Q. Today the SEC announced new charges against a California wealth management firm that grew out of its continuing investigation into expert networks and hedge fund insider trading. An expert network is also at the core of the SAC investigation. But what are they, exactly?
A. They’re sort of an eBay for experts… a platform through which money managers can contact and hire super experts in a specific field to help them evaluate technical issues about stocks. The vast majority of use is totally 100% legal due diligence and information gathering…. But, there are some bad apples, too
Q. An example of a “good” use?
A. Let’s say a flood destroys a battery manufacturing plant in Europe which happened to supply the batteries for a toy company. An investor in the toy company suddenly needs to know whether the company can find comparable batteries at comparable prices somewhere else… so needs an expert on supply and demand for a specific kind of battery. So they jump into an expert network.
Q. But then an example of a “bad” use… after all, the SEC does have a special investigation into them?
A. As an expert in the system, you get paid for specialized knowledge. Well, a lot of middle managers at companies are, indeed experts about their industries. So corporate executives who are also serving as experts have a temptation to start offering “expert advice” about their own companies– and that’s crossing the line, of course. And its not just leaking next quarter’s earnings… as in the SAC case, it might be about how the FDA trials are going, something like that.
Q. And are there efforts to cut down on these sorts of abuses?
A. Yes. The really key idea is that the managers who use the networks need to get representations from the experts that there is no insider information being provided to them. Remember… there’s nothing wrong with trading on non-public information unless its been obtained from an improper source. It’s OK to be “smarter” than your fellow money managers — and even trading on non-public information– so long as you get your insights in the right way.