SAC fine serves as warning to hedge funds on compliance, says IMS
The $614 million fine doled out to SAC Capital by the SEC should serve as a warning to hedge funds on the risks of insider trading, as well as ensuring they maintain strict controls and compliance frameworks in regards to their research processes, a regulatory compliance firm has said.
“The SEC has been bolstering its resources for dealing with insider trading cases such as SAC Capital for several years now and the agency has emphasised that it will be making increased use of technology to spot potential frauds. The SEC is looking at aggregating market data whereby it looks at orders on national exchanges, modification or cancellation of orders, execution of those orders as well as trades executed off exchange, and they have the ability to identify anything that jumps out," said Patrick Shea, managing director at HedgeOp Compliance, part of the IMS Group in New York.
The SAC fine was one of the biggest recorded for insider trading. A $600 million fine was issued to SAC Affiliate CR Intrinsic Advisors following allegations a portfolio manager traded two pharma stocks based on insider information from an expert network employee who divulged negative drug trial results. The portfolio manager in question is still facing charges. Meanwhile, Sigma Capital Management, another SAC affiliate, was fined $14 million for trading Dell and Nvidia stock in advance of earnings announcements in 2008 and 2009.
“The SEC and other federal regulators are extremely focused on insider trading. They are allocating resources in this area and are strengthening their ability to identify and pursue problematic trades. Hedge fund managers are also focused on avoiding risks related to disclosure of material non-public information and insider trading - it is something hedge fund managers need to take into account,” said Shea.
The case has bought again to the fore the role of expert networks, which have been subject to intense scrutiny over the last few years following several other insider trading scandals. Shea said many hedge funds he knew had improved their compliance procedures when dealing with expert networks.
“The clients we work with have beefed up their oversight and compliance procedures around expert networks. Front-end controls are typically in place and intense due diligence is conducted prior to any contact with expert networks. Many compliance personnel will ensure there are tight compliance terms in any agreement and strong controls in place, whereby expert network employees are required and trained not to disclose material non-public information. The calls with expert network consultants are closely monitored and it is not unheard of to have a compliance officer listening to conversations between experts and hedge fund analysts as well as tracking email exchanges,” said Shea.
The SEC is also conducting on-site examinations and has reportedly questioned numerous managers about their use of expert networks. “The SEC has delved into how hedge funds research companies and use expert networks. Given the regulatory scrutiny and risks to a manager, it is essential that managers have policies and procedures in place for monitoring research and in any dealing with expert networks. This very often includes regular training of employees on best practices to avoid the risks associated with material non-public information,” he said.
A Washington DC-based lawyer from Allen & Overy recently warned managers using political intelligence firms to bolster their compliance standards in light of growing SEC and Congressional interest in these organisations. This comes amid concerns some hedge funds have not applied the same rigour to their compliance standards when dealing with political intelligence firms as they do now with expert networks.
The SEC recently issued subpoenas for emails and documents from Marwood, a political intelligence firm established by Edward Kennedy Junior, following allegations the company may have warned its Wall Street clientele, including several hedge funds that the Food and Drug Administration was going to delay approval for a diabetes drug. One hedge fund is reported to have taken a substantial short position in the drug company following this advice generating a neat profit.
Nonetheless, Shea was confident many hedge funds had rigorous procedures in place for dealing with political intelligence firms. “Hedge funds we work with typically take a broad view in terms of potential risks and would treat political intelligence firms similar to expert networks in terms of compliance obligations surrounding the possible disclosure of material, non-public information,” he said.