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Hedge Fund Raids and Investing

Hedge fund raids and investing are in the news with several recent raids by the FBI on fund offices. According to various press reports and commentary the SEC, long criticized for laxity in oversight, has changed gears. Rather than looking to prosecute individuals who have bought and sold stock based upon non-public information, the SEC is now looking deeper into insider trading networks. From the viewpoint of the average investor we might ask just how insider trading, hedge fund raids, and investing are related. Certainly there are those who profit from inside knowledge of mergers and acquisitions, pending bankruptcies, and the like. But, how are hedge fund raids and investing related for the average investor? It probably depends to a great degree on how you invest. Is it more important learning whom to invest with than learning how to invest?

Long term very successful investors of the Warren Buffet sort preach fundamental analysis of stocks with an eye toward intrinsic stock value and a margin of safety. This thinking goes back to the teachings of Ben Graham and David Dodd at Colombia in the days after stock market crash that led to the Great Depression. Buffet, who has probably made more money in stocks than anyone in history, was a protégé of Graham. For analysis of stocks to be useful it needs to be thorough. To the extent that such research leads to knowledge and insights that others don’t have it can be financially rewarding. To the extent that an investor obtains insider information that is illegal to trade upon fundamental analysis crosses the line and becomes illegal activity. That is the point of how the current hedge fund raids and investing come together. People invest in hedge funds with the knowledge that they are risky and that they can provide huge rewards. The pressure to produce huge gains can lead to the sort of insider networks and passing of secrete information that the SEC is apparently investigating with its recent hedge fund raids.

So, how do hedge fund raids and investing correlate if your investing approach is to use your dividend repurchase plan to buy more shares of 3M or your choice of blue chip stock. Probably insider trading will not affect you a lot. However, if you are investing in new issue stocks, stocks that might just be a takeover target, or a come back from the dead IPO such as GM just had you may miss out on profits or lose money. To the extent that “insiders” had hints that the GM IPO was going to go off at $33 a share instead of the previously predicted $17 a share you could have missed out. To the extend that news of a disaster that could affect the price of one of your stocks is withheld while others bail out of the stock you are left holding the bag as the stock price drops. The hedge fund raids and investing are related when insider trading affects the price of your stocks. However, to the extent that “insider” information is really an aggressive form of due diligence it would seem that for the average investor the hedge fund raids and investing in your stocks are not really related. If you are investing in companies with cash and a strong history of prolonged growth you are probably not looking at the stocks that someone is trying to, or capable of, manipulating with insider information.

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