Hedge Funds and Insider Trading
A truism of investing is that
to beat the market consistently, an investor must either take
above-average risk or trade on inside information. That inevitably
casts a cloud over hedge funds, which exist to beat the market. Many
fail, sometimes spectacularly so. But many succeed. The question is,
The Wall Street Journal reported that Eliot Spitzer was asking just
that question. Shortly before he resigned as New York’s attorney
general to become the governor, Mr. Spitzer opened investigations into
whether employees at companies including Best Buy and Circuit City had
improperly given nonpublic information to hedge fund managers.
Two research firms, the Gerson Lehrman Group and Vista Research, a
unit of McGraw Hill, are also under investigation. They specialize in
matching up people who have information — say, middle managers — with
clients who crave information, like hedge funds managers. The firms
collect fees from hedge fund clients and pay sources as consultants.
Business for these firms has boomed since 2000, when federal regulators
enacted disclosure rules that made executives at public companies wary
of speaking privately with big investors.
It will be up to the prosecutors to determine if the matchmaking
firms merely appear to be conduits for nonpublic information, or if
they indeed are. The firms say they follow procedures to guard against
any inappropriate disclosures.
But the safeguards seem weak. Gerson Lehrman told The Journal that
it reminds its consultants not to divulge confidential or restricted
information. A Vista spokesman said consultants must sign an ethics
code that says they’re “never expected” to comment on their employer.
New York’s new attorney general, Andrew Cuomo, should pursue any
wrongdoing. And the new Congress should move forward with hedge fund
regulation. The possibility of a destabilizing meltdown only grows the
longer the funds escape oversight.