“Expert Networks” Under Investigation: Insider Trading Probe Into The Use of Consultants May “Ensnare” Hedge Funds, Mutual Funds, and Investment Bankers Across the Country


The Wall Street Journal reported on November 20 that a far-ranging insider trading probe into the use of outside expert consultants has the potential to “ensnare consultants, investment bankers, hedge-fund and mutual-fund traders and analysts across the nation.” According to the Journal, the criminal and civil probe is being conducted jointly by the U.S. Attorney’s Office in Manhattan and the SEC. The probe focuses, in part, on whether material, non-public information was provided by expert consultants to hedge funds and mutual funds. The widespread investigation extends beyond expert networks to include independent research boutiques. The Journal reported that one such research firm’s president had been asked by the FBI to record his conversations with the firm’s hedge fund and mutual fund clients. The joint investigation is ongoing, but the New York Times has subsequently reported that some charges may come before the end of the year, with the defendants numbering in the double digits. This investigation signals a sharp regulatory and enforcement focus on what has become a routine part of the investment process for hedge funds, mutual funds, and other institutional investors.

The Investment Industry’s Widespread and Increasing Use of “Expert Networks”

The use of outside expert network consultants has been increasing steadily at investment firms for a number of years. According to a recent report by Integrity Research Associates LLC, almost 40% of buy-side investment firms in North America and Europe currently use expert networks – a significantly higher percentage than many other types of alternative and independent research. While many of the early consumers of expert network services were hedge funds, much of the recent growth in the industry has reportedly come from mutual funds, pension funds, and private equity and venture capital firms.

An investment firm’s purpose in retaining these outside experts is to aid in researching or pressure-testing a particular investment thesis, or to help perform a “deep dive” on particular industry sectors or companies. Outside experts may include industry consultants, vendors, doctors, attorneys, suppliers, or past employees or executives of particular companies. Depending on the type of investor and the focus of the inquiry, expert networks can provide investors with various types of services, ranging from offering general market and company background and forecasting macroeconomic trends to setting up meetings with former managers or suppliers of a company.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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