On Monday, the Wall Street Journal broke a story that the Securities and Exchange Commission, the FBI, and the New York Attorney General's Office are conducting criminal and civil probes into possible insider trading at a number of companies. Three hedge funds were raided, and one of the research firms under investigation works with several prominent mutual fund companies, including Janus Capital Group, MFS Investment Management, and Wellington Management Co. Jessica Toonkel reports for Investment News that this insider-trading scandal is different from many in the past because it includes mutual funds, whose clients are retail investors. Don Phillips, director of research at Morningstar, told Investment News: "This could have much bigger implications for investors if mutual funds are involved. The expectations are much higher for mutual funds than for hedge funds."
Retail investors are already skittish, Toonkel writes, and an insider-trading scandal may only makes things worse. Harold Evensky, president and principal of Evensky & Katz LLC, told Investment News: "I am worried that this is just another nail in the coffin, in terms of undermining investor confidence."
CNBC host and former hedge fund manager Jim Cramer disagrees, and says the probe could actually increase investor confidence in the stock market. "With quant funds using opaque algorithms to trade stocks, Wall Street seeming to have better access to essential investing information, and the market appearing to be slanted in favor of the rich, average Americans had cashed out and left. But with [Monday's] announcement, Cramer said, the government may have taken an important step 'to bring people back,'" according to the story.
[See U.S. News's 6 Reasons to Buy Dividend-Paying Stocks.]
Henry Blodget, editor of Business Insider, says there's an important lesson in all of this. He points out that the investigation is focusing on "expert networks," which are consulting firms that share investing information with clients. Professional investors use these networks to gain an edge over the competition, he says. Retail investors may have access to SEC reports or real-time stock quotes, but they're at an inherent disadvantage because professionals use networks like this to stay ahead of the game.
The lesson isn't that the SEC is trying to level the playing field for average investors, or even that the game is rigged, Blodget writes. "The REAL lesson most investors should take away from the largest institutional insider-trading investigation in history is that competition in the global financial markets is so intense that it's basically idiotic to trade. Trading is what is known as a 'zero sum game.' To win, you have to beat the competition," he writes. He advises retail investors to play a game they can win—investing for the long term with low-cost index funds, and rebalancing over time.
[See U.S. News's Why Investors Are Flocking to Index Funds.]