Risk & Compliance

To Catch a Country

The SEC is on the hunt for insider trading. But what if the culprit is Norway? Or China? Or even Alaska?
Tim ReasonFebruary 7, 2008

When a federal court overturned the Securities and Exchange Commission’s plans to register hedge funds in June 2006, it seemed unlikely the regulator would ever lose a larger fight to regulate large pools of investment capital. At the time, hedge funds were estimated to control as much as $1.4 trillion in assets.

But just two years later, the SEC is publicly fretting about a potential foe that dwarfs even the largest of hedge funds. The SEC’s new nemesis? Other countries.

Sovereign wealth funds — investment funds controlled by foreign governments — are estimated to hold some $2.5 trillion in assets, SEC Director of Enforcement Linda Chatman Thomsen said Thursday in testimony before the U.S.-China Economic and Security Review Commission. What’s more, that amount could skyrocket to as much as $12 trillion over the next eight years, Thomsen said.

Thomsen’s testimony comes amid increasing concern about the financial influence of foreign governments, particularly as troubled U.S. banks look abroad for capital. Last month, for example, Merrill Lynch and Citigroup received capital infusions of $6.6 billion and $14.5 billion respectively from government-controlled funds in Asia and the Middle East, and many others have followed suit.

Among the players cited by Thomsen: The Abu Dhabi Investment Authority, Norway’s Government Pension Fund, and Saudi Arabia’s wealth fund. Each now holds more than $250 billion to invest. Runners-up include Kuwait, Singapore, Russia, and Hong Kong, each with more than $100 billion in assets. And the China Investment Corporation — the main focus of today’s testimony — is estimated to hold some $200 billion in assets.

“We are concerned that some sovereign wealth funds, or persons associated with them . . . may undermine market integrity by engaging in insider trading or other market abuses,” Thomsen testified. Like hedge funds, she said, sovereign wealth funds have substantial power to move financial markets because of the sheer volume of their assets. And, she said, “sovereign wealth funds, unlike hedge funds, have power derived from being governmental entities, which may give them access to government officials and information that is not available to other investors.” Add vast financial power and governmental power together, she said, and the result is a market player with vast ability to manipulate or abuse the market.

Thomsen noted that the SEC currently works all over the world with foreign governments to fight insider trading and other market abuses. As an example, she pointed to the SEC’s recently settled suit against the board member of Dow Jones, who the SEC alleged to have tipped off a close friend about News Corp.’s intended acquisition of Dow Jones. In that case, said Thomsen, the SEC sought help in its investigation from the Hong Kong Securities and Futures Commission. “Given the inherent difficulties of conducting a cross-border investigation halfway around the world, this kind of cooperation is essential for our effectiveness,” she testified.

But, she said, sovereign wealth funds could undermine that sort of cooperation. “We are concerned that if the government from which we seek assistance is also controlling the entity under investigation, the nature and extent of cooperation could be compromised.” Indeed, she added, “we have seen less than optimal cooperation when foreign governments have an interest in the issue or person we are investigating.”

While Thomsen’s testimony focused on foreign governments, the SEC could someday face challenges with U.S. borders as well, as not all government-run investment funds are foreign. The Alaska Permanent Fund holds some $40 billion in assets, and the permanent funds of Texas have diversified from oil holdings to broader financial portfolios.