SEC Probing ETF Use to Mask Insider Trading

Published by: Frank Galvano on 10th Feb 2011 | View all blogs by Frank Galvano
SEC Probing ETF Use to Mask Insider Trading

The U.S. Securities and Exchange Commission has reportedly launched an investigation into whether traders are using exchange-traded funds as a tool to disguise insider trading activity.  Sources familiar with the probe say that ETFs have emerged as a mechanism for maximizing gains in stocks while masking trading patterns.

For example, a trader might receive inside information about a stock, purchase an ETF that includes the stock, and short sell the other stocks in the ETF.  Known as ETF-stripping, the practice allows traders to benefit from gains in the stock's value without directly buying or selling the stock.

SEC regulators, working with officials from the US Justice Department, are concerned that traders may be using the approach to hide insider trading.  Investigators are also looking into whether are using the practice to avoid regulator detection.  The recently passed Dodd-Frank finance reform legislation will require a portion of ETF swaps to trade on exchanges.

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