New York, NY – A few weeks ago, the Wall Street Journal published an article revealing that federal authorities were preparing one of the largest insider trading investigations in history that was likely to ensnare numerous analysts, investment bankers, experts, mutual fund and hedge fund traders. Since then numerous subpoenas and one arrest have followed, with more subpoenas and arrests likely to follow in the next few weeks. However, one independent analyst who has already been subpoenaed, John Kinnucan of Broadband Research, suggests that the traditional business of investment banks and brokerage firms providing management access to buy-side clients is not terribly different from the expert network business that has been so terribly maligned by journalists covering the current insider trading investigation.
“Corporate Access” is a service provided by investment banks and broker-dealers where they arrange meetings between executive managers of public companies and their institutional investor clients. These meetings are often called “non-deal roadshows”. In recent years, some sell-side firms have added unique high value experts (industry consultants, former managers, regulatory / policy experts, etc.) to the mix of people they have provided their clients access to.
Corporate managers benefit from these events because they can tell their companies’ stories to existing or potential investors. Investors benefit from the ability to directly meet with and question managers of the companies whose stocks they own, or whose stock they are planning to invest in, as well as speak with various experts. The investment banks who arrange these meetings benefit from providing a valuable service to both parties which they can commercialize either through generating additional investment banking fees or from increasing the equity commissions they receive from hedge fund and mutual fund investors.
Institutional investors have found the corporate access business to be extremely valuable in recent years, particularly as Reg FD has reduced the amount of material nonpublic information that corporate managers can distribute through their favorite sell-side analysts. According to Greenwich Associates 2010 survey, institutional investors currently spend approximately 35% of the $7.0 billion they pay for sell-side research for direct access to company management (21%) or for research conferences and industry seminars (14%). This compares to 19% for access to company management and 12% for research conferences and industry seminars recorded in Greenwich Associates’ 2009 survey.
Source of Inside Information?
Many commentators (Integrity included) have often wondered why institutional investors have been willing to pay so much for a “concierge service” – particularly if company managers are not allowed to communicate material nonpublic information in these meetings. The traditional answer has always been that investors want to see if they can learn anything from the body language of company management when they ask their questions, or they want to learn about the company’s industry or competitors. However, in his recent article published On December 8th, John Kinnucan of Broadband Research explains one example of how institutional investors can benefit greatly from these “marketing trips”.
“On an early morning last February I was talking with a hedge fund client when apropos of nothing much he let out, “Wow. Company “X” (ticker “XX” for this post) — was just in here, and they are totally pumped. They said RFP (Request For Proposal) activity was off the charts, and they think their telco business is going to explode later this year and next.”
At the time of our conversation (around 10am EST), “XX” was trading at about $50, essentially unchanged on the day — but not for long. Within an hour the stock was up $2, and ended the day near $54, up 8% on the day, increasing the value of the company by hundreds of millions of dollars, and the net worth of the management team participating in the dog and pony show (CEO, CFO, Investor Relations guy) by tens of millions.”
Kinnucan goes on to explain that everyone involved in this arrangement benefits financially, from the buy-side investor to the corporate executive to the sponsoring bank. He concludes that, “this is essentially no different than how an expert network functions, i.e. facilitating access to individual company information by investors, for a fee.”
While we agree with one part of Kinnucan’s argument, we disagree with his general conclusion. It is clear to us that through sell-side Corporate Access programs, buy-side investors can speak directly with corporate insiders, industry consultants, former executives, or other experts. And through these meetings investors might be able to gain some valuable insight and information.
However, we also see some major differences between most Corporate Access programs and Expert Networks. First, most legitimate expert networks do not allow their clients to speak with employees of the public companies they are interested in. This is the exact opposite with Corporate Access programs. The second difference is that most investors do not use expert networks to access company insiders (C level executives), instead they use expert networks to speak with lower level employees, industry consultants, professionals, academics, etc.
Despite these differences, we disagree most vehemently with Kinnucan’s implication that buy-side investors use both Corporate Access programs and Expert Networks to access material nonpublic information that they can then trade on.
Based on our experience, good hedge fund and mutual fund analysts are looking for a number of pieces of nonpublic information that they can use in the development of their mosaic. This means that the information they collect from the non-deal roadshows they attend, and the information they gather from the experts they find through expert networks, provide small pieces of evidence either in support of, or refuting the investment theses they are working on.
Of course, there are bad apples in every industry who are trying to take commercial advantage of the information they have, including company executives, investment bankers, sell-side and independent analysts, buy-side investors, and even employees at expert network firms. The real question I have is who is to blame when this type of criminal activity takes place – the actors or the research tools they use like Corporate Access programs or Expert Networks? It is clear to this observer that the actors should be held responsible for their personal behavior and the blame should not be shifted to the research services they use.