The investigation into first-day trading of Facebook shares has revealed that large firms have a practice of disseminating information to a select group of hedge fund managers before making it known to the investing public.
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The practice is called front-running and regulatory rules prohibit it. The SEC has launched an investigation. The matter disgruntled smaller investors who lost money on Facebook shares during the initial public offering (IPO).
The practice of certain hedge funds seeking information from analysts before it has been made public has been active for a long time and is growing. The funds send out questionnaires to analysts and can pick up clues in the answers they receive.
The stated purpose of the questionnaires is to gather public information but several actually state that the purpose is to gather non-public information for the purpose of trading ahead of other investors. Official policies of the funds may prohibit the practice but these funds are large clients of the analysts’ firms and the information has been given out to keep commission dollars rolling in.
The purpose of the questionnaires is stated differently by public hedge fund documents than certain other confidential documents within the funds. Analysts across the globe receive the surveys.
Global regulatory bodies have discussed the appearance of wrongdoing but, so far, little has been done to effectively police the situation. FINRA proposed new rules in 2008 for equity research report dissemination but it has yet to be enacted. A revised rule that also includes fair trade of debt securities is expected to be proposed later in 2012.