The cost of the insider-trading investigation

By Felix Salmon
November 26, 2010
put out of business merely because they're being investigated by the FBI.  

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It’s not just small shops like John Kinnucan’s Broadband Research which have been put out of business merely because they’re being investigated by the FBI. Multi-billion-dollar hedge funds are faltering too: the latest to suffer devastating redemptions is FrontPoint partners. Max Abelson says it’s “on death’s door”, while Henny Sender reports:

Already senior staffers of FrontPoint are interviewing for jobs with other firms, one person with direct knowledge of the matter adds.

“It is difficult for an entity to keep going because at a certain point the business ceases to be viable whether it has crossed the line or not,” said the head of one firm which invests tens of billions of dollars in hedge funds on behalf of clients.

“The regulators effectively put them out of business.”…

Investors in these hedge funds say they have no choice but to pull their money at the first hint of trouble.

“If I get even a whiff of an investigation, I want to get out before the next guy, especially if I know they have illiquid stuff or I don’t know what they have,” says the head of one fund of funds.

The FBI’s insider-trading investigation, then, has already caused hundreds of millions* of dollars in damages — the value of FrontPoint alone has probably fallen a good $200 million since its involvement in the investigation was made public. And of course to date no one’s been convicted of anything.

This makes investigations very difficult: the FBI cannot be certain, when they start investigating a company, that it’s guilty of insider trading. That’s why they need to investigate it. But by the time any conviction actually happens, the damage has long since been done — and indeed will have been done even if there’s an acquittal or no charges at all.

I don’t know if there’s any way around this: certainly the FBI has to be able to investigate companies it suspects of wrongdoing. But does the existence of those investigations need to be made public, at least before any charges are brought?

*Update: I meant hundreds of millions of dollars, but originally posted hundreds of billions of dollars. Apologies, my bad. Thanks to Sean Matthews for noticing.

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