Finance

Is Insider Trading Sometimes OK?

The SEC says a hedge fund trader made more than $1 million based on a tip a bond salesman shared with him. The bond salesman called it a "nice little kiss," this morning's WSJ reports.

The SEC has filed a lawsuit alleging insider trading, but the men are arguing, in part, that the whole thing is none of the SEC's business.

The trader's profit came from buying and selling credit-default swaps — a financial instrument that acts like an insurance policy, and pays off if a borrower defaults on a loan.

Those swaps played a key role in the financial crisis, but they remain largely unregulated. Swaps are traded in private deals; there are no public exchanges like there are for stocks.

And in the case brought by the SEC, the the trader and the salesman argue that because swaps are private contracts, they are outside the purview of the SEC, the WSJ says. That raises broader questions about whether federal regulators can go after insider-trading cases involving credit-default swaps.

The men accused in this case also say they have done nothing wrong, and that the kind of information shared in this instance is shared all the time.

The issue of whether the SEC can go after insider trading in credit-default swaps has been around for years, Felix Salmon noted this morning. He pointed to this Bloomberg story from way back in 2006 that showed how the market for credit-default swaps moved before big public announcements — a pattern that suggested insider trading.

"In a market that is completely opaque, all sorts of abuses are made easier,'' the former director of trading at the Commodity Futures Trading Commission told Bloomberg at the time. "The temptation to make money, in a way that would be unacceptable in a regular market, is just too great."

The finance-reform bill working its way through Congress may bring more regulation to credit-default swaps. But just what that will look like remains unclear.

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