Portfolio managers, investment analysts and others with investment decision-making responsibility at hedge fund managers – especially those managing funds invested in public equity – face an ongoing predicament: the most valuable information from an investment perspective would be material, nonpublic information, but trading while in possession of material, nonpublic information is illegal. Accordingly, hedge fund investment decision-makers routinely seek to compile a mosaic consisting of material, public information; immaterial, nonpublic information; and other information that broadly falls under the rubric of “market color.” See “How Can Hedge Fund Managers Distinguish Between Market Color and Inside Information?
,” Hedge Fund Law Report, Vol. 2, No. 46 (Nov. 19, 2009). Generally, trading on the basis of such a mosaic is legal. But knowing whether you have a legal mosaic or illegal inside information is complex. In particular, determining materiality involves an assessment of the relevant facts in light of a daunting volume of statutes, rules, cases, SEC pronouncements and other formal and informal guidance. In a word, the “better” a piece of information from the perspective of a hedge fund manager, the more scrutiny it merits (from at least the manager’s general counsel, chief compliance officer and outside counsel) to determine whether the manager’s funds may trade based on the information (or whether manager personnel may trade in their personal accounts while in possession of the information). Nowhere is this predicament more pronounced than in situations in which hedge fund manager personnel talk to corporate insiders, in particular, executives of companies whose securities are owned or may be purchased or sold by the manager’s funds. Talking to corporate insiders is essential in light of the competition in the investment world. However, such communications are also fraught with the opportunity to acquire and inappropriately use material, nonpublic information. In an article in our October 29, 2009 issue, we discussed a number of specific strategies that hedge fund managers can implement to minimize the likelihood that communications with corporate insiders may result in insider trading violations. See “How Can Hedge Fund Managers Talk to Corporate Insiders Without Violating Applicable Insider Trading Laws?
,” Hedge Fund Law Report, Vol. 2, No. 43 (Oct. 29, 2009). One of the techniques discussed briefly in that article is the use by hedge fund managers of expert networks. Expert networks generally are companies that broker and structure communications between buy-side investors, such as hedge fund managers, and experts in designated areas, including corporate insiders and others with domain expertise. This article expands substantially on the discussion in our previous article, describing in detail: what an expert network is; how such networks operate; the categories of experts available via networks; fees charged for membership in a network and periodic access to experts; the mechanics of communications with experts in a network; the benefits and limits of expert networks in preventing insider trading charges; eight specific steps taken by expert network companies to prevent insider trading violations; and Regulation Fair Disclosure (Reg FD) concerns. One of the basic insights of this article is that expert networks have both offensive and defensive uses: they can be used to locate and glean information from experts who otherwise may be hard to find or hesitant to talk (the offensive use), and they provide a structure for communication that would be difficult to replicate in ad hoc or informal settings (the defensive use).