Fair or Not, Insider Trading's Touch Can Taint
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Friday, November 26, 2010

Fair or Not, Insider Trading's Touch Can Taint

Being "touched" by an FBI insider trading probe appears to be enough to put a hedge fund out of business. The question facing mutual funds going into the Thanksgiving weekend is whether the emerging scandal will merely touch a handful of mutual fund firms or slam into them in a full broadside. So far, there is no hard evidence that mutual funds are among the FBI's targets. Indeed, the only funds involved have been subpoenaed, which in many cases means nothing more than the authority desperately wants more information.

While the's Christopher Westfall follows the subpoena trail from Wellington Management and Janus Capital, its coverage stresses that "the mutual fund business does not currently appear to be the focus of the government's investigation into insider trading" (just ignore the somewhat alarming headline "Mutual Funds Touched by Insider Trading").

While hedge funds are closely related to mutual funds and close only counts in horse shoes and handgrenades (and nuclear war), TheStreet does admit that mutual fund firms will be dealing with fallout from the investigation whether or not any mutual funds turn out to be actual FBI targets.

The news outlet turns to former director of the SEC's investment management division and current Willkie Farr & Gallagher partner Barry Barbash to make that point: "At this point it's very hard to say it's an active compliance issue for [mutual] funds. But it will mean even more pressure on compliance, which has already been ratcheted up."

Some of that pressure will also be media driven. reporter spoke with spokespeople at both Vanguard and Hartford (two firms for which Wellington is a subadvisor to mutual funds) and in both cases the fund advisors stood by Wellington.

"We have a long standing relationship with Wellington, and we are confident in the firm," the Vanguard spokesman reportedly said. "It's important to denote that there have not been any allegations of wrongdoing on Wellington's part. We are in contact with the firm and we stand behind that relationship."

"The Hartford Mutual Funds enjoys a long-standing relationship with Wellington Management on behalf of our shareholders," emailed the Hartford spokesperson."While we are following this matter closely, we remain committed to our relationship and the investment services Wellington Management provides our clients."

Meanwhile, InvestmentNews' Jessica Toonkel took one more step down the same path on Wednesday afternoon. She also obtained comment from Vanguard and the same comment from Hartford. Vanguard's John Woerth told Toonkel that Vanguard has received “a handful of client inquiries” on the matter. Woerth also emphasized Vanguard's “rigorous oversight process of our external advisers, which are subject to several levels of controls and regulation to protect the interests of Vanguard shareholders.”

She also interviewed John Hancock Funds CEO Keith Hartstein. Hancock also employs Wellington as a subadvisor. “As you would expect, we have been in close contact with Wellington,” he emailed her.

The costs at hedge funds of being directly involved in the insider-trading probe are steep. reports that the three hedge funds raided on Monday -- Diamondback Capital Management LLC, Loch Capitaland Level Global Investors LP -- are seeing heavy redemption requests and are likely to close their doors.

"Just being named in the insider trading scandal is probably going to seriously damage the hedge funds that have been subpoenaed," states the article before it adds that "And for Loch Capital, Level Global, and Diamondback, the hedge funds that have been raided by the FBI, because they've had search warrants acted out on them, they're (most likely) done for. That's what we've been hearing from several people, anyway."

A fourth fund that employed a trader who has been tied to receiving insider information has seen redemption requests for $3 billion of its $7 billion in AUM, according to the Financial Times.

The consequences of allowing insider trading should make observers wonder whether management at Janus and Wellington would have allowed such activity to take place. Gary Black was brought into Janus following the fund scandals of 2003 to restore the Denver firm's reputation. Would he have allowed insider trades merely to boost a fund's track record? Would Black's successor Tim Armour have done so? Or new CEO Dick Weil? If improper trading was important enough to improve a fund's performance someone in management would have known. If it was not that important, why take the risk?

The same could be said for Perry Traquina at Wellington. The Boston asset manager handles more than $200 billion in subadvisory mandates, mostly for Vanguard. Any whiff of impropriety would likely cost it that relationship. And Wellington's core business is on the institutional pension business, an area where reputation counts as much or more, than performance.

To take such reputational risks, the gains must be proportional. Hedge funds, which can use leverage more freely to magnify a small edge and where the partners -- often that includes traders -- of the hedge fund gain the overwhelming reward are a much more logical realm for this scandal to unfold.

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