The now highly-visible insider trading probe on Wall Street is shining a harsh spotlight on “expert networks.” Relatively new to the investment research landscape, these networks offer access to experts across various industry sectors — medicine, biotech, technology, and others. Many of these so-called specialists are actively working at companies within those industries, creating a potential for access to insider information. For almost any industry in which an investment manager has an interest, the expert-network firm can find a specialist.
I think back to a meeting in 2006, when one of the early movers in this space came to CFA Institute to explain the business model. We discussed the “protections” that many networks have in place to help prevent their experts from revealing insider information. For example: some of these so-called experts may gain access to inside knowledge from their own companies or as the result of relationships with regulators like the U.S. Food and Drug Administration (FDA).
As current events demonstrate, preventing insider information from being leaked is no easy task. In truth, experts only make money if their services are in demand and they have repeat business, which means that the information they provide must provide the investing client an “edge.” For its part, the investment manager is itching to hear new insights about the prospects for an industry, sector, technology, or product. They want access to information that few others have and are willing to pay dearly for an advantage. The better the expert information, the more popular the expert becomes — a potent catalyst for insider activity.
We will soon learn what responsibilities expert networks bear for preventing this misbehavior, and how well they have lived up to those obligations. In due course, the investment managers who knowingly crossed the line to get that “edge” will be brought to account.
This is yet another serious breach of confidence for the investors who entrusted assets to those managers. In this post-Madoff era, we must expect more from the people we hire as fiduciaries. Investors, for one, can do more to avoid getting involved with these managers in the first place by looking for unambiguous signals of commitment to ethical conduct. Beyond “tick-the-box” compliance efforts, investment firms can agree to principles of conduct that elevate their ethical profile, accepting the peril of fraudulent representation if the reality of their practices do not match their public commitment. The CFA Institute Asset Manager Code of Professional Conduct offers just such a framework to give investors new reason to believe in the integrity of markets.