With the Spotlight on the Financial Crisis, Regulatory Loopholes, and Hedge Funds, How Should Hedge Funds Comply With the Insider Trading Laws?

Abstract

Since 2007, when it commissioned a working group to investigate insider trading in the hedge fund industry, the U.S. Securities and Exchange Commission (“SEC”) has leveled particular scrutiny at insider trading by hedge funds. Accordingly, it issued subpoenas to over fifty hedge fund advisers in July 2008. The SEC is not alone in this pursuit. On June 19, 2008, the Federal Bureau of Investigation, in conjunction with the Department of Justice (“DOJ”), arrested two former Bear Stearns hedge fund managers, Ralph Cioffi and Matthew Tannin, in connection with the collapse of two Bear Stearns hedge funds. Among other things, the indictment alleges that, while Mr. Cioffi and Mr. Tannin informed investors of a positive outlook, Mr. Cioffi transferred $2 million of his own money, about one-third of his personal position, out of a fund that invested primarily in collateralized debt obligations (“CDOs”). In addition to charges for securities and wire fraud, Mr. Cioffi has been charged with insider trading. Despite this increased scrutiny, no market practice has developed to assist hedge funds in complying with insider trading laws and to offer them the protection of collectively conforming to commonly accepted norms. To help fill this void, this Article proposes guidance on insider trading compliance for hedge funds and other institutional traders with similar concerns. Unlike the vast majority of the literature on insider trading, the focus of this Article is risk reduction and prevention rather than litigation or academic analysis. In particular, it considers how hedge fund compliance policies should take account of derivative and debt securities as well as the globalization of securities markets. Both of these areas present interesting legal issues in an evolving context of recent market and legal developments. For the many hedge funds that are highly active traders of debt and derivative securities in global markets, both of these areas are of special concern.