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Do Expert Networks Go Too Far?

Are so-called expert networks — collections of doctors and other professionals as well as ex–­corporate officials, typically brought together by boutique firms — suddenly in the SEC’s crosshairs as they carry out a sweeping crackdown on insider trading?

On Wall Street the most sought-after commodity is not gold but information. So in November, when U.S. Attorney Preet Bharara and the SEC charged a French doctor with insider trading for allegedly slipping a hedge fund early results from the clinical trial of a potential blockbuster drug, the reaction was shock — and puzzlement.

Are so-called expert networks — collections of doctors and other professionals as well as ex–­corporate officials, typically brought together by boutique firms — suddenly in Bharara and the SEC’s crosshairs as they carry out a sweeping crackdown on insider trading? Hedge funds, which often rely on outsourced expertise, worry that the agency aims to make it a crime to tap industry insiders for insights into developing trends in a bid to gain an edge on competitors.

However, the thrust of the probe should not have caught so many hedge funds by surprise. A year ago, Integrity Research Associates, a New York–based firm that helps asset managers handle research and compliance, warned its hedge fund clients that they needed to strictly control their relationships with expert networks to avoid compliance issues. Integrity Research’s 143-page report, based on an extensive survey of the hedge fund industry and expert network firms, found that most analysts and portfolio managers were neither well informed nor overly concerned about compliance considerations when employing expert networks. Moreover, the report said, 18 of 38 expert networks refused to discuss their own compliance capabilities, in many cases because they were minimal.

Integrity Research chairman Michael Mayhew tells Institutional Investor that expert networks in general are not fraught with compliance problems. “Our real issue,” he says, “is that we saw some firms with great compliance and some with not-great compliance.”

Mayhew emphasizes that the transfer of material nonpublic information to investors poses inherent risks for all parties involved. (Paradoxically, the very vagueness of insider trading rules as they relate to expert networks may make adoption of elaborate compliance systems all the more important.)

Mayhew’s firm cautioned in 2009 that to be seen as credible players in the market, expert networks may need to invest in compliance systems. One leading expert network, Gerson Lehrman Group, now employs no fewer than 18 compliance people, according to its general counsel, Laurence Herman. (He says he knew it was reported in the Wall Street Journal that someone who was briefly an expert at this firm was visited but not charged.)

Integrity Research’s advice about beefing up compliance may have come a little late, however, for expert networks now under investigation.

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