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How MAR II changes the game of insider trading for the buy-side

Insider trading has been with us for as long as there have been financial markets. At first, and right up until the early 20th Century, the practice was not illegal and was even viewed as something of a company perk. With greater regulatory oversight from the 1960s there followed a period of high-profile insider trading cases such as the Galleon hedge fund scam, Enron and even the Martha Stewart scandal.

These incidents often resulted in long prison sentences for those involved (in the case of the Galleon scandal billionaire Raj Rajaratnam was given the longest prison sentence in history for insider trading). The message from the courts and the regulators was clear: participate in insider trading at your peril.

Yet despite highly punitive sentences, insider trading persists. As CNBC recently pointed out, asset managers agree that while insider trading is much more difficult to carry out than in the past, it is absolutely still happening. Indeed, in 2015 the SEC charged 87 parties in cases involving trading on the basis of inside information.

When it comes to buy-side firms, this has important implications. In the past, the buy-side has largely been able to avoid the market surveillance tasks used to identify cases of insider trading; outsourcing this function to their broker partners. With the introduction of MAR II on July 3rd however this all changed: firms can no longer rely on the control provided by their brokers and must instead operate compliance policies to identify and control market abuse – including insider trading.

With MAR II, insider trading suddenly becomes a much more important consideration for buy-side firms; but putting in place the regulatory compliance and surveillance systems required by the regulation could prove highly costly and complex. Yet it is something firms must get right if they are to avoid falling foul of the Regulation.

If buy-side firms are to be able to adequately report on insider trading and other market abuses, they will need to build a completely new system. This is because the complexity of the data and the entity level for monitoring is very different than for the sell-side. Moreover, the way portfolio managers are measured impacts the risk of manipulation. As a result, a typical sell-side solution will not apply for the buy-side.

To build an in-house system, buy-side firms would need to invest significant sums in what would constitute nothing less than a complete overhaul of their compliance and reporting systems. Finding the skilled technicians and compliance officers to oversee this change would similarly prove challenging.

Insider trading has not gone away, but thanks to market regulation it is a bigger compliance challenge than ever for the buy-side. Managed compliance solutions will prove critical in helping firms rise to this challenge.

These topics will be debated at RIMES 2nd Regulatory Seminar in London, 27th October, to register, please email events@rimes.com

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