In other cases, the issue is not whether a bank acted as an improper conduit of information, but whether it acted on that information for its own benefit. That risk is at the root of the Australian Securities and Investment Commission’s (ASIC) current investigation into a unit of Citigroup. As the bank was advising Toll Holdings Ltd. on its $4.6 billion Australian ($3.3 billion U.S.) bid for Patrick Corp., its own trading desk (ostensibly behind the Chinese wall) bought up shares of Patrick on the trading day ahead of the bid’s public announcement. Citigroup dumped the shares at the end of the day, creating a profit for the bank of between $50,000 and $100,000 U.S. and contributing to a higher acquisition price for Toll, ASIC charges.
While Citigroup does not dispute the facts of its trading and profit, the bank says it did nothing wrong and “intends to vigorously defend itself,” according to a statement from Stephen Roberts, CEO of Citigroup Corporate and Investment Banking.
Regardless of the merits of that case, it’s clear that secrets are hard to keep on Wall Street. A recent study by Canadian firm Measuredmarkets Inc. suggests that leaks may have occurred in 40 percent of big companies that were acquired in the past year. The study, which looked at 90 $1 billion–plus deals, found that, in 37 cases, abnormal trading during the deal-making process did not coincide with any publicly announced news. The New York Times reported that anomalous trading coincided with bankers’ private meetings in at least 5 cases. However, it is not as obvious that advisers are double-crossing clients. “The study doesn’t tell us where the leaks are coming from,” says Measuredmarkets founder Christopher Thomas, adding that bankers he knows privately express frustration with the trend as well.
Further opportunities for leaks come on the lending side, via credit derivatives, or contracts that insure one party against another’s default. The credit-default-swap market grew from $632 billion in the beginning of 2001 to more than $17 trillion by the end of 2005, and banks are increasingly using the hedges — often with hedge funds as their counterparties — to help offset their risks from lending. That not only means banks are less invested in helping rehabilitate troubled companies, it also means they may be pressured to share confidential, nonpublic information about their lending customers with counterparties.
“The first thing a hedge fund or bank that buys one of these [credit-default swaps] will want to do is hedge it, and in today’s market, there’s so much pressure on banks to try to sell these things, there’s a lot of leakage,” says Christopher Whalen, managing director at Institutional Risk Analytics.
Homing In on Hedge Funds
It’s still unclear how pervasive any of these potential conflicts are. “This looks a lot like the 1920s, when a couple of great stories led to the Glass-Steagall Act, but you can always find great stories,” says Northwestern’s Petersen. “The question is, is this a 5 in 100 problem or a 50 in 100 problem?” For the most part, U.S. regulators seem inclined to believe the best about the banks, even as their international counterparts are concerned about the links between a regulated business — banks — and unregulated hedge funds.