How Can Hedge Fund Managers Update Their Insider Trading Compliance Programs to Reflect the SEC’s Focus on Systemic Violators, Gatekeepers, Trading Patterns, Profitable Trades and Expert Networks?

Insider trading enforcement remains a top priority for regulators and prosecutors.  For example, just this month to date: (1) Joseph F. “Chip” Skowron III, a former healthcare portfolio manager at FrontPoint Partners LLC, pleaded guilty to conspiracy to engage in insider trading and obstruction of justice; (2) the DOJ brought conspiracy to commit securities fraud and wire fraud charges against Stanley Ng, the former SEC Reporting Manager at Marvell Technology Group, Ltd., for allegedly providing material nonpublic information to Winifred Jiau; (3) the SEC charged a former professional baseball player and three others with insider trading ahead of the early 2009 buyout by Abbott Laboratories Inc. of Advanced Medical Optics Inc.; and (4) the SEC charged a California man with purchasing Marvel Entertainment call options while in possession of material nonpublic information obtained from his girlfriend (who worked at the Walt Disney Company) regarding Disney’s acquisition of Marvel.  In this still-heightened insider trading enforcement climate, hedge fund managers remain a prime target for civil and criminal insider trading charges.  This is so for at least five reasons.  First, regulators and prosecutors have been emboldened by the May 11, 2011 conviction of Galleon Group founder Raj Rajaratnam on 14 counts of conspiracy and securities fraud.  See “Implications of the Rajaratnam Verdict for the ‘Mosaic Theory,’ the ‘Knowing Possession’ Standard of Insider Trading and Criminal Wire Fraud Liability in the Absence of a Trade,” Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Second, wiretapping has become a viable tool for investigating insider trading by hedge fund manager personnel, and a source of persuasive evidence.  See “Will a Criminal Court Admit into Evidence a Recorded Telephone Conversation Between a Hedge Fund Manager Charged with Insider Trading and an Alleged Co-Conspirator?,” Hedge Fund Law Report, Vol. 4, No. 24 (Jul. 14, 2011).  Third, in the course of examinations of hedge fund managers, SEC examination personnel are looking for (among other things) evidence of insider trading that can serve as the basis of referrals to the SEC’s Enforcement Division.  See “Is a Hedge Fund Manager Required to Disclose the Existence or Substance of SEC Examination Deficiency Letters to Investors or Potential Investors?,” Hedge Fund Law Report, Vol. 4, No. 18 (Jun. 1, 2011).  Fourth, the staff of the SEC’s Enforcement Division can now use tools developed in the criminal context in bringing, negotiating and settling insider trading charges against hedge fund managers.  See “Entry by SEC into a Non-Prosecution Agreement with Clothing Marketer Illustrates How Hedge Fund Managers May Survive Discovery of Certain Insider Trading Violations,” Hedge Fund Law Report, Vol. 3, No. 50 (Dec. 29, 2010).  And fifth, budgetary constraints have led the SEC to place a higher priority on deterrence, and insider trading actions against hedge fund managers are thought to have a powerful deterrent effect.  See “Key Insights for Registered Hedge Fund Managers from the SEC’s Recently Released Study on Investment Adviser Examinations,” Hedge Fund Law Report, Vol. 4, No. 5 (Feb. 10, 2011).  In light of the vigor with which civil and criminal authorities are pursuing insider trading actions – and the ongoing susceptibility of hedge fund managers to insider trading charges – the Regulatory Compliance Association’s Fall 2011 Asset Management Thought Leadership Symposium will feature a session entitled “Insider Trading – The New Enforcement Paradigm.”  That RCA Symposium will take place on November 10, 2011 at the Pierre Hotel in New York. (Subscribers to the Hedge Fund Law Report are eligible for a registration discount.)  Scott Pomfret – Regulatory Counsel for a Boston-based institutional money manager and a former branch chief in the SEC’s Division of Enforcement – participated in the insider trading session during the RCA’s Spring 2011 Symposium and is expected to participate in the RCA’s Fall 2011 Symposium.  As a former regulator and current in-house counsel, Pomfret has a unique, and uniquely relevant, perspective on insider trading enforcement trends as they relate to hedge fund managers.  By way of revisiting some of the topics that Pomfret discussed during the last RCA Symposium, and by way of preview of some of the topics that he may discuss at the next RCA Symposium, the Hedge Fund Law Report recently conducted an interview with Pomfret.  Our interview covered: Pomfret’s background; a shift in the focus of the SEC’s insider trading enforcement efforts; the rationale for and implications of the SEC’s focus on “gatekeepers”; how the SEC collects and uses hedge fund trading data; the role of trade profitability in allocating SEC enforcement resources; how hedge fund managers can answer investor questions about SEC inquiries; specific steps hedge fund managers can take to mitigate insider trading risk when using expert networks; three specific ways in which hedge fund managers are revising their insider trading compliance policies and procedures; and insider trading concerns for hedge fund managers that typically invest in “private” securities and assets.  The full text of our interview with Pomfret is included in this issue of the Hedge Fund Law Report.

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