Financial advisers and mutual fund executives are increasingly worried that the latest insider trading probe will result in regulations limiting how active fund managers are allowed to use outside research, hurting returns and prompting investors to flock to index funds.
“A lot depends on how regulators end up defining this gray area of research,” said Jason D. Lina, director of research at DCA Global Wealth Management, a registered investment advisory firm with $200 million in assets under management. “If more kinds of research end up being branded as insider information, it could certainly cause investors to question the value of active management.”
Federal investigators are looking at whether traders at various financial services firms received non-public information from so-called expert networks and third-party research firms.
On Nov. 23, FBI agents raided the offices of hedge funds Diamondback Capital Management LLC and Level Global Investors LP as part of the investigation. A few days later, Don Chu, a consultant with Primary Global Research LLC, expert research network, was arrested on insider trading charges.
Janus
Capital Group Inc., Wellington Management Co., Diamondback and SAC Capital Advisors LP, another hedge fund, have received subpoenas connected to the investigation. Janus and Wellington issued statements last week saying that they had been told they aren't targets of the investigation.
Janus spokeswoman Shelley Peterson said in a statement: “Janus has not been accused of any wrongdoing, and the government confirmed that Janus is not a target of its investigation into potential insider trading.”
Other fund companies, such as MFS Investment Management, Affiliated Managers Group Inc.'s Friess Associates and Columbia Management, which is now owned by Ameriprise Inc., also are clients of Broadband Research LLC, one of the research companies being investigated.
Many large fund companies rely on third-party research, and expert research networks in particular, to get more information about the companies in which they invest. And though nothing is wrong with using outside sources to get information, it appears that regulators are looking closely at whether the information that expert-research networks provide could be viewed as insider information.
“It gets dicey when the expert-research network is acting as a liaison to a company and the fund manager gets the opportunity to sit down with someone the manager otherwise wouldn't get to talk to,” said Catherine Botticelli, a partner at Dechert LLP. “The question is whether that person is an insider who is sharing non-public and material information.”
In the past, insider trading cases that were successful in the courts generally involved clear-cut situations of insiders' sharing material information that would affect the price of a company's stock, Ms. Botticelli said.
LIMITING INFORMATION
But this probe appears to be going further than that, observers said. And if regulators decide that fund companies can't use expert-research networks, it could severely limit how they gather information, ultimately hurting their performance.
“If insider information is being passed along, then I hope the full force of the law comes down,” said F. William McNabb II, president and chief executive at
The Vanguard Group Inc.
“But what we don't want to see is some sort of barrier being put up that prevents active fund managers from doing good fundamental research. That would change the kind of work that is done,” Mr. McNabb said.
A number of advisers said they anticipate that this probe will prompt many clients to switch to passively managed funds.
“I think that for clients who are on the fence about whether to move money from active to passive, this may push them over to index funds,” said Al Gardner, a wealth manager at DeSeranno Wealth Planning.
Richard Schroeder, a financial adviser with Schroeder Braxton & Vogt Inc., primarily uses index funds, and plans to discuss the probe with clients as being yet another reason to move to passive management.
“We are always talking about the advantages of index funds, and this could be another advantage for the list,” he said.
But Mr. McNabb cautioned advisers against using this investigation to promote passive management.
“Investors want to believe in the system and trust the people with whom they are investing,” he said. “Any scandal that takes away that trust is a negative for the industry, and it would be very shortsighted to say that's good for us.”
Mr. McNabb said he is not worried that any mutual fund firms will be implicated in the investigation.
“I suspect that when this is all said and done, this will be a non-mutual-fund issue,” he said.
Advisers, however, don't appear to be as optimistic as Mr. McNabb. Thirty-seven percent of 308 advisers surveyed by
InvestmentNews last week said that they will postpone investing in the portfolios of the mutual fund firms named in the probe until they are cleared.
At the same time, just 23% said that they are considering withdrawing client money from those companies' mutual funds, according to the survey.
“I don't know enough yet to be pulling assets from Wellington, but I am going to wait to put more money with them,” said Dan H. Boyce, a registered principal with the Center for Financial Planning Inc., an RIA firm with $650 million in assets under management.
E-mail Jessica Toonkel at [email protected].
