Last year, German police arrested a senior fund manager in Frankfurt for insider trading. The fund manager worked as a senior portfolio manager for 16 years at Frankfurt-based Union Investment, one of Germany's top asset managers, overseeing actively managed equity funds with €31bn in assets.
The employee admitted to "front-running" investment decisions he made on behalf of his employer on 55 occasions in 2020, making €8.1m in net profit. According to the Financial Times, the defendant can face up to five years of imprisonment.
During the trial, he told the judges that he started insider trading because of a pay rise frustration. In 2019, he received half the pay he expected and decided to make the rest of the money himself trading.
In one of his front-running, "he spent €913,000 on call options for shares in Deutsche Post just seconds before placing a large order of the stock on behalf of Union that moved the share price by 2.7 per cent. He sold the options within an hour, making a profit of €227,000".
What is front-running?
Front-running is the illegal practice of purchasing a security based on advance non-public information regarding an expected large transaction that will affect the price of a security. An example is when a client orders a large stock, the employee or broker executes his own order (before the client's order) then performs the client's order. As a result, the stock price can go up, and the employee or broker makes a profit on top of non-public information.
Front-running is considered a form of market manipulation and insider trading because the person who traded knew in advance that the security price movement would change. The Corporate Finance Institute gives other examples of front-running illegal activities in this article.
Front-running has been explicitly reflected in the SEC Rule 17(j)-1, making it illegal for portfolio managers to front-run their clients. Recently, the SEC charged a quantitative analyst with a years-long for front-running. The accused traded approximately 3,000 trades and made $8 million from front-running trades in his wife's brokerage account.
Front-running is very similar to insider trading. In both illegal activities and an insider is involved. In front-running, the insider or employee takes advantage of the information of any future transaction and uses it for personal gains or with the hope of benefiting from a rise in the asset price.
What can firms do?
Market abuse regulations and personal account dealing policies are designed to prevent illegal front-running, insider trading and eliminate conflicts of interest. Having a robust PAD police in place and monitor employee preclearance requests can help protect the firm from trade violations and insider trading.
MCO has a solution to help firms capture employee trades and save Compliance Managers time and effort by enabling electronic capture of electronic trades and holdings and automating the various checks needed to maintain compliance.
You can review employee trading activity against restricted lists and insider trading rules and mitigate the risk of misconduct with a solution that is easy to implement and inexpensive. Contact our team today!