a few years ago. Now it is judged to be too dangerous to exploit.

Of course hedge funds and other Wall Street firms are not the only targets of regulators. There is the recent case involving allegations of insider trading against golfing great Phil Mickelson. Mickelson, involved in a trade of Dean Foods (DF) shares, netted around $1 million in gains.

Hedge funds and all other investors should have the right to seek information from government sources as long as trades are not based on non-public information. Furthermore, investors of all stripes have the right to expect unambiguous laws and regulations. Until these ambiguities are eliminated, no one is well-served. In such an ambiguous regulatory and legal environment, all available information is not pursued for fear of investigation and, as a result, the decisions made are not as well-informed as they might otherwise be. Does anyone believe this serves the public’s best interests?


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