Hedge-Funders Are Now Supposed to Be Nervous About the SEC

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Raj Rajaratnam. Photo: Patrick McMullan

When the federal government swooped in to take down Galleon Group founder Raj Rajaratnam, the reverberations didn't just stop with his own hedge fund. To begin with, the five other people arrested in conjunction with his alleged insider-trading scheme were highly placed elsewhere: IBM executive Robert Moffat, for example, was considered to be a lead contender to take over the company some day soon. Now he's been placed on leave. But on a broader scale, the hedge-fund community has bigger things to worry about than this particular scandal. This morning, Bloomberg swept away the curtain behind which the Securities and Exchange Commission had been hiding a complex new program they've quietly been using for two years to weed out more clusters of insider trading.

Basically, the program works this way: The SEC mines data from the hundreds of millions of "blue sheets" (records provided when the SEC looks into an exchange of stocks) to find patterns of traders who make similar lucrative, well-timed bets over time. Looking for connections among such clusters of traders, the program can turn up what might be the common link — for example, a law firm that advised on a particular deal, or a bank that may have handled it.

While Raj Rajaratnam wasn't brought down using this technology, his downfall (his lawyers maintain he's not guilty of anything) combined with the revelation of this new system (which has already felled some hedge-funders) might mean big changes for a secretive industry that currently can easily hide suspicious trades here and there behind a cloak of thousands of other trades, coincidence, and what they call skill.

U.S. Said to Target Wave of Insider-Trading Networks [Bloomberg]