Inside Trading Becomes ‘Systemic’ at Hedge Funds, Khuzami Says

Date: Friday, November 13, 2009
Author: Joshua Gallu, Bloomberg.com

Insider-trading cases among hedge funds including Galleon Group LLC may reflect a “systemic” behavior that has spread within the industry, Securities and Exchange Commission Enforcement Director Robert Khuzami said.

“You have funds whose business model consisted of vigorous attempts to collect information from corporate insiders and to utilize that information to trade,” Khuzami said yesterday at the Bloomberg Washington Summit. Such an approach is “potentially more dangerous” than previous insider-trading cases that reflected “opportunistic” behavior, he said.

The SEC has sued more than 20 people and firms in the past month, including billionaire Raj Rajaratnam and his New York- based hedge fund Galleon Group, in a broader crackdown on insider trading. The lawsuits, based in part on wiretaps and years of data-mining, allege that hedge-fund managers and traders obtained tips, at times in exchange for payment, on corporate deals and earnings that generated as much as $53 million in illegal profits.

“I’m sure that the vast majority of hedge funds and others operate in a lawful manner,” Khuzami said. “However there are some aspects to hedge-fund operations that do give enforcement types like myself concern,” he said, citing algorithmic trading, dark pools and the lack of a corporate culture of compliance among the issues. In a dark pool, trades are matched without posting quotes on public exchanges.

Laws forcing hedge funds to register with the SEC will increase transparency and improve compliance, he said.

Tips ‘Uptick’

Rajaratnam and his accomplices were part of a network that shared confidential tips on at least 10 companies, including Google Inc., Hilton Hotels Corp. and Intel Corp., investigators said Oct. 16. The lawsuits name witnesses who cooperated with authorities. Rajaratnam and the others have denied wrongdoing.

Since the arrests were announced, the SEC has seen an “uptick” in individuals coming forward with information on misconduct, Khuzami said, adding that people trading on confidential information “should be worried.”

Khuzami, 53, said prosecutors will continue using undercover techniques including informants and front businesses to attract wrongdoing and wiretaps to “ferret out” misconduct. The SEC has endorsed legislation that would let the agency pay whistleblowers for information leading to a case.

Khuzami, a former federal prosecutor who joined the agency in March, is reorganizing the division to add front-line investigators, speed inquiries and create specialized units after the agency was faulted for missing Bernard L. Madoff’s Ponzi scheme. He’s also seeking to bolster his attorneys’ powers by gaining greater access to grand-jury evidence and expanding deal-making and cooperation with informants.

The SEC is also looking “closely” at laws in the 2002 Sarbanes-Oxley Act, which let the SEC punish executives for misconduct at firms even when they aren’t involved in the wrongdoing, he said last month. Sarbanes Oxley was enacted to combat corporate fraud after accounting scandals at Enron Corp. and WorldCom Inc. shook investor confidence.

To contact the reporters on this story: Joshua Gallu in Washington at jgallu@bloomberg.net.