Wednesday, September 19, 2007

Back to The Future - Inside Information 80's Style

It looks as if the SEC is stepping up its examination of insider trading at hedge funds. According to Bloomberg "SEC officials told hedge funds to list clients and workers who serve as officers or directors of publicly traded companies, along with the names of any relatives who hold such posts, according to a 27-page letter to industry executives."

I have to say. My market radar has been sounding the alarm for some time now and I will tell you why. Read the book The Junk Bond Revolution. You will have to buy an old copy but you can get it through Amazon (link on the right). It is the story of the all powerful junk bond market of the 80's where billions were being made by lots of young people and the King of it all, Mike Milken, came crashing down after being accused of inside information. This was against a background of political concerns over the role junk bonds played in the market.

The problems started for Wall Street when Ivan Boesky was caught red-handed trading on inside information for his arbitrage fund. That quickly lead to lawyers, investment bankers and analysts being arrested and put in hand cuffs for all to see. There is a good account of the whole thing in 'Inside Out' - a confessional book of Dennis Levine, one of the culprits (also available on the Amazon link, right)

The case against Milken was brought under the RICO statutes in the US, which were originally designed for the Mafia. This effectively closed down Drexel Burham Lambert (Milken's fim) and eventually lead to Milken recieving a 10 years prison sentence (he served just over 2) even though they found only $300,000 worth of trades that were suspect. Considering he earned a then record of $500mn this seemed more of a political statement than anything else. Rudolph Guliani was Mayor at the time.... and he is going for the highest job in the land now...enough said.

My point here is that there has been a raft of corporate convictions with Enron etc and there is now an environment of political criticism of both the hedge fund and private equity industry, there are also many politicians who would love a large hedge fund or private equity scalp to kick off their carreer. With the markets being turbulent, people losing jobs as PE bought firms are 'rationalised' and huge earnings being atributed to hedge fund managers and PE firm bosses alike, it just seems to me that the environment, and will, is now there to reign in the industry one way or another.

I hate to be the prophet of doom, but can you see the similarities too?

The odds of not finding someone trading on inside information is small, in my opinion, because it is just too lucrative for some to ignore. With some deals involving over 1000 people as reported in some corners of the press, can you tell me that absolutely none of them traded on inside info? If you think that you are not only 'away with the fairies', you have probably bought a house in Goa and smoke copious amounts of mind bending drugs.

We, in the industry, know it goes on and so do the politicians and regulators. I will make a prediction now that someone big, somewhere, is going to pay the price and this SEC investigation is just the start.

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