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Front-running: Is Wall Street tipping off HFs?

The SEC has launched a probe into allegations that Wall Street firms might be tipping off certain customers, namely hedge funds, before large trades are made by mutual funds, a practice often referred to as "front-running".

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.

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