Pick up a newspaper these days and there is plenty to read about enforcement actions on insider dealing. In fact as I write I have just received an email newsletter from a leading law firm in the U.S. on the very subject.
Developments on the enforcement of insider dealing offences are interesting but even more intriguing are the way enforcements are being implemented and why more obvious enforcement actions are not happening. Some of it is fairly obvious – what constitutes dealing on market sensitive information or material non public information can be difficult to prove and to bring a legal action can be costly both in terms of money and reputation for the regulatory authority although there is clearly a much greater appetite developing.
The way U.S. enforcement actions work – whilst a pragmatic way of getting results – are to my mind no more than a tax on wrongdoing through the use of consent orders and it is unfortunate that the FSA appear to be taking a leaf out of that book. What this means (and I have seen this thinking operate in practice) is that the ends justify the means and the end is always profitability – the measure of success in our business. This is the wrong approach to adopt for regulation – the regulator should not get fixated on the statistics of enforcement but on formulating a clear framework of what is acceptable and unacceptable and then taking a zero tolerance approach to what is unacceptable. Is this too idealistic? In the current framework of course it is, but with an election looming and the future of the FSA hanging in the balance – now is the right time to be taking stock on being an effective and fair regulator. The FSA may have a good reputation with those it regulates but its current approach erodes its principles based foundations.
When one looks at the US model of regulation I am puzzled by what it appears to condone. On the one hand we have press reports of zealous efforts with wire tapping on Galleon and on the other the existence of funds that raise questions by their very structure. Everyone knows that effective trading is dependant on the analysis of flows of information and it is clear that investors look to tap into that analytical prowess. Yet if a fund can exist that invests primarily in a single security and where the investment manager sits on the board of the company issuing the securities in which investments are made, are you only tapping into analytical ability? Even if trading occurs only outside closed periods how much knowledge can be imputed to unpublished market sensitive information? None it would appear. Difficult to prove one way or the other? Perhaps – but intuitively what conclusions might one reach even if intuition alone is insufficient? Yet I am not aware of any regulatory interest in funds of this nature. Perhaps there is some technical loophole in the rule based regulatory system that permits their existence – but if there is – what has been done to address it? I am not necessarily implying wrongdoing either, wilful or otherwise – it is well known and understandable that investors like to appoint directors on boards to protect their interests. The director has an immediate conflict between the fiduciary duties owed to the company to which he is appointed and the investors who have appointed him and upon whom they may rely in making investment decisions.
These can be difficult issues and can result in grey regulatory boundaries. Yet when a regulator takes enforcement action – should it be a reprimand that in effect is nothing more than a token fine for the institution?
We all know that regulatory boundaries are constantly being tested – so when one reads that a big name house has paid a regulatory fine with reductions to that fine for cooperation – the message delivered should not be seen to be simply yet another tax on the institutions profitability, because it got caught.
From a due diligence perspective it is often said that if an organisation has a history of regulatory fines it is best avoided – yet if one looks at a number of institutional grade houses there would be few that have unblemished records. But there is no sign of investors rushing to the exits because of the existence of such fines – is it because the investor’s focus is on the results rather than how they are obtained? Is it because they believe there has been a mending of ways? Is it because investors do not see the reasons for the fines to be matters for concern? Perhaps investors consider the pushing of boundaries on insider dealing and other regulatory issues to be to their advantage because they do not carry any direct risk from the manager’s actions? Does it mean that the regulators concerns are not aligned with those of the investors? Should they be?
It can be a puzzle.
©Jaitly LLP