It is July 21, 2009, and one Wall Street hedge fund manager has a sudden change of heart. Having bought more than 1m shares in the giant technology company AMD over the past two weeks, the trader loses confidence in his bet and swiftly dumps a third of his stake.
The volte-face immediately looks shrewd. As the markets close that evening, AMD makes a quarterly earnings announcement admitting to a $330m (£201m) loss and a 13% drop in revenues. One day later, AMD shares slump 13%, meaning the hedge fund manager had avoided losses of at least $140,355.
Despite appearances, the unnamed trader's move may have been neither clever nor lucky: in the hours preceding AMD's announcement, the seller had conducted a 10-minute phone call with one Mark Anthony Longoria, who is AMD's supply-chain manager.
That case is now part of the huge insider-dealing inquiry fixating Wall Street, which became even more sensational last week when the US securities and exchange commission filed civil charges against Rajat Gupta, the former head of the management consulting firm McKinsey.
Gupta, who denies any wrongdoing, is alleged to have passed corporate secrets learned as a board member of Goldman Sachs to Raj Rajaratnam, the founder of the Galleon hedge fund, whose own trial on several counts of fraud and insider trading is due to start on Tuesday.
Insider dealing is as old as markets themselves and the Financial Services Authority, the UK regulator, said there were "abnormal pre-announcement price movements" before 30.6% of 2009 takeover announcements. While Gupta's name makes the US inquiry among the highest-profile pursuits of insider traders since the groundbreaking Wall Street investigations of the 1980s, what is really unusual about this crackdown is how the likes of Longoria have become embroiled in the controversy.
The 44-year-old from Round Rock, Texas, made the fateful AMD call while moonlighting as a paid consultant for Primary Global Research (PGR), a so-called "expert network" firm that matches industry experts with money managers looking for informed corporate news. Court papers state that Longoria, who is plea bargaining, was paid $300 an hour to provide information to PGR clients and, from January 2008 to March 2010, received more than $130,000 for his time.
Little is known about the world of expert networks. Even the grandaddy of the sector – Gerson Lehrman Group (GLG) – was once dubbed New York's "most valuable company no one outside of Wall Street has ever heard of". The business practice is perfectly legal, unless inside information is exchanged and used, but increasingly there are suspicions that impropriety is occurring more often than regulators would like.
In November, one Don Chu, a PGR employee, was arrested after evidence gleaned from wiretaps and the co-operation of Richard Choo-Beng Lee, who had already pleaded guilty to insider trading in the Galleon case and is now a key witness. Also that month, Yves Benhamou – a French doctor who was reportedly part of the Guidepoint Global Investors expert network – was charged after allegedly tipping off a hedge fund manager with confidential information about a clinical trial.
The questions these cases raised over the expert network industry have been limited to the US, where many of the firms are based, and there is no suggestion of any wrongdoing in London where the FSA privately plays down such firms' significance.
However, the Guardian has unearthed eight expert network firms operating within London – with one hired "expert" claiming that he alone has conducted "consultations" with more than 70% of the top investment banks in the City.
Big players including GLG, Coleman Research and the Benhamou-linked Guidepoint all operate out of London, as do other firms including AlphaSights, CognoLink, DeMatteo Monness, ExpertView and Informed Edge. Apart from ExpertView, none of the firms would speak publicly to this newspaper about their industry or the impact the US inquiry is having on their business.
However, ExpertView's founder, Martin Tripp, said: "Expert networks are a brilliant bespoke research tool, but you absolutely have to know the questions you can ask. We have had letters from US companies asking if we have any of their employees on our network and to remove them if we have. We have spent a lot of time and money getting our compliance right. We have telephone conversations with every single expert that we sign to the network. They are not authorised unless we've spoken to them."
While ExpertView, which bills itself as a niche player concentrating on "quality not quantity", says it speaks to all its experts, that is not always true of some of the bigger players who conduct much of their vetting online.
GLG claims to have more than 850 clients worldwide, served by 300,000 experts in sectors such as healthcare, energy, accounting and finance. One UK-based expert with GLG said: "You get 15 minutes' ethics training but it's very basic. They tell you 'don't say anything if it is confidential'. It is that level. I don't think there is much vetting. It is 'buyer beware'."
Another GLG expert insisted said there was "quite a stringent process of form filling", while in a recent note to clients after the industry-wide controversy, GLG's chief executive, Alexander Saint-Amand, said: "We believe our policies and approach are the most robust in our industry and add significant transparency and controls over many types of uncontrolled and undocumented methods of information-gathering that exist outside of an expert network framework."
Still, despite these efforts, even experts admit that problems occur. John Ansell, a pharmaceutical consultant who has conducted over 200 consultations for GLG over four years, added: "Only once has there been a problem. I told a bank something based on a rumour but they didn't want to hear it. It can happen inadvertently."
Big names accused
Last week's announcement that Rajat Gupta, the former head of management consulting group McKinsey, was among those charged in the securities and exchange commission's long-running insider dealing investigation propelled the inquiry's profile to new heights.
Gupta, who denies any wrongdoing, is a former Goldman Sachs and Procter & Gamble director as well as being a one-time adviser to the United Nations and the biggest name to be directly dragged into the investigation thus far. It is alleged he passed corporate secrets to Raj Rajaratnam, whose hedge fund Galleon is being examined in another part of the case, which in turn triggered charges against four further hedge fund managers.
One-time Olympic speed skating hopeful, Donald Longueuil, and Noah Freeman – who both once worked at $12bn hedge fund SAC Capital – have been charged with Samir Barai, founder of Barai Capital Management, and his employee Jason Pflaum.
Prosecutors allege the four men swapped tips from employees of public companies and from expert network consultants. Former hedge fund analyst Danielle Chiesi, who compared insider dealing to an orgasm, has admitted making $4m (£2.45m) from the illicit deals.
SAC founded by famed trader, Steven A Cohen, has a high profile on Wall Street but the fund has been embarrassed by names of other former employees being dragged into the glare of this SEC investigation.
Following the charges against Longueuil and Freeman the company said it was outraged by their alleged actions.
But hedge funds garner the media's attention and some have already felt the fallout from this latest scandal. Bloomberg reports that David Ganek's Level Global Investors shut down its operations:
The $4 billion firm hadn’t lost money. No senior people had quit. What spurred Ganek’s decision was a November raid by the Federal Bureau of Investigation of the company’s offices overlooking Central Park, part of the U.S. government’s investigation into insider trading.
Within weeks, investors started to pull money, even though none of Level Global’s 61 employees had been accused of wrongdoing. To this day, no one has been charged and the firm maintains it isn’t a target of the probe. Still the damage was done.
“When the feds knock on your door, it’s game over,” said Brad Alford, head of Alpha Capital Management LLC in Atlanta, which invests in hedge and mutual funds on behalf of wealthy clients. “Integrity is all you have in this business.”
Integrity is all you have in this business but there is so much nonsense going on every single day in the stock market that you have to wonder if there is any integrity left. On any given day, you'll see some stock get pounded, down 20% or more on no real news, volume surging as the naked short sellers pile in and the hedgies scoop up shares while retail investors run for the hills. The stock then rebounds 10% or more the following day and some analyst comes out to say that the "market didn't price the news correctly" (got to love those analysts!).
One final thought on hedge funds. There are many excellent hedge funds that earn their fees. Bridgewater, the largest US hedge fund, is one that comes to mind but there are plenty of others that are much smaller and deliver true alpha. Then there are crooks peddling nonsense whose only real skill is marketing to investors that they have a "niche strategy" based on "rigorous analysis". My advice to all hedge fund investors is to always be skeptical. If it looks too good to be true, walk away. Even if it doesn't, make sure you know what you're paying for -- alpha or leveraged beta? The former is worth paying fees, especially if you can't reproduce it internally.