Hedge Funds May Be Responsible for Rise in Insider Trading

In recent testimony before the Senate Judiciary Committee, Professor John Coffee of the Columbia Law School suggested that hedge funds could be responsible for the increase in suspicious insider trading. More broadly, he called hedge funds the principal destabilizing force in corporate governance today. Hedge funds are different than mutual funds in two principal respects, explained the professor, they need not diversify and they can sell short. As a practical matter, mutual funds and pension funds do neither; the former must diversify, and latter are largely indexed. Thus, neither is as prepared to make a large firm-specific investment as a hedge fund.

That is part of the story, he continued, but the other part is that hedge funds are unregulated and their managers are not monitored as closely by compliance officers and counsel. Therefore, he said that hedge fund behavior may ``often resemble the Wild West.’’ There is the question of who would leak to a hedge fund since they are not loved by the business community. Here, emphasized the professor, the answer may be that because they trade in larger increments than more diversified institutional investors they will also pay more for useful tips. This point has a further implication: as usual, the most promising prosecutorial strategy is to “follow the money.”