Expert Networks and Information Flow

The lifeblood of Wall Street is the exchange of information. But with an increasingly short-term (or even event-driven) view of equity ownership, some market participants have pushed the edge of the envelope in their quest to gain a competitive edge.

In recent months we have seen another round of alleged insider trading schemes, with subsequent high-profile raids, civil and criminal charges, fund closures and expanding investigations. The news media describe the rise of consultants and expert networks that provide, for a fee, information to traders and fund managers. These networks are characterized by some as a response to the success of Reg. FD in preventing companies from speaking more freely with favored analysts and investors, yet we note the distinction between information and material non-public information.

LHA recommends that executives of public companies take a closer look at information control to ensure that individuals — both within and outside the company — with access to information or to key data points keep such information confidential.

Details about these consultants and their networks are a bit murky. According to The Wall Street Journal, many expert network firms bar their consultants from discussing current or past employers. Yet there are examples where executives were paid to provide advance information on their firm’s earnings or other developments. In one case, a firm that promoted its ability to provide information on industry trends, issues and regulations through a global team of advisory experts, apparently paid more than $200,000 to a “consultant” for detailed information on two firms’ upcoming quarterly results. The consultant was later arrested.

The challenge regulators face is to prevent illegal disclosure without discouraging legitimate information gathering, even if it is through unconventional means. For years, analysts and money managers have built networks of information sources within the ecosystems of the companies they follow. For example, analysts routinely conduct “channel checks” by tapping suppliers, distributors and customers for information.

On the other hand, paying experts for inside information is not really new, either. We note an August 2005 report from the Seattle Times that uncovered “at least 26 cases in which doctors leaked confidential and critical details of their ongoing drug research to Wall Street firms.” The physicians were paid as much as $500 per hour to speak with hedge funds or expert networks.

The recent allegations of wrongdoing serve as reminders to public companies that safeguards are needed against market participants driven to seek an edge. Employees, contract consultants and business partners who are privy to material information need to be reminded of a company’s disclosure policy and procedures, and the potential consequence of violating those rules. Furthermore, companies may need to consider a formal prohibition on employees participating in any type ofinformation network, even if there are assurances that the employees will only be asked about such topics as industry trends or competitors’ strategies.

At LHA we are experts in managing the flow of information to provide investors and analysts with what they need, while best positioning the company’s investment merits. We are firm believers in maximizing transparency to narrow the gap between what is provided and what is desired, and welcome the opportunity to discuss our services.