SEC to Focus on Derivatives as Insider Probes Expand

Date: Tuesday, November 24, 2009
Author: David Scheer and Joshua Gallu, Bloomberg

The U.S. Securities and Exchange Commission will focus on financial instruments such as derivatives as it broadens a crackdown on insider trading by hedge funds, enforcement director Robert Khuzami said.

“The days of insider-trading scrutiny being focused almost solely on the equity markets are now gone,” Khuzami said today at a New York legal conference on hedge-fund regulation. After bringing its first insider trading case tied to credit default swaps in May, the SEC will “roll back the curtain on those markets and look at patterns across all markets,” he said.

Insider trading has become “systemic” behavior in the hedge-fund industry and the SEC is working with criminal authorities to ferret out misconduct, Khuzami said this month. Billionaire Raj Rajaratnam and his New York-based Galleon Group are among more than 20 people and firms the agency has sued since Oct. 16 in its probe of hedge funds.

The SEC brought its first insider-trading case tied to credit-defaults swaps in May, when it sued a Deutsche Bank AG salesman on claims he illegally fed information on a bond sale to a hedge-fund money manager. Prices on credit-default swaps, which insure investors against bond defaults, have surged before corporate takeovers in recent years, fueling speculation that traders are abusing inside information. The SEC has said since at least 2007 that it’s examining the trades.

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company’s ability to repay debt. The contracts, typically expiring after five years, pay if a borrower fails to meet obligations.

Khuzami, in an interview today, declined to say whether the SEC has any current insider-trading investigations involving derivatives.

Confidential Tips

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 last month. Rajaratnam and other defendants have denied wrongdoing.

The lawsuits, based in part on wiretaps and years of data- mining, allege that hedge-fund managers and traders obtained tips, sometimes in exchange for payment, on corporate deals and earnings that generated as much as $53 million in illegal profits.

Khuzami, a former federal prosecutor who joined the SEC in March, is adding front-line investigators, speeding inquiries and creating 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.

To contact the reporters on this story: David Scheer in New York at dscheer@bloomberg.net; Joshua Gallu in Washington at jgallu@bloomberg.net.