Are Small Research Firms Tainted?


The final image of the mercurial John Kinnucan, sole proprietor of Broadband Research LLC, is one of pathos: a broke and broken man, defended by a court-appointed attorney, pleading guilty in a subdued voice while his wife and two kids sell their belongings to pay for food.  How are we supposed to react?  Here is a guy that sent flame mail to clients and threatened federal prosecutors.  Kinnucan’s antics heightened investor fears of using unregulated research.  Yet his ending seemed almost tragic.

Or consider Karl Motey, sole proprietor of Coda Group Inc., who in contrast to Kinnucan eagerly cooperated with prosecutors, including signing up as a client of expert network Primary Global Research at the request of the Government, and making over 60 calls seeking incriminating evidence.  Motey recently testified in the trial of his former hedge fund client, Doug Whitman of Whitman Capital, saying that he passed inside information about Marvell Technology Group to Whitman.

Motey, who was a technology analyst at Alex Brown and Wachovia before setting up his own boutique, also testified that he did not pass along inside information when he worked at Wachovia because “it was improper and put my job at risk.”  It was only after he set up his own independent research firm that he felt “pressure” from his clients after he became an independent consultant to seek out inside information.

Taken together, Kinnucan and Motey are a nightmare for independent research providers.  Kinnucan, made unstable by the pressure from prosecutors, abused his hedge fund clients and generated a huge amount of negative publicity.  Motey is even worse: testifying against his clients after feeding them tainted information.

The larger problem for small independent research firms is providing assurance to clients and prospective clients that Kinnucan and Motey were aberrations, not the rule.  The vast majority of small research boutiques did not, and does not, seek out inside information.  However, reassuring others of this can be difficult for small unregulated firms.

There are many compliance best practices that small firms can follow as well as large firms.  However, creating an objective, third party compliance process which has some distance from day-to-day operations can be especially challenging for firms with limited staff.  (Of course, large firms can fail at this also, not because of a lack of resources but because of a failure of culture and management.)

One alternative is to become a registered broker/dealer or affiliate with one.  For small firms, registering as a broker/dealer may not be practical, so affiliation may be the only option.  The issue here is that if the broker/dealer is distributing independent research as third party research, the level of compliance oversight is less than that given to proprietary research.

We are increasingly seeing small firms turn to outside parties for assistance in administering their compliance processes.  In some cases, it is help in setting up the appropriate compliance practices or documenting them for internal and external use.  In other cases, it is for ongoing compliance training or supervision of research.

For sole proprietorships, like those of Kinnucan and Motey, the problem is particularly acute.  How can you supervise your own research?  The answer is that you can’t.  You absolutely need an outside entity to help with compliance.  In our view, the level and nature of outside assistance needed varies with type of research being performed.  For example, a channel checker like Kinnucan would need controls on his channel check process to protect him and his clients against getting confidential information from his sources.

Don’t read this wrong: this is not a soft sell for Integrity’s own services.  We don’t offer this kind of compliance oversight.  But, because we get the questions so often, we have compiled a list of lawyers and compliance specialists we know who understand research and don’t charge crazy fees.  Contact us if you would like a copy.

For too long independent research providers assumed that because they were independent of investment banking they did not need to invest in compliance.  The fates of Kinnucan and Motey say otherwise.  A healthy compliance process is no longer a nice-to-have, but it doesn’t have to break the bank either.


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