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SEC taking tougher stance on Wall Street practices?

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NEW YORK—Former regulators say governmental agencies face difficult questions in their efforts to improve the fairness of the U.S. financial system.

Panelists at the 2011 Professional Liability Underwriting Society's D&O Symposium in New York on Feb. 3 discussed recent developments ranging from insider trading cases to the Dodd-Frank Wall Street Reform and Consumer Protection Act.

For example, the SEC said in recent weeks that it charged hedge fund portfolio managers and analysts who allegedly netted millions by illegally trading on confidential information. The SEC, which alleged that the tippers were technology company employees moonlighting as expert network consultants for Primary Global Research L.L.C., has been investigating such expert networks that purport to provide professional investment research to their clients.

The crackdown on insider trading has “been a more intense wave than we've seen before and shows changes in thought regarding prosecution,” said Timothy Treanor, a New York-based partner at Sidley Austin L.L.P. Before representing companies and individuals for the law firm, Mr. Treanor was an assistant U.S. attorney in the Southern District of New York.

He said the practice of mosaic theory, or the idea that small pieces of information are not material and can be used collectively to direct successful trading, has been thrown into question. “Around New York and in the country, there are people who are questioning the way they conducted their own business, and they're uncertain about how to proceed because of the lack of understanding about a standard,” he said.

Recent insider trading cases, starting with hedge fund Galleon Group L.L.C. in 2009, have involved traders allegedly getting information from channel partners, employees or officers of the companies being traded. While it's clearly “over the line” to obtain information from a chief financial officer about quarterly earnings ahead of an announcement, there are all kinds of ways to get information relevant to trading. Mr. Treanor said questions have arisen around the definition of “materiality,” or the amount of information considered important enough to require disclosure.

Simon M. Lorne, who is chief legal officer at hedge fund manager Millennium Management L.L.C. and has held public sector roles such as SEC general counsel, said it's clear that if you go to an expert network that gives you inside information in violation of its duty, you can't legally trade on it. Insider trading matters that the SEC and Justice Department have brought so far “haven't stretched the imagination,” he said, and were clear violations not only now but also 10 years ago.

But he said there are questions around the distinction between legitimate research and improper use of material information. For example, suppose a manufacturer in Taiwan—someone not easily subject to U.S. law—tells an analyst how many parts it shipped to a major technology firm. Does that supplier have a duty not to provide such information? “Those are difficult questions,” Mr. Lorne said. He said he thinks such issues might be implicated in future cases.

The panelists also discussed various other regulatory issues.

For example, panel moderator Alexander Southwell, a New York-based partner at Gibson, Dunn & Crutcher L.L.P., asked if the economy would be where it is now if new laws such as Dodd-Frank had existed before 2008.

Brian McCormally, a partner at Arnold & Porter L.L.P., said the Office of Thrift Supervision had examined American International Group Inc. many years before the crisis that led to the New York-based insurer's bailout by the government. Dodd-Frank “would not have changed the fact that the agency just dropped the ball because they didn't understand credit default swaps,” Mr. McCormally said.

Mr. McCormally has held senior legal positions in the enforcement and regulatory compliance areas at the OTS and the Office of the Comptroller of the Currency.

Mr. Lorne said people are aware of the problems that took place at AIG, so if those same circumstances were to occur again, the newly created Financial Stability Oversight Council would do something to prevent them. But if the events at AIG hadn't happened, he said he doubted that regulators would be aware of such problems.

“The odds of the next big collapse—five or 20 or 50 years from now—are not much changed by Dodd-Frank,” Mr. Lorne said.