There was a front page article in today’s New York times as part of the coverage of the guilty verdicts against Raj Rajaratnam, that was titled, “Next Up: A Crackdown on Expert Networks”. The gist of the article is that federal prosecutors were now going to focus their insider trading crackdown on the use of expert networks. In fact, there have already been a number of indictments and guilty pleas resulting from the government’s investigation.
Expert networks, in a classic example of the law of unintended consequences, sprang into being following the enactment of Regulation Fair Disclosure. The theory was Reg. FD was forcing companies to stick to a plain vanilla disclosure script, telling everybody at the same time, whereas investors would pay to get something more than plain vanilla before everyone else. It proved to be a good theory, as on Wall Street, time and information are money, and expert networks could help investors with both. If an investor needed to get up to speed on a new industry, a new drug or a new technology, paying an expert for an hour or two of their time could be much more efficient than spending a week researching the topic. And presumably the investor could get the information free of corporate spin with some insights into the topic that corporate management might be unwilling to discuss.
Alas, like all good ideas, abuses soon appeared. Some expert networks solicited people to act as experts on the companies they worked for, with the implied marketing pitch to investors that they would be able to get an insider’s perspective. And lo and behold, some of the experts actually gave out material, non-public information about their companies. Many of these “experts” were in technical fields, such as medicine or technology, and it would be easy to say that they might not be expected to know technical SEC regulations. However, when someone is paying a person large sums of money to tell them about things that are not generally known about their company, it’s fair to say that person knows he’s doing something wrong. At the very least they are violating their duty of confidentiality to their employer, at the worst, they are violating the federal securities laws.
So now that people are beginning to be sentenced, what does it mean for expert networks?First, they’re not going away. The desire of Wall Street for fast information that may give them an investment edge will insure that the expert networks will continue to be around. Costs will go up as more compliance is layered into the process, both by investors and the networks, but the demand for the product will not go away. Second, companies will strengthen their disclosure policies to prohibit employees from acting as experts. As I write this I am sure there are securities lawyers all over the country drafting memos advising their clients to update their disclosure policies to prohibit all employees from participating in expert networks. Third, maybe, perhaps, we hope, the bad actors will be forced out of the business.
I hate to sound like a cynic about the last point, but when you’ve hung around the industry as long as I have and witnessed Michael Milken, Dennis Levine, Martin Siegel, Ivan Boesky, R. Foster Winans (The “Heard on the Street” columnist from the Wall Street Journal), James McDermott (the former CEO of Keefe, Bruyette & Woods who gave tips to his adult movie star mistress) and Martha Stewart, you get just a bit jaded about the ability of regulations and compliance programs to overcome the lure of making a quick buck.