In the wake of the alleged insider-trading ring involving
hedge fund manager Galleon Group, compliance departments at asset management firms and broker-dealers are stepping up their vigilance.
As regulators increase their scrutiny of insider trading, firms are actively reviewing their compliance policies, making sure that em-ployees understand them and conducting more audits of their trading patterns to make certain that nothing is potentially amiss.
“This is the hottest topic right now,” said Rick Nummi, executive consultant at Accounting and Compliance International. “At least once a week, we are getting calls from clients to come in and do a presentation on insider trading.”
The main worry at firms is that employees could be sharing information and unwittingly contributing to an insider-trading scheme.
“Many investment companies get alpha from information, so this calls into question what [constitutes] an inside tip and what is perfectly reasonable information,” said Meyrick Payne, partner at Management Practice Inc., a consulting firm. He noted that fund directors are holding meetings about these issues.
Financial advisers are aware that they must be more diligent than ever in making sure that they understand how their analysts and managers obtain their information.
“The last thing you want is to have your clients' money in a fund that gets in the headlines,” said an adviser at a national brokerage firm, who asked not to be identified.
Advisers also have to understand where clients get their own information.
“I have a client who is in an industry where it's hard to get public information,” said Madeline Noveck, a principal at Novos Planning Associates Inc. “So if that client is interested in a stock, I need to make sure she isn't basing that decision on inside information. That is my responsibility as the adviser.”
Active traders looking for the next hot stock will find getting information more difficult as the trading community grows reluctant to discuss things that might be construed as inside information, said Alex Quint, president of advisory firm Quint, Miller & Co.
“For the fast-money people who are looking to trade eighths and quarters, and who want to take advantage of the word-of-mouth process, this environment is going to make it harder for them to do that,” said Mr. Quint, who said he takes a more long-term approach.
Many advisers are concerned about the potential that a widening insider-trading probe is going to have on client
trust and on the markets in general.
“If we start to see a lot of these hedge funds begin to unravel, it's going to affect the markets,” said an adviser at a national brokerage firm, who asked not to be identified.
Since the investment scam involving Bernard Madoff, both the Securities and Exchange Commission and the
Financial Industry Regulatory Authority Inc. have stepped up their audits, which now include unusual questions. Over the past few months, for example, a number of broker-dealers have been asked how often they vet the cleaning crews at their offices.
“This was the third question asked of three of our broker-dealer clients during their last exams,” said Mr. Nummi, who is a former attorney in the SEC's Office of Compliance Inspections and Examinations.
“The reason I think they are asking that question is that Charlie Sheen dressed up as a cleaning person to get insider information in the movie "Wall Street.'”
Finra has not told examiners to ask specifically about cleaning crews, said spokesman Herb Perone.
As a result of regulators' increased scrutiny, firms are also expanding their compliance departments, according to the executive search firm Russell Reynolds Associates Inc.
Compliance hiring searches are up 20% from last year at this time, officials for the firm noted. “This is the strongest area of hiring we are seeing,” said George Wilbanks, managing director in Russell Reynolds' investment management practice.
“What I see at our own firm — and I imagine is the case at other firms — is that there are understaffed compliance departments coming out of the down market,” said a compliance executive at an investment management firm.
This executive, who asked to remain anonymous, expects to expand his compliance department over the next few months.
“We are all being pushed by regulators to step up our focus on compliance and surveillance,” he said.
Specifically, the firm is looking to hire five new compliance managers to oversee audits of its brokers throughout the country.
“We are looking to hire more-experienced people who can hit the ground running,” the compliance executive said. He estimated that salaries would range from $65,000 to $80,000.
The firm also is implementing an electronic surveillance system to oversee trades made by its broker-dealer. The cost of getting the system up and running, and hiring the people to run it, could amount to $8 million over the next couple of years, the executive said.
After seeing what happened with Galleon, the firm wants to make sure its employees understand that even passing seemingly innocuous information can get them in trouble if the recipient of that information is able to piece it together with information from other sources, the executive said.
“We are getting a lot pickier about who our guys talk to and what they share,” the executive said.
In his presentations with firms, Mr. Nummi is warning employees that if they receive any personal benefit for providing non-public information, they can get in trouble.
“That can just be a steak at Sparks Steak House,” Mr. Nummi said.
Many firms now are reviewing their “rumor procedures,” said Joel Sauer, a principal consultant at ACA Compliance Group.
“A lot of our clients are trying to get education about the potential risks of passing along unsubstantiated rumors,” said Mr. Sauer, noting that his firm has received a lot of requests for assistance on educating employees about insider-trading issues.
Compliance departments also are making sure employees are careful with how they use other forms of media, such as voice-over-Internet, social-networking websites such as Twitter, and blogs.
“People need to understand that the law is the law, no matter what communication medium they are using,” said Ralph “Chip” MacDonald, a partner at Jones Day.
E-mail Jessica Toonkel Marquez at [email protected].
