Readers may recall that I’ve been a long-standing critic of Gerson Lehrman, a “research” firm that signs up so-called experts to provide information to clients, typically hedge funds.
The problem with the Gerson model is the experts are often full time employees, and hence are effectively re-selling information they learned on their employer’s nickel. I’ve not seen Gerson’s consulting agreements, but I would strongly suspect that they are designed to shift liability for compliance with corporate policy to the consultant. And unless Gerson independently contacts the HR or legal department, there is no assurance that the employee is operating within official policy. One former head of research for a major bank expressed serious doubts about Gerson’s business model; he was pretty certain many Gerson consultants either had not obtained approval or had not done so properly (ie, a casual chat with the boss, “Do you mind if I spend a few hours a month on my own time working with some investors?”)
The SEC and the New York attorney general did probe Gerson in 2006 but it did not lead to charges being filed. But now the SEC is taking a broader view of what constitutes inside information, and Gerson may fall afoul of this reading.
Roger Ehrenberg provided a his idea of where the line between inside information and legitimate research might be drawn. But even his distinction is not as clean as it might seem:
As it relates to the research process, I think fairness should be judged by whether a motivated investor could learn the information through resourcefulness and hard work. If an investor was focused on better understanding the prospects for a particular product, could they read published research, explore primary sources and perform surveys? Sure. Would it be difficult? Absolutely. But it could be done if the individual was sufficiently motivated. Alternatively, they could obtain this information by paying money for it via an expert network. Is it “fair” that someone has the resources to pay for access to experts where another might not? I think so. Those who have built careers around investing and are willing and able to spend money to streamline their investment process are ok with me – provided that the information to which they have access could be obtained by a highly motivated person. What isn’t fair, however, is when experts provide information that couldn’t be obtained through any amount of hard work, e.g., if an official at the FDA was on an expert network panel and had non-public information about the likelihood of a drug making it through clinical trials, sharing this information with a subscriber would unquestionably be unfair. Another example would be a company executive handicapping the prospects of an M&A deal. In these circumstances the recipient of the information would have the ability to trade on it, capturing the benefit between the current stock price and the target stock price reflecting the information they have received. Does this promote efficient markets? Yes. Does it support fair markets? Clearly not.
The problem with the “any amout of hard work” is it assumes time is not a constraint. But in the real world of markets, timing is crucial. If, say, the head of the purchasing department at a major IT retail chain of a sudden falloff in orders for a particular product or vendor , it might be possible to replicate that information via other avenues, but probably not quickly enough to gain a trading advantage.
And Gerson, at least historically, has focused on “channel checking”: they cultivate 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 order levels could also give an early warning of the company’s overall revenue trends. Third, disclosure might damage its relationships with suppliers.
From the Wall Street Journal:
Federal Bureau of Investigation agents questioned a consultant for Gerson Lehrman Group in August as part of the probe, according to people familiar with the matter. The consultant, an employee of Marvell Technology Group Ltd., provided information about the technology industry to a Gerson client, Diamondback Capital Management LLC, a hedge fund the FBI raided last week, the people said.
Gerson controls two-thirds of the market for expert networks, which set up meetings and calls with current and former managers from hundreds of companies for hedge-fund and other traders seeking an investing edge…The FBI questioning of the Gerson consultant shows the government’s examination of the expert-network business is broader than Primary Global. Criminal and civil authorities are investigating whether these consultants passed inside information to clients, who pay the expert companies large fees for their services….
The Gerson consultant, Menucher Menuchehry, is a 41-year-old employee of Marvell working in the business-development and strategy area of the company, according to public records. It isn’t known whether authorities suspect Mr. Menuchehry passed inside information to any fund.
Yves here. Ahem. Gerson engaged someone who worked in “business strategy and development” and this is supposed to be kosher? For those not savvy about corporate life, that area is deeply involved in (in many cases, formally responsible for) M&A and other major corporate initiatives, like large-scale capital investments and new product planning. It is the single biggest hub of valuable trading information in a company. Engaging someone like that as an “expert” for investors is asking for trouble. A supposedly savvy firm like Gerson can’t pretend it didn’t know what was going to happen. It’s like pretending those beautiful women rented out by escort services are hired only to be arm candy.
If Menuchehry really is the only corporate development type in Gerson’s network, it might have a defense, that he somehow slipped though the cracks. But if he has company, then Gerson’s business model is probably every bit as dirty as my contacts have long insisted it is.
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I find it very hard to believe that Mr. Menuchehry didn’t have any idea that what he was doing was not kosher. Gerson is very likely to run a dirty business, but what was a guy in Biz Strat & Dev for a given corporation thinking in doing a “little consulting on the side” (for investors, no less!) like that?
It wouldn’t be because they’re paid min wages, me think.
I’m sure that 99% of employees would not be allowed to provide this kind of consulting as it would be a violation of their company’s code of ethics. That being said, unless they’re on the corporate board, this is not insider information, as they don’t have the ultimate decision-making power as I believe the law now stands. On the other hand, I find it somewhat exasperating that WFC jumped up so drastically as compared to its peers on no news; but the next day the news that their settlement with C was “only” $100 million. Obviously many people traded on the “news” before it was publicly disclosed. Were they “insiders” probably not, but employees in the know, friends of employees in the know, regulators, hedge funds with expert networks….
“…this is not insider information, as they don’t have the ultimate decision-making power as I believe the law now stands.”
The mythology of centralization does lead one to believe that only the big people around the big table have the information of the big moves. However, corporate headquarters don’t work in an ideal fashion.
I think the last sociological study I read showed office gossip at right around 90% accurate. And that’s just people chatting in the aisles. If you get the assitant who actually does the work for the executive, or the juniors who create the presentation of the only alternatives to be discussed, or the gal or guy who’s bonking Mr. VP, you get pretty much 100 for 100.
One might think of this as leaky or one might realize The Deciders aren’t as clever as they think. The supporting players for the star leads in the great drama of the corporation don’t get much credit or recompense, but they know the script. If the rules were made by people less full of themselves, this would be specifically against the law.
This is the government/lobbyist model of regulatory capture. The less than stringent controls over civil servants, Pentagon brass and politicians going to work for the corporations that they previously contracted with, passed legislation or regulated directly is the open secret of condoned corruption which needs reform and criminal penalties, including capital punishment for sever incidents.
Furthermore, how much different is it from the interlocking directorships which form the commercial clusters of cartel like behavior.
So when is the SEC going to go after Mozillo for insider trading; that is talking up Countrywide’s prospects, yet undertaking “portfolio diversification”?
And is Dodd going to exploit the loopholes of his bill, a la Rubin?
Let’s not overlook the journalists in DC who call their investor contacts with not yet public information. These people find out all kinds of stuff by shmoozing/working members of congress/staff/department workers, and get paid to call Josh in Manhattan first. Very efficient, but is it inside? Bwahaahaa, they have the 1st amendment.
Well now I know why I had that funny feeling in my gut when I interviewed with them earlier this year. When they described their business model to me, I was admittedly a bit confused and had a subsequent uneasy feeling about the legitimacy of their business.
I’ve used the services of Gerson, which is referred to in the business as “GLG”.
In addition to the problems of inside information leaking out through them, which I’ve never encountered but believe probably happens a lot, the issue I’ve always had with GLG is that they often play a dysfunctional role in the research process. I have found that analysts at hedge funds and PE firms frequently use the opinions of GLG’s consulting “experts” as a substitute for real primary source research. GLG is just too easy an intellectual short-cut to resist for most young, relatively inexperienced Wall Street professionals. What these users of GLG often fail to appreciate is that the “expert” on the phone is talking through his hat about a topic about which he knows relatively little. This problem is compounded greatly by the reality that a large portion of hedge funds and PE firms are consulting the same few semi-informed GLG experts about whatever the financial issue or deal of the day is, so they are led astray en masse.