We recently had an article published in the Hedge Fund Law Report which discusses how asset managers review the compliance platforms of external research providers. The article summarizes our experience in working with hedge funds and other asset managers in conducting due diligence on research providers. The following are a few of our observations. For the full article, please go to http://www.hflawreport.com/issue/254.
- The scope of due diligence varies by asset manager, and by the type of research the provider performs. Expert networks are consistently scrutinized, as are other types of primary research providers such as channel checkers and market research firms. Industry consultants, fundamental research firms, forensic research and policy research firms often trigger reviews. Economic research and quantitative research are less commonly part of the due diligence process, but may be included in a manager’s review of all external providers.
- The vendor due diligence process typically consists of questionnaires and supporting documents, and may also include interviews, onsite visits and background checks.
- Asset managers usually conduct due diligence when a new provider is added, and update on a periodic basis. If the provider’s services are contracted, contract renewal can occasion an update.
- Due diligence is primarily centered on reducing insider trading risks. The manager may also examine other regulatory risks such as conflicts of interest arising out of businesses affiliated with a research provider such as asset management or consulting businesses. Selective dissemination of research has also received regulatory and media attention.
- Some asset managers prioritize their due diligence by perceived risk of receiving confidential or material non-public information. Generally, unregulated providers appear to receive more compliance scrutiny than registered broker dealers.
Research providers can help their cause by following a core set of best practices: having designated compliance professionals, established compliance policies which include attention to information control, regular compliance training.
Information control means knowing how your firm obtains information, and having reasonable safeguards to ensure that you minimize the risk of receiving confidential or material non-public information, and, if you do, you can quarantine it. Ultimately, the viability of the compliance is a function of how seriously senior management takes it.
As we have discussed in the past, one- or two- person shops will need outside assistance in administering a compliance program. This can be done with existing legal counsel, or compliance specialists. We don’t offer this as service, but we can recommend qualified people if that would be helpful.
We are in our third year of insider trading prosecutions. Compliance is now a fact of life, and being an independent research provider is no longer a self-evident mark of distinction. We are in a new era with clients who are increasingly regulated, and looking for similar controls within their research providers.