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Hedge Fund Woes After U.S. Crackdown Don’t Surprise SEC’s Chair

Hedge fund returns have fallen off a cliff since U.S. prosecutors and regulators initiated a sweeping crackdown against insider trading in recent years. Securities and Exchange Commission Chair Mary Jo White is among officials who’ve taken notice.

“I don’t think anyone would argue that some of those returns at some hedge funds, and I don’t want to paint with too broad a brush, can be attributable to obviously trading on insider information that one is not allowed to trade on,” she said in a Thursday interview on CNBC. White made the comments in response to a question about whether there was a link between lackluster hedge fund performance and the government’s aggressive enforcement.

The arrest of Raj Rajaratnam in October 2009 set off what could be called a golden age for insider trading cases, with at least 75 others convicted in the ensuing years. The hedge fund industry responded by dramatically beefing up compliance. Some firms now constantly snoop on their traders’ e-mails and instant messages, and others have hired dozens of legal advisers to keep employees in line.

In about seven years since Rajaratnam’s perp walk, hedge funds that invest in stocks have gained 33 percent, according to Hedge Fund Research Inc. Such funds gained 55 percent in a similar time period leading up to his arrest. The lagging returns have prompted hedge-fund investors to pull billions of dollars from the industry and forced some firms to shut down.

Hedge funds have also switched from handily beating stocks to trailing them, as the Standard & Poor’s 500 Index has risen 100 percent since October 2009. The benchmark index gained 13 percent over a similar length of time before Rajaratnam’s arrest. Insider trading continues to be a focus at the SEC. Last month, the agency brought a case against billionaire hedge-fund manager Leon Cooperman, who has repeatedly denied wrongdoing.

The government has suffered setbacks. In December 2014, the U.S. Court of Appeals in New York ruled that prosecutors must show that a defendant knew their tips came from someone who had a duty to keep the information secret and that the leaker got a benefit from passing it on. The decision prompted the government to drop about a dozen cases, while imposing new burdens on investigators. The debate over what information funds can legally trade on continues to simmer, as the U.S. Supreme Court heard arguments on an insider-trading case this month for the first time in two decades.

White declined to comment on the case against Cooperman during the CNBC interview. “We’ve always maintained a very aggressive program,” she said about the SEC’s efforts to go after insider trading.

This article was provided by Bloomberg News.

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