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Recent SEC insider-trading investigation leads to seizures

Monday, November 29, 2010

Loch Capital ManagementLast week, federal officials executed search warrants and seized boxes of information from three well-known hedge funds, Diamondback Capital Management, Level Global Investors and Loch Capital.  Former employees of SAC Capital operate these three “smaller” hedge funds.  The very next day, federal officials subpoenaed two hedge fund titans SAC Capital and Citadel, seeking information about the two funds trading activities.  Federal officials arrested Don Chu as he was preparing to leave the country.  Mr. Chu is an executive with Primary Global Research, which provides deep level due diligence and expert opinion on publicly traded companies. 

To cap off the week, federal authorities sent information requests (not subpoenas) to several large mutual funds, including Janus Capital Group Inc. and Wellington Management Co.  It is unclear whether this activity stemmed from a SEC Whistleblower, but certainly the new SEC Whistleblower Program can still play an important role in ferreting out illegal insider activity. 

Time will tell the true nature of the alleged insider trading scheme, if any, but this cascade of activity across the entire web of Wall Street –from large mutual funds to large hedge funds to smaller hedge funds to so-called due diligence firms -- certainly raises one real question:

When does aggressive or creative due diligence equal insider information?

Hedge fund whistleblowers and insiders rely on a lucrative cottage industry known on Wall Street as the “expert network." Hedge Funds, mutual funds and investment banks pay large sums of monies to private companies that purport to link investors with due diligence, unique research and experts in a range of sectors, countries and thousands of individual companies. The detailed information they provide on product development, sales numbers and internal company strategy can be important research for any investor.  The largest “expert” firms are Gerson Lehrman Group Inc. and Guidepoint Global LLC, neither of whom was named in this investigation.   

“Expert” companies can be quite proctorial.  As part of their research, expert companies contact customers, suppliers, former employees and at times even current employees of a public company under investigation.   “Expert” companies retain recently retired executives to opinion upon the industry and company that executive just left.  “Expert” companies are paid to be aggressive and to bring to their clients unique, tradable information.

So when then does this activity cross the line to become illegal insider information? 

The SEC certainly believes that Mr. Chu, working for the “expert firm” Primary Global Research, crossed the line.  The SEC alleges in the criminal complaint against Mr. Chu that his collection of “experts and consultants” were in fact employees of large publicly traded companies and that his “experts and consultants” were in fact providing insider information about the companies at which each was employed.   

Time will tell if other “expert” firms have crossed the line as well.