August 2, 2006
Investment banks are now in the private equity business and the hedge fund business; private equity funds are also starting hedge funds; hedge funds are starting private equity funds. The reason is more than just financial diversification. These financial operatives develop valuable information and are attempting to share this information across investment vehicles. But there is a problem -- conflicts. Some information can be shared legally, some cannot. These multi-purpose investment vehicles will push and perhaps occasionally cross the boundaries of what information can be shared internally.
An investment bank earns fees underwriting and consulting. So doing, it gathers valuable information about clients. Can it use the information to invest in clients? to speculate in client's stock? to invest in competitors of the client? to itself compete with the client for other investments? A private equity fund often takes a role in the management of clients (often a director's position); can it use the information for short term speculation in client stock? The answers are complex. Some depend on the nature of the information; others depend on the nature of the client's industry; finally, others depend on the procedures used to invest on the information. Will financial institutions respect the limits?? They all will profess to do so, but pressures to slide up to and over the line a bit will be very, very strong.
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