Insider Trading Scandal at KPMG: A Belief in the Weakness of Enforcers

With all the press surrounding the foray of one of KPMG's now former senior partners into the murky world of insider trading, one is struck again by the stupidity of people.

This was no neophyte. This was a senior partner in a major accounting firm exchanging confidential client information for cash from a diamond trader. The news reports allege that the accountant downplayed the risks to his "client", dismissing the likelihood of being identified. While one would expect that the accountant’s professional ethics would ensure appropriate treatment of confidential client information, one would equally think that by now such people would be familiar with the risks of passing insider tips.

Evidently the accountant advised his accomplice and pay master that it would be very hard for any inside trading activity to be traced if he did relatively small trades. Well, apparently not, as the FBI turned up on the diamond dealer's door not long afterwards. Then it seems it was not too hard to "turn" the dealer and soon exchanges of envelopes stuffed with cash for his clients' secrets were being filmed by these "imbecilic" investigators.

Even after the effectiveness of the FBI and lawyers from the Department of Justice in successfully pursuing insider trading cases has been made clear in case after case, the myth of their ineffectiveness seems to continue in the minds of many. People should be put on notice that this is one branch of the government that works.

This belief in the omnipotent weakness of government seems to be allied with questioning in the mind of some as to the very illegality of insider trading (see Justin Grant's piece, which asks, Should Insider Trading Become Legal?). There appears to be confusion in the minds of some, the perpetrators it seems as much as anyone, over this crime. Some people appear to conflagrate the difficulty of proving insider trading (this can clearly be the case) with an alleged ambiguity of the law on this (there is none). Trading on inside information is about as clear a contravention of the law as plain old stealing. It is like being privy to the hands of your fellow players in a game of poker and the advantage is just as clear.

In all this, there is of course, the unmistakable element of hope - hope that springs eternal- behind these foolish schemes: hope that insider trading will somehow be OK, hope that those whose job it is to identify the perpetrators will be hopeless at their jobs. Greed apparently, for some, overtakes capacity for rational thought. The opportunity for this accountant, however, was hardly immense riches. Neither was it for the diamond dealer who was paying the cash.

[Shaking Up The Risk Teams]

Troubling in this context were the results of a recent survey of hedge fund managers reported on here by Phil Albinus.

According to this survey, 35 per cent of respondents reported feeling pressure from bonus plans to violate the law or engage in unethical conduct while 13 per cent said they would commit a crime — insider trading — if they could get away with it. In addition, 54 per cent reported that the SEC is ineffective in detecting, investigating and prosecuting securities violations.

There are two clear issues: first, to reiterate, thinking that the powers of enforcement are weak is surely sheer folly and second, the ethical issue needs to be confronted once and for all. As regards the second issue, the ethical question should be of greater concern to us since whether or not people get away with it is really beside the point. A major educational effort is obviously required to help those who work in the industry understand what the rules are and how to stay within them.

In addition, hedge funds, for their own good, need to have senior risk managers who can review new positions and strategies, the investment theses for them and the facts supporting them. Any potentially inside information should be disclosed and discussed, if necessary, brought to appropriate compliance and legal experts. Obviously a top priority for accounting firms should be to reinvigorate their training and controls on this issue. The industry needs to get ahead of these issues if it is to regain investors' and regulators' confidence.