FSA flexes its muscles on insider trading

Sat May 1, 2010

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By Neil Wilson

Last October the Securities and Exchange Commission caused a sensation when it unveiled its wide-ranging insider dealing probe into Raj Rajaratnam and the Galleon hedge fund group. Notwithstanding some glaring omissions over the years—such as, most embarrassingly, its failure to lay a glove on Bernie Madoff—the Galleon case, with its Hollywood thriller-style use of wiretap evidence, can only have enhanced the SEC's reputation as a get-tough, no-nonsense regulator.

More recently, in the U.K.—after the United States still the second biggest center for hedge funds—the Financial Services Authority has also made a high-profile move against an alleged insider dealing ring. In late March it revealed that it was taking action against seven individuals from various companies in London.

Unlike Rajaratnam, none of them was actually a hedge fund manager. Although those charged included Julian Rifat, a well-known execution trader at Moore Capital Management's London operation, Moore was quick to point out that the charges had nothing to do with its funds and that it was cooperating fully with the investigation.

As with the SEC case against Galleon, the FSA move came with a spate of publicity, ensuring that the FSA was also seen as an agency taking serious action. After the initial surprise, however, many in London were underwhelmed. As one prime broker told me, "If they deployed more than 200 agents, you would have expected them to catch some bigger fish—like one of the big equity managers—not just people mainly from the sell side."

Insider trading is, of course, a notoriously difficult thing to prove. But the FSA had been warning for some time that it was stepping up its investigatory activities and hinting that some high-profile action would be taken.

Nevertheless, the agency does unfortunately seem to have got itself into a position where it can't really win, whatever it does at the current time.

Over the past decade, as the hedge fund industry grew in London, the FSA was widely hailed as a light-touch regulator, with appropriate, not invasive, regulatory requirements. Until the credit crisis, at least, its approach appeared to have been vindicated, with the hedge fund industry growing strongly but remarkably scandal free compared with the United States, where there was a regular pipeline of frauds, blowups and other scandals.

Some cynics may see this as evidence that the FSA was not so much a light-touch as a soft-touch regulator. But in the U.K. there have been few scandals, and most have involved firms with non-U.K. origins and connections, such as the implosion of Absolute Capital Management, which was set up initially in Mallorca, Spain, by the German manager Florian Homm. The cases of Weavering Capital, headed by former Swedish prop trader Magnus Peterson, and Dynamic Decisions Capital Management, headed by Italian professor Alberto Micalizzi, are two exceptions.

But overall the U.K. regulatory scheme for hedge funds seems to have worked pretty well: It requires registration for all managers, even those managing only offshore funds, with a "fit and proper person" test barring those with criminal records, backed up by independent administration.

The problem for the FSA is not really hedge funds. It has been the ongoing controversy surrounding regulation of the banks. This goes back to the decision in 1997 of then-Chancellor Gordon Brown to hand over authority for setting interest rates to the Bank of England.

At the time, partly to avoid concentrating too much power at the Bank, Brown took away its supervisory authority over banks and handed it to the FSA.

After the financial crisis the FSA was attacked for not having been up to the joof regulating the banks, with the opposition Conservative Party, leading in the polls ahead of the U.K. general election in May, now proposing to hand that power back to the Bank of England.

Some in the hedge fund industry agree with this line of thinking, including one who told me recently: "The FSA is, unfortunately, a busted flush. What it's doing here is a case of too little, too late."

This critic of the agency viewed the FSA's recent action on insider trading as a last-ditch move to try to save its own role in the system.

But there are probably many more in the industry who would regard the diminution of the FSA with dismay, especially when hedge funds are fighting the threat of new restrictions from the European Union. AR

ISSN: 2151-1845 / CDC10004H

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