Are Compliance Policies Enough?


New York, NY – In the 4th Quarter of 2009, Integrity Research conducted an extensive analysis of the global expert network industry, along with a review of the compliance policies and procedures of one third of the expert networks in existence at the time.  Based on the written policies and procedures of these firms, we concluded that a number of firms, including Mountain View California-based Primary Global Research had relatively good compliance policies in place.  Unfortunately, the insider trading investigation that has come to light over the past four months suggests that Primary Global’s actual compliance practices did not match up with their written policies.  This has led us to rethink our approach of determining the compliance risk of using external research providers.

Our Previous Approach

In the past, the team at Integrity Research developed and sent out compliance questionnaires to research firms, in order to identify the various policies and procedures they had in place.   In addition, we would conduct short interviews with compliance officers to clarify our understanding of how they actually implemented these policies. 

It is important to note that the questions we developed were specific for the different types of research providers, since the compliance practices of an expert network would be extremely different than those of a channel check provider or a fundamental research firm.

This approach helped us to understand what compliance concerns the research firms thought were particularly important.  Unfortunately, this approach didn’t help us understand what the research firm actually did on a day-to-day basis.  It also did not help us identify the culture of the firm, nor did it help us understand what type of commitment the executives of the firm had for compliance issues.

Developments at Primary Global

As we mentioned earlier, Integrity Research Associates conducted an extensive analysis of the expert network industry in the 4th quarter of 2009.  As part of this research, Integrity evaluated the compliance policies and procedures for a large segment of the expert network providers (though a number refused to participate in our research).  Based purely on firm’s written policies, Primary Global Research looked to have a relatively robust compliance system in place.

However, since November of 2010, the Securities and Exchange Commission has charged eight people who have had some involvement with Primary Global Research in its growing insider trading investigation.  This includes three former PGR employees (Don Ching Trang Chu, Bob Nguyen, and James Fleishman) and at least five consultants (Mark Anthony Longoria, Daniel Devore, Winifred Jiau, Walter Shimoon and Manosha Karunatilaka) who have gained access to hedge fund clients through PGR.

Apparently, PGR’s actual compliance practices and culture were not consistent with the firm’s written policies.  In other words, this research firm probably did not do what it said it would do. 

Integrity’s New Process

As you might guess, these developments made the team at Integrity Research take a hard look at our process for conducting due diligence of a research firm’s compliance practices.  Consequently, we did a number of things to help us better understand the compliance risks that using an external research provider might create for an asset manager.

The first step we took was to hire former attorney with the SEC’s enforcement division – Ms. Susan Mathews – to bring both legal and regulatory expertise to the firm and to lead Integrity’s new ResearchCompliance practice.  Click here for more information on Susan Mathews’ background.

The next step was to develop a more comprehensive due diligence process for our compliance audits.  Our new process includes the following:

  1. Develop and send out detailed compliance policy questionnaires to each research provider based on their specific research methodology.
  2. Send out document requests for all written ethics codes, compliance policies, etc.
  3. Review the completed policy questionnaires and the actual documents.
  4. Audit actual practices by reviewing internal logs, forms, and signed agreements.
  5. Develop interview guides, and interview both current and former employees.
  6. Conduct regulatory background checks for the firm, as well as for key managerial staff.

Our final step was to design a set of deliverables for this new research compliance due diligence service.  This includes a concise report which analyzes all the information we collected with a focus on a research provider’s written policies, procedures, personnel, actual practices, and overall culture to identify the strengths and weaknesses of their research compliance program.

The Upshot of Integrity’s New Process

Integrity Research has recently started implementing this new process.  Although it is still too early to make definitive judgments about its efficacy, it is clear to us that the depth of our current due diligence process has helped us better identify risky compliance practices when compared to our former approach of just collecting information about a research firm’s compliance policies.

One big question remaining is, “How important is it to hedge funds and mutual funds to better identify the research providers whose actual corporate culture and compliance practices encourage risky behavior?”  We suspect that some of the hedge funds and mutual funds recently swept up into the insider trading investigation would have found these audits to be extremely useful – particularly as the consequences of government subpoenas, criminal and civil charges have already had a devastating impact on the reputations and actual financial viability of some of these firms.    

Another key question is, “How important is it that research providers show their commitment to research compliance by having an independent third party conduct a comprehensive audit of their practices?”  We know that many research firms have been questioned about their compliance policies by their buy-side clients, with a number suffering client defections as institutional investors have decided that the reputational, legal, or financial risk of using these firms is higher than the benefits of their research.

For more information about Integrity’s new ResearchCompliance service, or the specifics about our new due diligence process, please contact Michael Mayhew at


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