I taught a CLE on recent developments in insider trading law last Friday, and got some questions after the session about expert networks. These networks have been much in the news recently because some of them have functioned as systemic insider trading rings, linking up traders with current and former corporate employees who are all too willing to share material, nonpublic information for an appropriate fee. The gist of the questions was: are expert networks okay to use? Put another way, can portfolio managers use them in a manner that can add value to their investment decisions but won’t cross the line into tipping material, nonpublic information? I think the answer is plainly yes. It’s just a matter of drawing the lines between what information is appropriate to share and what isn’t.
The questions reminded me of a Fortune magazine article I read several years ago about Ken Heebner, a mutual fund manager at Capital Growth Management in Boston. The story, titled “America’s Hottest Investor,” was glowing and put Heebner in a very favorable light. What I found interesting about it then (and now) was his focus on hard data as the basis for his investment decisions. The story starts with a junior analyst from Goldman Sachs going on and on about different trends he sees affecting the markets in coming years. Unfortunately for the analyst’s efforts to keep Heebner awake, the trends were quite general. Agriculture is growing, oil demand is outpacing supply, sovereign wealth funds are big, etc., etc.
But Jon Birger’s excellent story puts it better than I can:
Then, just as the meeting is looking like a washout, Goldman analyst Marc Fox lets something slip that starts Heebner’s brain whirling. Fox mentions that sovereign wealth funds are diversifying out of bonds and bank bailouts and into broad portfolios of common stocks. Coming from Goldman, the world’s top trading house, this is valuable information. Heebner is one of the few fund managers who routinely engages in short-selling, and the prospect of a couple of trillion dollars flooding the equity markets should be enough to give any short-seller pause.
Immediately Heebner is peppering Fox with questions about where all this sovereign dough is going, wondering, for instance, whether Goldman is now recommending “short-busting” strategies to its worldwide clientele. (Short-busting involves trying to drive up the prices of stocks that a lot of investors have sold short.) “All I can say,” Fox replies, looking a tad overwhelmed, “is you’re multiple steps ahead of me.”
The story goes on to describe Heebner’s relentless pushing of his staff to learn as much useful information as possible about the markets Capital Growth Management invests in. He doesn’t care about theories or broad trends. He cares very much about, say, scrap steel prices in China and deep-sea oil rig leases. Those facts affect his commodities-related investments greatly, so that’s what he drives his people to learn. The story obviously doesn’t describe Heebner plotting to learn Intel’s quarterly earnings just before their public release.
Anyway, I think the story highlights a way forward for expert networks. They certainly cannot serve as funnels for material, nonpublic information the way Primary Global Research appears to have done. But it seems plain that a portfolio manager or other trader would seriously benefit from the sort of research that Heebner’s staff does all the time (even if his funds’ performance figures have not been quite as stellar of late). And it also seems to me that outsourcing that research to an expert network might be the most efficient way for such a trader to reap its benefits, in lieu of or perhaps in addition to fulltime staff members. Professional traders have to have information that will keep them ahead of competitors. Getting those hard facts from expert networks would be entirely legitimate and valuable to investors, and could be lucrative for the networks themselves.