Under Scrutiny: Expert NetworksBy , , , , and
The federal government's recent raids of high-profile hedge funds, part of an insider-trading investigation, have focused attention on firms known as expert networks. The firms act as matchmakers, connecting investors with people who have extensive knowledge of countries, industries, and companies and who can provide information on product development, sales, and strategy.
"My contacts are the foot soldiers and the worker bees of the industry," says John Kinnucan, who runs Broadband Research, specializing in tech companies, from his home in Portland, Ore. Several firms he says are his clients, including Steven A. Cohen's SAC Capital Advisors, Wellington Management, and Janus Capital Group (JNS), have been asked for documents as part of the federal probe. Janus says it is cooperating with the inquiry. Spokesmen for SAC and Wellington declined to comment.
Insider trading involves buying or selling stock using significant non-public information. The current investigation is being conducted by the office of U.S. Attorney Preet Bharara in Manhattan. Two hedge funds, Level Global Investors and Diamondback Capital Management, were searched by FBI agents on Nov. 22. Both firms were founded by former employees of SAC Capital Advisors. A third hedge fund, Loch Capital Management, was also searched by FBI agents. None of those firms have been accused of wrongdoing. Diamondback says the raid focused on one of its employees, who was put on leave. A Level Global spokesman says the firm is cooperating with the investigation. A Loch spokesman did not return a call seeking comment. Kinnucan, who hasn't been accused of wrongdoing, says there is nothing inappropriate about his research.
On Nov. 24, a consultant to hedge funds, Don Ching Trang Chu, was charged with arranging for insiders at publicly traded companies to provide information improperly to clients of his firm. Chu worked as the Taiwan liaison for Primary Global Research. Mountain View (Calif.)-based Primary Global said in a statement that it "has severed its relationship with Mr. Chu" because of "recent events." Chu's lawyer, James DeVita, declined to comment.
Primary Global Research did work for Spherix Capital, a hedge fund where Richard Choo-Beng Lee used secret tips to trade stocks, according to his guilty plea. Lee helped the FBI tape Chu as part of a U.S. probe of insider trading at Galleon Group, whose co-founder, Raj Rajaratnam, was indicted a year ago and faces trial next month. Rajaratnam denies wrongdoing.
The FBI has also questioned a consultant who worked for expert network Gerson Lehrman, according to The Wall Street Journal. A spokesman for the firm declined to comment. The firm has a marketing relationship with Bloomberg LP, parent of Bloomberg Businessweek.
Geoff Bobroff, a fund consultant in East Greenwich, R.I., who is part of Gerson Lehrman's network, says the use of experts has risen in response to the decline of Wall Street research after 10 firms collectively paid $1.4 billion in 2003 to settle claims they slanted their research to win banking business.
Michael W. Mayhew, chairman of Integrity Research Associates in New York, estimates that the roughly 40 expert networks in the U.S.—up from 8 in 2001—took in a total of $450 million to $500 million in revenue in the past year. Gerson Lehrman, based in New York, operates the largest network and has 60 percent of the market, according to Mayhew.
Burton Greenwald, an independent fund-industry consultant in Philadelphia, is part of three networks, including Gerson Lehrman's, usually providing hedge fund managers with information and his analysis of investment-management companies. "I've found the networks make an honest and vigorous effort to make sure non-public information is not disclosed to the clients who use their services," he says. "I have to sign an agreement with Gerson that I won't talk about anyone who is my employer or about non-public information."
Greenwald says the networks that arrange phone calls between experts and investors don't monitor them, and, theoretically, investors could use them to seek insider information. "The top-tier hedge funds may not do this," he says. "But I think when you get down to lesser players, you're in the Wild West."
The bottom line: An investigation into expert networks is raising questions about the line between providing information legally and insider trading.