It’s not surprising that investors are willing to pay $1,000 or more per hour to expert networks to gather insights on multi-million dollar investment decisions. This is the essence of investment research, and it’s what professional investors are paid to do.
But any time that big money and high stakes are involved, the temptation to step into the grey area – or fully across the line – will be too much for some people to resist. And that’s a line that needs to be carefully navigated, since on the other side is insider trading, two words guaranteed to kill the mood and conversation at any party involving financial folks.
The official definition of insider trading is divulging information that is both non-public and material. In other words, information that would affect the stock price if it were publicly known.
As we’ll see, you’ll have ample opportunity to get acquainted with the ins-and-outs of what is legal and illegal before you reach the stage of having to part with any information under the auspices of an expert consulting agreement.
It’s important to stress that expert consulting is not a “minefield” when it comes to this sort of issue. Expert networks facilitate over a million client calls per year, and compliance breaches are extremely rare.
Once you are familiar with the rules, it’s not difficult to follow them, and almost everyone involved does. Especially clients, who if anything have more on the line than the experts, as they are playing with their company’s reputation.
All that said, it’s also important to know the example of what happens when people ignore this advice.
The following story (covered at length in this New Yorker article) not only ruined the lives and reputations of the expert and client involved, but also threatened the very existence of the expert consulting industry.
If you don’t want to end up as Pulitzer-fodder, read on!
SAC Insider Trading Scandal Ropes in GLG
Up to 2012, although there had been some rumblings in the press about insider trading cases tied to consultants at expert networks such as Primary Global, the expert consulting industry as a whole, and in particular its largest player, GLG. Still, the nascent industry had largely avoided both scandal and scrutiny during its first decade of rapid growth.
Then came the court case that the press dubbed the greatest hedge fund scandal of all time, that still ranks highly among the exploits of Bernie Madoff and the fall of Galleon Group. And unfortunately, GLG was – if not at the center – very firmly in the vicinity when the proverbial hit the fan.
The historic debacle that unfolded in 2012 involved hedge fund trader Mathew Martoma (the client) and Dr. Sidney Gilman (the expert).
Martoma had been working as a portfolio manager at CR Intrinsic, which was affiliated with SAC Capital, a giant investment firm known for its stellar returns, whose boss, Steven A. Cohen, is the current owner of the Mets, and the inspiration behind the character of Bobby Alexrod in “Billions”.
The case hinged upon a relationship the trader Martoma built with the clinician Gilman over the course of more than 40 consultations relating to a new Alzheimer’s drug, then in the trial phase. The press reported that Gilman earned over $100k from the consultations, charging a rate of $1,000 per hour.
The drug in question had shown promise in its initial tests, drawing considerable interest from the investment community. Later, disappointing results led to a decline in the stock price of the firms involved. In other words, access to foreknowledge about the drug’s progress at each stage could definitely be classified as ‘material’.
The FBI accosted Martoma at his home several years later, and confronted him with information they had gathered about his past, which included evidence that he had illegally obtained proprietary information in his former dealings with Gilmen.
Gilman, who was involved in leading the drug trials, later testified that he had indeed divulged non-public data during the consulting sessions regarding trial outcomes while speaking with Martoma.
Martoma, in turn, had allegedly used the information gathered from his calls with Gilman to make his firm $276 million in profits by speculating on shares of Elan and Wyeth, the firms behind the new drug.
The official SEC complaint made it clear that the expert network for whom Gilman was working (in this case GLG, whose name was not mentioned explicitly) was not at fault, and that both Gilman and Martoma had circumvented the network’s compliance procedures by, amongst other things, deliberately misrepresenting the discussion topics of their meetings.
Apart from anything else, Gilman had violated the terms of the confidentiality agreement, in which he stated that he would ‘share only information that is openly available’. GLG also provided email evidence in which they had explicitly told Gilman that Alzheimer trials were out-of-bounds for discussion with Martoma.
So how did it all go wrong?
The calls were not recorded, and so we will never exactly know. All we have is the testimony of Gilman, who stated that it was difficult in retrospect to identify the precise moment in the relationship when the line was crossed. Using his words, at some point the answers just ‘slipped out’.
While Martoma and SAC both maintained that no illegal actions had taken place, Martoma was the eighth employee of SAC to be charged with Insider Trading. A federal investigation later concluded that the culture of SAC not only tolerated but encouraged the gathering of inside information.
Upon conviction, Martoma’s assets were seized to settle a part of the multi-million dollar fine, and he began a nine-year sentence in federal prison, from which he was released earlier this year. Dr. Gilman resigned from his position at the University of Michigan, and his name was scrubbed from the institution’s records, including the hospital wing that had been named after him.
Expert Network Compliance Expands in Response to Insider Trading Scandals
The resulting exposure clearly had the potential to inflict long-term harm on the reputation of expert networks, and GLG in particular. It may have seemed, briefly, that the future of the industry was in doubt.
As it turned out, this was not the case. GLG turned a potentially bad situation around, not only by redoubling its compliance efforts to ensure that similar incidents would be preventable, but also by diversifying its focus, brand and client base beyond Wall Street and into Fortune 500 companies and major law firms. The industry as a whole has followed their lead by making rigorous expert network compliance screening, training and monitoring a cornerstone of their product offerings.
The key takeaway for us is that compliance procedures are not – repeat, *not* – a meaningless formality! They are there to protect the reputations, livelihood, and integrity of everyone involved.
There are guidelines that each network will have in place that govern client-expert relationships. Here are some example guidelines from GLG’s compliance framework:
- Employees may not engage in projects about their own company
- Employees may not consult with known competitors of their company
- Extensive or ongoing projects, which may ‘entail a deeper relationship with clients’ are subject to a special qualification process.
More generally, the rules and procedures that expert networks put in place typically include:
- Who can and cannot participate in projects where conflicts of interest might be present
- Topics that certain consultants may and may not address in consultations with certain clients
- Training for both clients and consultants in all relevant protocols and guidelines.
- Tools to assist compliance departments (e.g. call transcriptions and recordings) and provide documentation to protect those involved in case of a subsequent allegation.
You will likely be required to sign and annually re-affirm a document that states you have reviewed any agreements you are subject to and are permitted to take part in expert consulting, and that you will decline to take part in any project that would violate these agreements.
The onus is partially therefore on you to pre-vet any engagements that may turn out to have conflicts of interest involved, although the network is obviously incentivized to help you identify them.
Annual, sector-specific training may well also be mandatory, whereby you will reacquaint yourself with what constitutes confidential information in your area of expertise. This will help to hone your spider senses for any edge cases you might come across.
Separately, the network will be liaising with the client and making it as easy as possible for their own compliance departments to pinpoint potential issues with candidates.
Above all, if you suspect that you are being asked to provide non-public, material information, you should always err on the side of safety: politely end the call, and notify the network. Many networks, including GLG, Prosapient, Guidepoint and Alphasights, will incentivize you to act conservatively in this way by reimbursing you for the full-time slot.
Expert Network Compliance Training and Monitoring Helps Keep Everyone Out of Trouble
It is incredibly rare for compliance failures to occur – let alone criminal activity – in the ordinary course of expert network consulting.
You will likely never face a situation where you feel pressured to give confidential information. This is for the very simple reason that clients are subject to the same insider trading laws as everyone else, and crossing the line is not worth the risk. Most firms also make a heavy investment in compliance, which in turn place a heavy scrutiny on expert network calls to keep both the firm and its employees out of trouble.
As with all things, it comes down to a combination of knowledge and common sense. Learn what you can and can’t share on an expert network call. Take your training, trust your senses, and when in doubt, play it safe.