An SEC spokesman said that the regulator "is looking into potential information leakage that could be unfairly benefiting customers at the expense of others." He added that all the big firms on Wall Street would be investigated, and that hedge funds would be among those that might be being tipped off, but are not necessarily the only investor base receiving such information.
A high level of complaints from mutual funds has apparently prompted the SEC to take action. One industry body that has been urging an investigation is the Investment Company Institute (ICI), whose members hold more than 20% of the value of publicly traded US equity outstanding. ICI president Paul Stevens started pressuring the SEC in 2005. "Unfortunately, confidentiality and anonymity are not conditions we can take for granted," he says. "As several recent cases brought by the SEC illustrate, there are individuals and firms quite prepared to profit unlawfully by obtaining information about mutual fund and other institutional orders and trades and then ‘trading ahead’ of those orders. We owe it to fund shareholders and the market at large to root out such abuses, where they exist."
Can abuses be proved? Intermediaries often have to tout around to see how much interest there is for a trade by a large institution, and defenders of Wall Street have been quick to say that there is too fine a line between "tipping off" and "gauging interest" to be able to pinpoint the guilty.
That’s not so, argues David Remnitz a senior managing director at FTI Consulting. FTI advises financial companies on areas including SEC investigations. "Yes there may be a challenge in exploring all the different sources of information, communication and trades that would reveal tip-offs but technology today can deal with that," he says. "But how difficult is it to prove if illegal activities have been going on? Not very difficult. Most of what people do today is recorded in some way, which will allow the SEC to determine which organizations have been involved in direct trading ahead or trading information – knowingly or unknowingly.
"As for telling a tip-off from a genuine business communication, there is the technology to build up specific patterns, words and phrases that appear in one and not the other to develop a model that can quickly search through the databases of information."
Hedge funds are implicated in the SEC probe because they pay more commission to Wall Street firms than mutual funds do. So some mutuals argue that hedge funds are treated as preferred customers.