Self-Regulation of Insider-Trading in Mutual Funds and Advisers

Authors

Tamar Frankel, Boston University School of LawFollow

Author granted license

Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International

Document Type

Article

Publication Date

Fall 2013

ISSN

1934-2497

Publisher

Brooklyn Law School

Language

en-US

Abstract

Mutual funds are required to impose Codes of Ethics on many of their employees. Did this requirement make a difference? After all, similar Codes proliferate in many other financial and business corporations! ⁴ with fairly miserable results. In fact, the temptations facing employees and managers of many business corporations that published self-imposed Codes are relatively weaker than the temptations facing employees and managers of mutual funds. Yet as compared to mutual funds, these business companies have failed to prevent insider-trading!

I believe that regulated mutual funds are less prone to insider-trading than non-regulated funds and traders because their Codes of Ethics have introduced enforcement mechanisms and have influenced their culture. Regulated mutual funds' Codes of Ethics are accompanied by four features that may have helped reduce the zeal of temptation for insider-trading:

1. The Codes are far from voluntary. They are required by law.
2. The Codes contain both general principles and self-enforcement mechanisms.
3. Mutual funds depend not only on their performance but, like other financial services, are heavily dependent on investors' trust. The managers of regulated mutual funds recognize that a hint of unfair treatment can decimate their entire business and may result in "runs." Similar to banks, open-end funds must offer investors redemption within seven days of demand, with few exceptions." Mutual funds receive investors' demands, and in seven days investors must receive their money! ¹⁶
4. The Investment Company Institute-the professional and trade organization of investment advisers that manage mutual funds-has supported the legally required provisions of the Code.

It may well be that these four conditions help increase the deterrent effect, reduce temptation within an organization, strengthen the prohibition on insider-trading, and-most importantly-establish a culture of compliance.

This Article concludes with two questions. First: what is not included in the Code of Ethics? And second: does it pay to internalize enforcement, and if so, to whom? The following is a discussion of each of these four components.

Recommended Citation

Tamar Frankel, Self-Regulation of Insider-Trading in Mutual Funds and Advisers , in 8 Brooklyn Journal of Corporate, Financial and Commercial Law 80 (2013).
Available at: https://scholarship.law.bu.edu/faculty_scholarship/3002