Financial Regulatory Forum

Funds auditing expert network relationships, asking for guidance

By Guest Contributor
February 3, 2012

By Rachel Wolcott

NEW YORK, Feb. 3 (Thomson Reuters Accelus) - Fund managers and investment firms are auditing their expert network relationships to ensure they do not breach insider trading rules. While many are reinforcing their rules and policies around these relationships, the fund industry has sought additional guidance from the U.S. Securities Exchange Commission (SEC) and its international counterparts.

The Galleon Case in 2010 started the industry’s self-examination of expert networks’ role in insider trading, and last week the UK Financial Services Authority (FSA) reinvigorated the issue with a £7.2 million fine given to David Einhorn and his Greenlight Capital fund. Julian Korek, founder of Kinetic Partners, told Thomson Reuters: “Hopefully the SEC or the fund management trade bodies will issue some guidelines for firms to use. It’s an issue worthy of the industry getting together and setting some standards.”

Korek suggested that the Managed Funds Association (MFA) or the Alternative Investment Management Association (AIMA) should put together some sound practices guidelines as they did when the smoothing of fund valuations became an issue.

A year ago Richard Baker, president of the MFA, told an industry conference: “Our industry would like to know where the sidelines are right now so that we can stay well within them. The trouble is the referees aren’t quite clear where those lines are right now.”

A spokesman at the MFA told Thomson Reuters that the trade body and its membership had discussed the possibility of creating guidelines for expert network relationships. An AIMA spokesman said, however, that it was not planning any guidelines, explaining that the expert network issue was viewed as more of a U.S. problem.

Last March, after the SEC announced a series of prosecutions where the use of expert networks was a component of the case, Carlo di Florio, director of the Office of Compliance Inspections and Examinations (OCIE), made a speech in which he outlined some practical measures firms could take to use expert networks safely and lawfully. Regulatory lawyers do not expect further guidance on the subject, however.

Marc Elovitz, partner at Schulte Roth & Zabel, said: “The SEC doesn’t give formal guidance as to what is insider trading and what isn’t, but the fact is they said expert networks are not inherently improper and OCIE director Carlo di Florio and others have given guidance on policies and procedure to use them properly. There’s no specific insider trading statute and there’s not likely to be any time soon, because they’re trying to get at a wide range of conduct.”

Know your expert

The Einhorn fine is a stark reminder to firms of the need to conduct a detailed examination of their relationships with expert networks, although the best way to handle expert networks, and training employees to deal with them properly, have been continuing issues since the Galleon case.

Jamie Nash, partner at Kleinberg, Kaplan, Wolff & Cohen in New York, told Thomson Reuters: “Most funds have strong policies and procedures, but even those that did have re-examined and tightened them and put more controls in place. They’ve been operating under the new procedures and adjusting them as they go along to see what works and what doesn’t, what’s practical, where risks are.”

Fund managers have brought in outside experts and lawyers to audit their relationships with expert networks. The result has been that some managers have severed ties with networks deemed to be too risky and have redoubled staff training on how to use networks legally. Firms are now requiring some calls with expert networks to be chaperoned so that compliance officers can cut off the conversation if it strays into uncomfortable territory.

Nash said: “They need to be vigilant about their policies and procedures surrounding insider trading. They need to educate their employees to understand which situations present risk to the firm and their careers. You have compliance personnel in place for a reason; before acting they should use that as a resource to protect themselves and the firm.”

Firms are also auditing the expert networks themselves to ensure they have adequate policies and procedures in place and that their staff are trained properly and understands insider training rules and regulations.

Korek said: “If you use an expert network, you need to understand their controls. Investors need a framework to assess the validity of a network. It’s an area that would be perfect for a trade organisation to come up with some parameters.”

 

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus.  Compliance Complete (http://accelus.thomsonreuters.com/solut ions/regulatory-intelligence/compliance- complete/) provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges.)

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