2011 Review – Compliance


One year ago, who would have guessed how deeply litigation and regulation would impact independent research?  Not us.  We were predicting that inside information concerns would abate in the second half of 2011.  Besides getting the duration wrong, we also did not foresee scope of concern, which broadened from inside information to confidential information, putting the mosaic theory to the test.  Here is a brief summary of the year’s compliance-related activity, with focus on the key themes.

1. Insider trading investigations turned into highly successful prosecutions. Since August 2009, Justice department attorneys under Preet Bharara have charged 56 people in insider-trading cases, of whom 52 have pleaded guilty or been convicted at trial.  Besides Galleon Group, former portfolio managers from SAC Capital and CR Intrinsic Investors LLC, an affiliate of SAC Capital, pleaded guilty.  We have had a lull in the investigations during the fourth quarter, although a Wall Street Journal article predicted in December that more indictments were pending, reportedly impacting an analyst at Neuberger Berman Group LLC and traders who worked at hedge funds Diamondback Capital Management LLC and Level Global Investors LP.

2.  Insider trading concerns spread to independent research firms. The FBI’s so-called “Investigation Matchmakers” focused on expert network Primary Global Research, which ceased operations after three employees, seven consultants and six clients pleaded or were found guilty.  Details here.  Peripheral players like John Kinnucan and Karl Motey who had their own research boutiques helped to broaden concerns beyond expert networks to other types of research providers.

3.  Confidential information is becoming as risky as material non-public information. Big Lots Inc. used the insider trading investigations as an opportunity to sue Retail Intelligence Group, a channel checker, for “wrongfully induced” information obtained from Big Lots’ store managers.  The suit was settled out of court, leaving market participants questioning where to draw the line on safe non-public information.  These concerns were exacerbated by the conviction of Primary Global Research salesperson James Fleishman after prosecutors focused on Fleishman’s involvement with confidential information rather than material non-public information.  Since obtaining confidential information is a easier case to prove (and a simpler infraction) than the materiality of inside information, the safe harbor afforded by mosaic theory is weakened.

4. Anti-bribery statutes became a concern. The broad language and aggressive enforcement of the U.S. Foreign Corrupt Practices Act generated concerns for international research providers, particularly in China where many enterprises are government-affiliated.

5.  Insider trading regulation spread to non-equity markets. Regulators have periodically brought inside information cases relating to fixed income markets, most recently in 2009.  The Dodd Frank Act extended insider trading sanctions to futures and swaps markets.

6.  Regulators brought actions against broker dealers for faulty insider trading compliance practices.  The SEC fined Janney Montgomery Scott and FINRA fined Midtown Partners & Co. LLC for allegedly having inadequate insider trading compliance.

7.  There is increasing scrutiny of political intelligence research. The Stop Trading on Congressional Knowledge Act, or STOCK Act, which would prohibit Members of Congress and federal employees from profiting from nonpublic information obtained new life after it was featured by 60 Minutes.  The House version of the legislation requires registration of political intelligence research firms.

8.  Quantitative models received regulatory actions. The SEC instituted administrative proceedings against three AXA Rosenberg entities for inadequate oversight of quantitative research models.

9.  The SEC reviewed trading ideas platorms. The SEC conducted a series of ‘sweeps’ focusing on whether ‘alpha capture’ platforms violate sanctions against selective disclosure of research.  The probe was prompted by  Goldman Sachs’ practice of providing favored clients advance notice of potential research actions as part of its ‘trading huddles.’  Goldman paid a $10 million fine to Massachusetts and agreed to end its practice.  The SEC has taken no action with alpha capture platforms.

10.  Challenge to management access. EuroIRP, the European trade association of independent research providers, issued  a report arguing that management access does not meet the European definition of research and should not be payable through commissions.  The report also suggested that the U.S. insider trading investigations may lead to greater regulatory scrutiny of corporate access.  As far as we know, this has not happened.





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