Insider Trading Probe: The Implications

While reports that mutual fund Janus Capital has received requests for information regarding an insider trading probe may not come as a surprise, it is "another kick in the stomach for the industry in general, not good for overall market confidence and add yet another overhang for the financials," as one trader said to me this afternoon.

While this has nothing to do with market fundamentals, it has everything to do with market psychology. It reinforces the view that early November may have been the highs for the year and that other issues (Europe, Korea) do not provide a supportive outlook for further gains.

Look, for example at the MSCI REIT Index, a basket of large real estate investment trusts, down nearly 10 percent this month and far underperforming the S&P 500. One REIT investor noted "[T]here's no strong rationale why anyone would want to reinvest and risk those profits a month ahead of year end."

As for the insider trading investigation, the dramatic appearance of John Kinnucan on CNBC's Strategy Session this afternoon only reinforced the concern that the authorities are trying to expand the definition of insider trading.

Mr. Kinnucan told David Faber and Gary Kaminsky that he was approached by the FBI and asked to wear a wire to gather evidence against others on Wall Street. Mr. Kinnuncan, whose firm provides tech and health care analysis and who freely admits his research is based on channel checks (interviews with industry participants and other data gathering), insisted he did nothing wrong and refused.

What's the implications for stock traders and stock pickers? In an information age where data is incredibly cheap, if you remove the ability to gather information, you remove the ability of people to effectively pick stocks, traders say.

One former fund of funds manager told me that several traders had already concluded that if they are not going to be able to pick stocks based on research — if they are taking stock pickers out of the market — we may see much more trading in sectors. The use of ETFs will increase.

This will also increase correlations between stocks.

Others insist that hedge funds are being paranoid — that the indication so far is that this is an investigation of an insider trading ring of a fairly traditional variety. Maybe. But if Mr. Kinnuncan's comments are correct, the feds are using a shotgun approach to information gathering.

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