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Trading ahead of client accounts. Insider trading. Breach of fiduciary duty.
These were just some of the concerns that the SEC had when it adopted the requirement for investment advisers to establish policies to monitor employee personal trading in 2004. While seemingly straightforward, in the decade since the adoption of SEC Rule 204A-1, investment advisers still struggle to find the right balance of policy, procedure and cost in meeting the Rule’s requirements.
What’s the right employee personal trading policy? No one policy is right for all hedge funds. Ban all personal trading? Allow only trading in mutual funds? Let employees trade freely? Depending on the type of securities that the fund trades, the right policy can be derived. However, it is not as easy as it sounds, as consideration must be given to a variety of factors, including the potential for receipt of non-public information, trading against the fund and what the fund’s related securities markets are.
How is the fund going to collect and review all those personal account statements? This is where the passage of time since 2004 is telling. The Rule requires not only the establishment of personal account trading policies, but the collection of “holdings and transaction data” on regular basis. However, the explosion of online and discount brokerages has led to proportional increase in the sheer volume of employee personal accounts, thereby creating a massive amount of paper that has to be sorted and reviewed. In response, a small industry has grown up around the collection of this data, which leads to the next consideration…
Cost: Whether the fund dedicates internal personnel to this task, or attempts to automate the process, there is a cost associated with this task. Make no mistake, handling the task internally can be a very time-consuming task. From ensuring that all required statements have been received, to actually reviewing them, the hours add up quickly. Automation can help, but can be costly and not perfect, in that receipt of all statements automatically may not be possible. Either way, funds eventually come to the conclusion that this is not an insignificant task.
What are we looking for anyway? And here lies the rub… The easy part is to check for personal trading in restricted securities or lack of proper pre-clearance of a trade. Beyond that, it can get a little difficult. Should you check for trading against fund positions? Signs of insider trading or attempts to manipulate the market? These sound like worthwhile endeavors, but how would you do that? While methods of digger deeper into the information collected do exist, as noted above, this exercise needs to be balanced against cost.
Read more articles about the hedge fund industry and related legal issues at Hedge Rows, a blog by Judith Gross.
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