Tag: Expert networks

Now We are Talking About Real Money – SEC Brings $250 Million Insider Trading Case

On Tuesday, the Securities and Exchange Commission released news of an alleged insider-trading scheme that reaped profits and avoided losses of more than $276 million. The SEC brought the charges against (1) CR Intrinsic Investors LLC, (2) its former portfolio manager, Mathew Martoma, and (3) a medical consultant for an expert network firm, Dr. Sidney Gilman. The insider trading scheme involving a clinical trial for an Alzheimer’s drug being jointly developed by two pharmaceutical companies. The illicit gains generated in this scheme make it the largest insider trading case ever charged by the SEC.

Dr. Gilman has agreed to settle with SEC and cooperate. The Department of Justice has brought criminal charges against Mr. Martoma and tossed a non-prosecution agreement to Dr. Gilman.

According to the complaint, Dr. Gilman chaired a committee that oversaw a clinical trial for an Alzheimer’s drug that Elan Corporation and Wyeth were developing. Dr. Gilman, a professor of neurology at the University of Michigan Medical School served as the chairman of the Safety Monitoring Committee overseeing the clinical trial of the Alzheimer’s drug. Elan and Wyeth selected him to present the final clinical trial results at a July 29, 2008 medical conference. This would coincide with the after-market hours public announcement of the trial results by the two companies.

CR Intrinsic is a unit of Steven A. Cohen’s SAC Capital Advisors LP, the firm at the center of the expert network cases being brought by the SEC. Mr. Martoma met Dr. Gilman through an expert network firm. During consultations, the SEC alleges that Dr. Gilman provided Martoma with material nonpublic information about the ongoing clinical trial, including the actual, detailed results in advance of the July 29 Announcement.

According to the complaint, Mr. Martoma used the information to reposition almost a billion dollars in Elan and Wyeth stock, reaping profits and avoiding losses of over $276 million. At one point Elan and Wyether wer over 10% of the fund’s portfolio. At the end of 2008 Mr. Martoma pocketed a bonus of $9.3 million. CR Intrinsic paid Dr. Gilman $100,000 for his information.

The complaint does not identify the expert network firm, but the Wall Street Journal points to Gerson Lehman.

The facts look very bad for the parties. I assume that is why Dr. Gilman settled. Why is Mr. Martoma fighting the charges? He is subject to criminal charges and I assume the prosecutors wanted more prison time than Mr. Maroma was willing to serve.

The big question is whether the trades were illegal insider trading. The prosecutors will need to prove that Dr. Gilman had material non-public information and had a duty to keep that information confidential. They will need to prove that Mr. Martoma knew or should have known that the information should not be traded upon. That will be the test of this case and other expert network cases. These are likely to be the key issues to prove in this case:

61. Martoma knew, recklessly disregarded, or should have known, that Gilman owed a fiduciary duty, or obligation arising from a similar relationship of trust and confidence, to keep the information confidential.

63. Martoma and CR Intrinsic each knew, recklessly disregarded, or should have known, that the material nonpublic information concerning the Phase II Trial that each received from their respective tippers was disclosed or misappropriated in breach of a fiduciary duty, or similar relationship of trust and confidence.

There is no doubt that fund managers were using expert networks to gain an information edge on the markets. As Gordon Gecko said: “The most valuable commodity I know of is information.” The issue is finding the line between legitimate information gathering and illegally using material non-public information.

According to the SEC press release: “Since October 2009, the SEC has filed more than 170 insider trading actions charging more than 410 individuals and entities. The defendants in these actions are alleged to have made more than $875 million in illicit gains comprised of profits and the avoidance of losses.”

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More on the Massachusetts Regulations on Expert Networks

The Massachusetts Secretary of State issued a new regulation that would affect the ability of investment advisors to use expert networks. This was a direct result of Risk Reward Capital Management being based in Massachusetts. Since the management company was registered as an investment adviser in Massachusetts they are subject to examination and enforcement by the Secretary of the Commonwealth.

The regulation highlights the continuing split between the state-lvel and federal-level of regulation of investment advisers. Dodd-Frank only widened that split by kicking thousands of advisers out of registration with the Securities and Exchange Commission and over to the various states.

Risk Reward Capital Management had just under $25 million under management. Dodd-Frank raised that level.

To clarify its new regulation, Massachusetts issued this policy statement:

The Securities Division has received several questions regarding the applicability of the expert or matching services regulation to investment advisers that are under the authority of the Securities and Exchange Commission. This notice is to restate and clarify information included in the Division’s adopting release for the regulations adopted on August 19, 2011.

The expert or matching services regulation will not be deemed applicable to investment advisers subject to Securities and Exchange Commission authority, consistent with the requirements of Section 203A(b) of the Investment Advisers Act of 1940. The Securities Division retains its authority to take enforcement action against an investment adviser or any person associated with an investment adviser with respect to fraud or deceit, consistent with Section 203A(b)(2) of the Investment.

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Massachusetts and Expert Network Services

At least one of the hedge funds being investigated for its use of expert networks in based in Massachusetts. In an unusual instance of the state regulators acting before Securities and Exchange Commission, the Massachusetts securities regulators are proposing a new regulation to address the use of expert network services. They are proposing a new section under 950 CMR 12.205(9)(c)(16) to the existing list of dishonest and unethical practices:

16. a. To retain consulting services, for compensation that is provided either directly to the consultant or indirectly through a Matching or Expert Network Service, unless the adviser obtains a written certification, signed by the consultant that:

(i) describes all confidentiality restrictions that the consultant has, or reasonably expects to have, regarding Confidential Information; and

(ii) affirmatively states that the consultant will not provide any Confidential Information to the adviser.

b. Notwithstanding section (a) an investment adviser who comes into possession of material Confidential Information through a consultation is precluded from trading any relevant security until such time as the Confidential Information is made public.

c. Definitions. For purposes of this section:

(i) “Confidential Information” means any non-public information, which one is bound by a confidentiality agreement or fiduciary (or similar) duty not to disclose.

(ii) “Matching or Expert Network Service” means a firm that for compensation matches consultants with investment advisers.

As alleged in In the Matter of Risk Reward Capital Management Corp., RRC Management LLC, RRC BioFund LP, and James Silverman, Docket No. E-2010-057, some investment advisers have paid expert networks and consultants to access confidential information about publicly traded companies.

Massachusetts wants additional measures to ensure that confidential information is not being accessed and traded upon. The proposed regulations do not alter an investment advisers’ existing duty not to trade on insider information. The goal is to provide investment advisers with greater clarity as to what is impermissible conduct when paying consultants for information.

In the end, it seems like it is just a record-keeping exercise to me.

You can review comments or submit a comment on the proposed regulation.  There is a proposed effective date of December 1, 2011.

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Massachusetts Brings Charges Against a Hedge Fund

You need to worry about more than just the Securities and Exchange Commission when it comes to private fund fraud. State securities regulators generally have the ability to bring fraud charges. Case in point is the Massachusetts’ Secretary of the Commonwealth bringing charges against Risk Reward Capital Management, RRC Management, the RRC Bio Fund and James A. Silverman.

William F. Galvin’s office moved against the parties because the fund allegedly used the “expert network” firm, Guidepoint Global LLC, to gain inappropriate information about clinical trials for biotech drugs.

“The first year returns for the Fund were poor, losing 16.9% of its value. In early 2008 Silverman began to pay $80,000.00 a year from the Fund’s assets to retain the services of Guidepoint Global LLC, (“Guidepoint”) a so-called “expert network” firm, in an effort to make the hedge fund more profitable. With access to Guidepoint, the Fund began a dramatic resurgence, generating returns of over 55% in 2009 and 52% in 2010. These returns were generated, at least in part, upon Silverman’s receipt of material non-public information he received through Guidepoint consultations.”

The complaint focuses on two public companies for which Silverman received non-public information through Guidepoint consultants: Ariad Pharmaceuticals, Inc. and Questcor Pharmaceuticals Inc.

The complaint lays out in detail how the government sees an “expert network” in operation and how it breaks the law.

The Secretary of the Commonwealth is looking not just at the misuse of the information, but also administrative violations of the Massachusetts’ Uniform Securities Act

The Division’s books and records review of Risk Reward also uncovered a widespread pattern of non-compliance with the Act and the Regulations. The Division uncovered violations of minimum financial requirements, document retention requirements, and a myriad of dishonest and unethical business practices, including improper assessment of performance-based fees. The Division observed a disorderly office appearance during the on-site Examination. In addition to leaving client documents including sensitive financial information laying about on tables, chairs, sofas and floors, the Division discovered that the office doors did not lock, leaving client data vulnerable.

This action was brought pursuant to the enforcement authority under M.G.L. c. 110A §§204 and 407A. You may have notice that the operative agency is the Secretary of the Commonwealth, not the Secretary of State. Massachusetts is a commonwealth, not a state. Not that there is a difference.

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SEC Is Serious About Expert Networks and Gets a New Logo

The Securities and Exchange Commission charged a hedge fund and four hedge fund portfolio managers and analysts with illegally traded on confidential information obtained from technology company employees moonlighting as expert network consultants.

Even bigger news is that the SEC came up with this fancy new logo to brand its expert network investigations and prosecutions.

“It is illegal for company insiders who moonlight as consultants to sell confidential information about their companies to traders, and it is equally illegal to buy that corruptly obtained information and trade on it,” said Robert Khuzami, Director of the SEC’s Division of Enforcement.

Expert networks are not inherently illegal. Of course it’s legal to obtain advice and analysis through experts. It becomes illegal to trade when that material nonpublic information is obtained in violation of a duty to keep that information confidential.

It would be perfectly legal to have someone look at the traffic count for a store to use as a measure of whether sales are up or down. Legend has it that some investors used satellite photos of Wal-Mart parking lots to help with their earnings estimates.

In this case, the SEC is accusing the experts of leveraging insiders to reveal sales forecasts, revenues, and other detailed inside information about their companies. There will be questions about the information: is it material nonpublic information? and did the parties have a duty to keep the information confidential?

The cases should be interesting as an evolution of insider trading prosecutions. The new logo just makes it more interesting.

Thanks to Dominic Jones of IR Web Report for pointing out the new logo in one of his Twitter updates.

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