Gerson Lehrman Getting its Wings Clipped?

What’s amazing isn’t that Gerson Lehrman is under scrutiny, but that it has taken so long to happen. From today’s Wall Street Journal:

In recent weeks, the New York Attorney General’s office has begun examining whether employees of companies including Best Buy Co. may have inappropriately discussed material nonpublic information in consulting arrangements like these with hedge funds and other investors. The examination also concerns Circuit City Stores Inc., according to one person briefed on the matter.

According to people close to the situation, the office is looking into whether consultants paid by Gerson Lehrman and another major provider of this kind of service, Vista Research, may have inappropriately disclosed important information about the companies in which they work. Securities rules prohibit trading on material nonpublic information — the term for potentially market-moving business details not otherwise available to the investing public.

The New York Attorney General’s office has issued subpoenas recently to Gerson and Vista, a unit of McGraw-Hill Cos., as well as to hedge funds that are clients of Gerson and Vista…

Separately, the Securities and Exchange Commission is working on several investigations to see if hedge funds have received nonpublic information due to research firms like these….

Regulators are focusing on whether consultants who are or were employed by public companies have shared nonpublic information with the investors they talk to, either knowingly or unintentionally…

In a page-one article on Gerson, The Wall Street Journal reported in November that Gerson consultants employed by public companies sometimes are unaware of their own companies’ restrictions or have a hazy understanding of what qualifies as nonpublic information.

Gerson and Vista take steps to prevent their consultants from sharing inappropriate information. Gerson has said all of its consultants must agree in writing each year to follow the rules of their primary employers. The firm also has said it constantly reminds consultants and clients not to discuss confidential or restricted information and advises them on how to learn if their employer has rules governing this consulting…

The Journal’s story in November about Gerson said its consultants sometimes don’t inform their employers when they are being paid to speak with a hedge fund or other investor. And they sometimes consult with investors in violation of their employers’ policies.

A colleague who once ran one of the biggest international research operations says that this sort of, ahem, research is as suspect as it sounds. Hedge funds and investors use Gerson and its lot for “channel checking,” that is, they ring up people at companies who are buyers of certain goods to see what kind of orders they are placing. It’s not hard to see why employers would object to this information being shared. First, the employee has no right to trade on his employer’s data. Second, information on how certain products are selling could also give an early warning of the company’s overall revenue trends. Third, disclosure might damage its relationships with suppliers.

You can see why this information is prized. It’s clearly non-public; the only question is whether it is confidential, and the answer is likely to be yes.

Why did the SEC and Eliot Spitzer take so long to act on this one? Hard to know, but our guess is that, unlike the insider trading cases, these breaches of confidentiality don’t lead to huge trades. It’s more like a death of a thousand unkind cuts. But as Gerson and its ilk extended the reach of their operations, and became more visible, the powers that had to be were forced to act. Faith in the markets rests on the (often mistaken) belief that the particicpants have (or can have if they spend the time) reasonably equal access to information. Gerson Lehrman makes a mockery of that idea.