The financial community is understandably shocked by the resignation of Berkshire Hathaway’s David Sokol, who until this week was on the short list of successors to Warren Buffet. For those of you who missed the story, Sokol bought millions of dollars in the chemical company Lubrizol just before encouraging Buffett to acquire them.
Sokol’s decision to buy shares in Lubrizol and then pitch it to Buffett (and, it seems, Citigroup as well) shows an amazing lack of judgment. It certainly constitutes an ethical violation that threatens to tarnish Berkshire Hathaway’s and Buffett’s’ squeaky-clean reputations. We’ll have to sit tight to see to whether Sokol and Berkshire will be merely embarrassed or wind up facing insider trading charges.
As risk mitigation consultants, we encourage our clients to pay attention to cases like these and view them as a reason look closely at their own compliance strategies. If you’re a CEO or investment manager, you might want to ask yourself what you would do tomorrow if you were presented with an outlier trade in your organization, or if you’ve done enough proactive internal intelligence and analysis to mitigate such issues before they blow up.
A hedge fund client, frustrated by the increased compliance demands around assessing his insider trading risk, recently turned to me and said: “It’s not like my traders and PMs are going to write an email saying, ‘let’s insider trade this stock’ or ‘hey, I got some inside information we should trade on!’” My initial thought: stranger things have happened.
But the point was a fair one. While it’s true that the history of insider trading cases is littered with head-scratching emails and incriminating statements, current-day portfolio managers, traders and analysts are quite cognizant of how their trades are monitored. They know the keywords to avoid in emails, they know what not to discuss on their work phones, and what type of trades will raise the eyebrows of their internal compliance department and securities regulators.
A case in point: The second week of the Raj Rajaratnam trial highlighted just how far individuals will go to cover their own insider trading tracks. The government provided evidence that Mr. Rajaratnam instructed colleagues on how to create a fraudulent email trail in order to make it appear as if they had done their due diligence on a stock and invested on fundamentals rather than insider information. He suggested drafting emails in which they discussed “how cheap” the stock was in order to create a smokescreen. Subsequently, he also suggested that a co-conspirator trading on inside information place a flurry of trades in a short period of time (i.e. buy 10,000 shares, sell 5000 a couple days later) in order to make it more difficult for regulators to detect insider trading.
With this sort of activity on the public record, the question for a compliance-minded mutual fund or hedge fund becomes: where does this leave an institution that wants to increase internal transparency, identify potential insider trading and network risks, and stay out of the regulators’ crosshairs? What proactive solutions are available to avoid the fate of the Level Globals of the world?
In reality, there is no simple answer. One should start with the idea that the SEC has begun thinking outside the box in evaluating data and deciding where to bring insider trading investigations. Gone are the days when internal staff can simply examine outlier trades and send document requests on that basis alone. The SEC uses wire taps and other sophisticated technologies; they identify the overlap of suspicious trades with social and professional relationships; they look closely at both internal and external data sources to track down potential insider trading.
We’ve seen that banks, hedge funds and mutual funds have been slower to understand the SEC’s current approach and slower still to embrace potential outside the box testing and evaluation of traders, trade risks, and relationships. Still, adopting such practices would allow them to see these issues through the SEC’s lens and mitigate potential problems.
Traditional methods of regulatory due diligence and internal compliance focusing on trade issues do not embrace proactive testing, evaluation of outlier trades, or the understanding that technology and relationship networks have changed the nature and scope of risks faced by financial organizations.
The Galleon case is a particularly egregious example of insider trading, but the industry should learn from it and understand its ramifications and not dismiss it as an outlier. Financial organizations are already familiar with the environment created by the Galleon case: investors redeem their money at the slightest hint of a regulatory issue; regulators fire off document requests at the slightest provocation; investigators use the press as a weapon.
By the time an insider trading risk leads to a public investigation, it’s already too late for a fund to survive. Sustainable and successful companies in this environment cannot, therefore, be merely reactive. Instead, the goal must be an honest, proactive approach to identifying and mitigating potential risks associated with trades, traders and relationships. By taking a proactive approach, financial institutions show investors and regulators they are serious about risk mitigation and a culture of compliance.
Funds need to put themselves in a better position with skittish investors and demonstrate a proactive posture. An enthusiasm for testing and risk analysis goes a long way toward easing concerns when a regulatory inquiry is initially opened. The development of a culture that prevents regulatory violations and resulting inquiries can be a complex and multi-layered. It’s an ambitious goal, but one that’s attainable for financial organizations willing to take a critical look at themselves, their potential trade issues, and their risk from a difference perspective.
El Mapa de Riesgos y la planificación de plantillas atenúan el impacto de las desvinculaciones masivas
En los últimos meses la crisis ha obligado a muchas
empresas a prescindir de muchos de sus empleados. En
unas ocasiones se ha tratado de despidos puntuales, en otras
que ajustes de plantilla masivos. El impacto de estos despidos,
también conocidos como desvinculaciones, ha incidido sobre
la gestión del talento y sobre el clima laboral. Para analizar las
consecuencias de las desvinculaciones masivas Capital Humano
ha organizado un coloquio, en colaboración con la consultora
K2 Global, en la que un grupo de expertos han analizado cómo
minorar el efecto de los despidos en las organizaciones. La confección
de un Mapa de Riesgos, la planificación de plantillas y la
comunicación son algunas de las medidas que proponen para
recuperar el clima laboral y conseguir el compromiso de los que
se quedan después de las crisis.
Joseph Goldstein’s March 3rd article in The New York Times, “In Social Media Postings, a Trove for Investigators”, is an interesting discussion of real life examples of Facebook and other social media helping criminal investigators move a case forward.
Yet as the article notes, social media research is not without weakness. While looking at someone’s Facebook or LinkedIn profiles (and related relationships) can shorten an investigator’s research time, it can also overload the investigator with information, some of it potentially misleading.
Unlike the investigations cited in the Times article, K2 investigations focus less on questions of guilt or innocence and more on risk – i.e. whether a subject is safe to do business with, represents him or herself honestly, or has risky relationships. Thoroughly understanding risk means more than merely confirming the existence of a relationship or figuring out where someone was at a certain time.
Whether we are charged with determining how capable an executive is, or understanding the relationship between a trader and a public company, or evaluating the principal of a startup, we have to remember that subject’s online profile and social connections may be compelling and informative, but they are still the product of subjective, user-generated content. It takes thorough investigation and objective analysis to understand the frequency, quality and meaning of a subject’s online interactions and the risks they reveal.
Las consultoras de máximo nivel ‘se cuelan’ en los
despachos de los consejeros delegados y reorientan el rumbodelas compañías.
Jeremy discusses due diligence and its importance to the bond ratings business.