Wall Street's biggest banks are under investigation for allegedly tipping off their favoured hedge fund clients when other customers are planning big share trades. The hedge funds are accused of profiting from the information by using it to predict when a big sell or buy order will move a particular stock.
The Securities and Exchange Commission, Wall Street's watchdog, is examining trading data from dozens of banks and their clients over a two-week period last year, in what will be one of its largest ever sweeps of information in the battle against insider trading. It demanded the data in letters to brokers, including Morgan Stanley, Deutsche Bank and Merrill Lynch, last month. None of the banks would comment last night.
Mutual fund managers have long fulminated about the practice of "front-running", where traders take positions knowing a big buy or sell order is about to move the price of a stock. It makes it more difficult for the mutual fund to do the trade at a good price, and therefore disadvantages mutual find investors, who are usually ordinary savers.
Hedge funds - which cater only to rich investors - are more active traders and pass more business through brokerage firms, making them more valuable clients.
SEC spokesman John Nester said that the commission had a strong track record in taking action against insider dealing. "Information leakage as a concern to the SEC is not new. We know that information leakage can harm investors. What is new is the methodology of looking closely at the same time period and at the same trade."
Investigators will comb through millions of trades carried out in the equity and derivatives markets in the final two weeks of September, traditionally a busy time for mutual fund managers rearranging their portfolios ahead of the end of the third quarter. They believe that hedge funds are being given tip-offs from one broker that they then act on by trading through a different firm. That makes the paper trial more obscure, but circumstantial evidence could be thrown up by a careful analysis of data from across Wall Street.
"If an investment bank is tipping a hedge fund on a trade we are doing on Dell, those people all need to go to jail," Andrew Brooks, vice-president and head of equity trading at the mutual fund company T Rowe Price told The New York Times. "We are absolutely concerned and worried and paranoid about information leakage, information that would allow someone to know about our trades and run ahead."