Expert Network, Insider Trading, MNPI, SEC

What is an Expert Network?

An expert network connects institutional investors, hedge funds and others with industry specialists and consultants, helping them gather data to make investment decisions. Most commonly known expert networks include GLG, GuidePoint, ThirdBridge, etc. Experts within the network are ‘for hire’ by third parties who are clients of the expert network. Clients are those who need consultation on specific topics that fall outside of their general knowledge base on a particular topic or industry.

It is not surprising that the biggest user groups of expert networks includes hedge funds and other investment firms. The investment industry seeks the expert insight to gain a competitive edge into specific types of stock or markets that they likely do not have in-house. Talking to corporate insiders and subject matter experts is essential in light of the competition in the investment world.

How the Expert Network Works

Consultants in the expert network can be hired via long or short-term contracts, on an as-needed basis or held on retainer through one of the expert networks mentioned previously. Experts are not cheap – typically charging large fees per hour in exchange for their services and may have unlimited access to the expert depending on the subscription model.

How Expert Networks are used in the Investment Process

Expert networks became popular in the 2000’s but demand for their services declined around 2009 when some expert networks offered investors access to inside information. Over the decades, regulations governing expert networks have tightened – laying out the specific types of information experts are permitted to provide to the firms that hire them and how that information may be used.

To help avoid compliance issues, some expert networks don’t allow their experts to work for publicly traded companies of which they may have insider information. This helps mitigate the chance that the expert could share insider information or MNPI to the expert network client.

Typical real life example:

  • A hedge fund is interested in buying a pharmaceutical stock that just received approval from the FDA to begin selling new cancer medication. The hedge fund may have a research analyst on the healthcare team who has an MD or prior health industry experience, but chances are – the experience and knowledge is not enough
  • Hedge fund hires a SME from an expert network to help them understand the potential market impacts of the cancer medication and what it could mean for that publicly traded company’s profits
  • The hedge fund is looking to ask questions like:
    • how many people could use the medication
    • what type of cancer is it used to treat
    • what is the anticipated effectiveness on patients who have been diagnosed with that particular cancer
    • what are the potential side effects
    • who are the other competitors in the space
  • The expert provides an inside view of the medication – in this particular example, the SME is a medical doctor – explaining how the medication works differently from other treatments and usually makes predictions regarding the demand for the new medication
  • The hedge fund gains a better understanding of the potential value of the company and is in a better position to decide 1) whether they want to buy the stock 2) at what price and 3) project what the stock could eventually be worth

High Profile SEC Insider-Trading Cases Linked to Expert Networks

  • In 2008, former S.A.C Capital hedge fund manager Mathew Martoma alleged to have traded on confidential information about a drug trial provided by Dr. Sidney Gilman, chairman of a safety-monitoring committee overseeing a clinical trial and paid consultant to an expert networking firm. The SEC alleged that $276 million in illegal profits or avoided losses were made by investment advisers and their hedge funds, by trading ahead of negative news in July 2008 on a clinical trial involving an Alzheimer’s drug developed by Elan Corp. and Wyeth, now a subsidiary of Pfizer Inc.
    • According to the SEC complaint, Gilman met Martoma through paid consultations arranged by the networking firm and Gilman received more than $1,000 an hour for his advice
    • The SEC said the expert networking firm provided training about federal securities laws to Gilman, reminding him not to share non-public information with clients
    • Nevertheless, the insider-trading alleged in the charges stem from connections made through the expert networking group, a trend in many insider trading cases brought by the SEC

In the Spring 2009, the SEC launched an expert networks investigation, seeking to identify more insider trading related to these intermediary firms.

  • In 2010, Mark Anthony Longoria, former AMD executive who also worked as a paid consultant for Primary Global Research, was charged by federal prosecutors with passing quarterly earnings information to hedge fund managers. Namely, tied to the insider-trading case involving convicted billionaire and Galleon Group chief Raj Rajaratnam who made over $45 million from trading on illegal stock tips. Longoria was a most sought after consultant, making well over $100,000 in a 60 day period via his conversations.

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