The fact that expert networks are now ensnared in the government's multiyear probe into insider trading was driven home Wednesday. Don Chu, 56, an Asian liaison for the expert network firm Primary Global Research (PGR), was arrested by federal agents for allegedly arranging for the firm's consultants working inside publicly traded companies to pass along "insider information" to the firm's hedge fund clients, who then used the material and non-public information to make profitable trades.
This is the latest development in what is shaping up as a major offensive by the feds on insider trading. The crackdown is on both criminal and civil fronts, with pressure being exerted by Preet Bharara, the U.S. Attorney for the Southern District of New York; the FBI; and the U.S. Securities and Exchange Commission.
Major hedge funds, big mutual fund companies and smaller firms that provide research to big institutional investors are under fire. This week the FBI raided three hedge funds, and federal authorities have started asking some big investment firms for trading data and other records pertinent to the inquiry.
Securities lawyers say the government is being aggressive by targeting expert network firms. "The Chu arrest reflects the government's willingness to pursue all participants in the insider-trading scheme," says Jacob Frenkel, a former SEC prosecutor and now partner at Shulman Rogers. "This is the first of what will be many indictments."
The roughly 40 expert network firms had annual revenue near $400 million in 2009, says Sandy Bragg, CEO at Integrity Research Associates. Nearly four of 10 investment management firms use the networks, Bragg says, and expert consultants earn $100 to $500 an hour.
In providing "independent investment research" or "market intelligence," the firms provide a legal service. They typically arrange for clients to meet or communicate with experts who can provide insight on new business strategies, how sales are going and other data points that highlight how a company is faring.
In Chu's case, prosecutors allege the information given to the hedge fund client was non-public and material and, therefore, illegal. The complaint says Chu had relationships with employees at firms including Broadcom, Atheros Communications and Sierra Wireless. Prosecutors say Chu would contact his experts to get information about the companies' financials before they reported the results, then pass the information to Richard Choo-Beng Lee, who as a former employee of the hedge fund would use the information to make a profit.Chu's attorney did not respond to a call for comment Wednesday night.
Lee pleaded guilty to insider-trading charges and has been cooperating with the investigation. In one instance, the complaint alleges that an expert in a phone call gave Lee detailed information on a tech company that included "revenue numbers, average sales prices, unit sales for different product lines, gross margin figures and revenue forecasts."
Expert networks are "a major gray area right now. We're getting into uncharted territory," says Andrew Stoltmann of Stoltmann Law. The distinction between good fundamental research and misuse of material non-public information will need to be clarified.Stringent compliance policies are in place. PGR's policy states that experts are "explicitly instructed to decline to comment on subjects that represent (company) information that is confidential or proprietary."
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