Re-examining Expert Networks: A New Perspective
Richard D. Marshall
Katten Muchin Rosenman
Abstract:
Expert networks play a legal and useful role in investment research, but have been implicated in several
recent civil and criminal insider trading prosecutions. Although compliance enhancements have been
implemented since these prosecutions, the response of the industry has been to add restrictive andsomewhat arbitrary controls that do not sufficiently alter the risk profile of the interactions, and limit thedissemination of legitimate information. The secrecy of the consultation between the expert and his or
her client remains a critical weakness in the current system.
To mitigate this weakness, expert networks should become more transparent. By integrating technology
and broad public access into these interactions, an important step can be taken to reduce the risk while
enabling the valuable exchange of information in these networks within a compliant
environment. Slingshot Insights' expert network model provides a method for this approach. By
recording and making available online all expert interviews, Slingshot’s model is more transparent andpublic than current expert network practices, reducing the need for arbitrary and limiting compliancerestrictions, while simultaneously enhancing expert network compliance.

About the author Richard D. MarshallRichard D. Marshall focuses his practice on the representation of financial institutions and employees
subjected to investigations by the Securities and Exchange Commission, Department of Justice, Financial Industry
Regulatory Authority and state securities regulators. Rick also counsels broker-dealers, investment companies andinvestment advisers on regulatory issues, particularly relating to SEC and FINRA regulations. He also frequently
counsels clients on compliance and risk management issues and the handling of inspections. Prior to entering
private practice, Rick worked for several years for the SEC as both a branch chief in the Division of Enforcement inWashington, DC and as a senior associate regional administrator in New York, where his staff conducted
inspections of investment companies and investment advisers, and instituted enforcement actions against thoseentities.

Re-examining Expert Networks: A New Perspective
Richard D. Marshall
For many years the SEC’s website featured a famous quotation from Louis Brandeis:“Sunlight is said to be the best of disinfectants; electric light the most effective policeman. . . If
the broad light of day could be let in upon men’s actions, it would purify them as the sun
disinfects.”1
Over the past decade there has been an increased focus on expert networks from both
regulators and the media. After several well publicized prosecutions involving information thatwas conveyed through expert networks, compliance departments have tightened policies with thegoal of preventing the disclosure of material nonpublic information and avoiding regulatory
scrutiny.
However, it is time to consider improvements in the current workings of expert networks
and re-examine the situation with a fresh perspective. Instead of the previous ”secrecy”
approach - where the consultation between the expert and his or her client occurred orally, on a
one-on-one basis, and without any third-party observation - the simple answer may be to let the“sunlight” in on these expert consultations.
I.

The Legitimate Value of Expert Networks

Many users of information cannot retain valuable experts as full time employees.
Instead, they must seek out and retain experts on an as needed basis. Expert networks identify
and make available experts on demand to fill this gap. “The term ‘expert network’ is used torefer to firms that are in the business of connecting clients, principally institutional investors,
with persons who are deemed to have special expertise in the client’s area of interest. Experts
can include academics, scientists, engineers, doctors, lawyers, suppliers, and professional
participants in the relevant industry, including in some cases even former employees of thecompany of interest. These networks can save investors the time, cost, and uncertainty
associated with obtaining specialized knowledge on their own. If used properly, expert
networks can be a valuable and legitimate research tool that facilitates efficient access byclients to persons with specialized and valued expertise.”2
Expert networks are necessary and provide value to the markets as a whole. Although therecent prosecutions involving expert networks highlight the deficiencies in the historic expert
network system, this does not impact the inherent legality of the use of expert knowledge, which
has continually been acknowledged by the courts and SEC.
The United States Supreme Court, relying upon observations by the SEC, expressly
recognizes the value and legitimacy of research and information gathering that may give one
trader an informational advantage over others:
1

Louis D. Brandeis, “What Publicity Can Do,” Harper’s Weekly (Dec. 20, 1913).

2

Bondi and Lofchie, “The Law of Insider Trading,” NYU Journal of Law and Business 151, n. 1 (2011)I(emphasis
added).

© Slingshot Insights 2015

2

Imposing [insider trading liability] solely because a person knowingly receives
material nonpublic information from an insider and trades on it could have an
inhibiting influence on the role of market analysts, which the SEC itself
recognizes is necessary to the preservation of a healthy market. [Footnote 17] It
is commonplace for analysts to "ferret out and analyze information," 21 S.E.C.
Docket at 1406, and this often is done by meeting with and questioning corporate
officers and others who are insiders. And information that the analysts obtainnormally may be the basis for judgments as to the market worth of a corporation's
securities. . . . It is the nature of this type of information, and indeed of themarkets themselves, that such information cannot be made simultaneously
available to all of the corporation's stockholders or the public generally.
[Footnote 17] The SEC expressly recognized that "[t]he value to the entire
market of [analysts'] efforts cannot be gainsaid; market efficiency in pricing
is significantly enhanced by [their] initiatives to ferret out and analyze
information, and thus the analyst's work redounds to the benefit of all
investors." 21 S.E.C. Docket at 1406. The SEC asserts that analysts remain free
to obtain from management corporate information for purposes of ‘filling in theinterstices in analysis'. . . ." Brief for Respondent 42 (quoting Investors
Management Co., 44 S.E.C. at 646).3
The courts also recognize the legality and legitimacy of the “mosaic theory,” under which“a skilled analyst with knowledge of the company and the industry may piece seemingly
inconsequential data together with public information into a mosaic which reveals material nonpublic information.”4 The SEC also expressly recognizes the legitimacy of this theory stating,for example, in the adopting release for Regulation FD, that “an issuer is not prohibited fromdisclosing a non-material piece of information to an analyst, even if, unbeknownst to the issuer,that piece helps the analyst complete a ‘mosaic’ of information that, taken together, is material.”5
The SEC has explicitly stated that “it is legal to obtain expert advice and analysis
through expert networking arrangements.”6 Indeed, Carlo Di Florio, the former director of
the SEC’s Office of Compliance Inspections and Examinations, made clear in a speech on March
21, 2011, that recent insider trading prosecutions do not reflect a hostility by the SEC towards
expert networks:
Contrary to some reports that I have seen, I believe these cases do not represent
some inherent hostility by the Commission toward expert networks, nor do they
indicate that the Commission is seeking to undermine the mosaic theory, under3

Dirks v. SEC, 463 U.S. 646, 658-59 (1983)(emphasis added).

4

Elkind v. Liggett & Myers, Inc., 635 F.2d 156, 165 (2d Cir. 1980).

5

Selective Disclosure and Insider Trading, 17 C.F.R. §§ 240, 243, 249 (2000), available at
ttp://www.sec.gov/rules/final/33-7881.htm#P22_3882
6

Press Release, U.S. Sec. & Exch. Comm’n, SEC Charges Hedge Fund Managers and Traders in $30 Million
Expert Network Insider Trading Scheme (Feb. 8, 2011), available at http://www.sec.gov/news/press/2011/201140.htm© Slingshot Insights 20153

which analysts and investors are free to develop market insights through assemblyof information from different public and private sources, so long as that
information is not material nonpublic information obtained in breach of or by
virtue of a duty or relationship of trust and confidence. . . . . I am not suggestingthat advisers must avoid using expert networks.7
As stated in the Dirks case, the nature of much information is that it cannot
simultaneously be disclosed to all investors; however, this does not mean information
dissemination should be limited beyond what is necessary. In an ideal world where value isassigned to information and efficient pricing, broader distribution of information and greater
information parity are desired goals.
II.

Compliance Gaps in the Historic Expert Network System

Recent highly publicized criminal prosecutions have highlighted the weaknesses in thehistoric expert network system. In one such case, according to the indictment, Mathew Martoma
obtained and then traded on confidential information about a drug trial from a University ofMichigan professor, Dr. Sidney Gilman, who was consulting on the trial. The professor
allegedly swapped information with Mr. Martoma through “paid consultations that . . . werearranged by a New York-based expert-network firm.” Martoma was convicted after trial andsentenced to nine years imprisonment. Martoma’s employer at the time was also charged both
criminally and civilly because of the conduct of certain of its employees, including Martoma, andsettled by paying almost $2.5 billion in monetary penalties.
In another insider trading case involving expert networks, the government alleged thefollowing:This case involves insider trading by ten individuals and one investment adviser
entity, all of whom are consultants, employees, or clients of the so-called "expert
network" firm, Primary Global Research LLC ("PGR"). Longoria, DeVore, Jiau,
and Shimoon were all employed by technology companies and also served as
PGR consultants, or "experts," who used their access to material nonpublic
information regarding technology companies to facilitate widespread and repeatedinsider trading by numerous hedge funds and other investment professionals.
Each obtained material nonpublic information about sales, earnings, or
performance data, concerning various public companies, and shared that inside
information with hedge funds and other clients of PGR who traded on theinformation. Each also received cash compensation from PGR in return forproviding the inside information. Fleishman and Nguyen were PGR employees
who facilitated the transfer of material nonpublic information from PGR
consultants to PGR clients and, in certain instances, acted as conduits by receiving
material nonpublic information from PGR consultants and passing that
information directly to PGR clients. Barai, Pflaum, Barai Capital, Freeman, andLongueuil were among the recipients of the material nonpublic information7

Speech by Carlo DiFlorio, (March 21, 2011), available at
http://www.sec.gov/news/speech/2011/spch032111cvd.htm© Slingshot Insights 20154

supplied by PGR consultants and employees, and either traded on the information
or directly or indirectly caused hedge funds they managed or were otherwise
affiliated with to trade based on the information.8
The SEC particularly alleged in this action that the secrecy of the expert consultations was a
critical aspect of the alleged misconduct:"When soliciting consultants for PGR, he [Fleishman] made clear that
their telephone conversations with PGR clients would not be monitored orrecorded."9•"To assuage prospective clients' concerns that this illegal activity would be
detected, Fleishman assured them that PGR would not monitor or record theircalls with the PGR experts."10•

These insider trading cases resulted in significant penalties for many of those charged, including
significant periods of incarceration, although a few of the defendants avoided imprisonment bycooperating with the government in its prosecutions of others.
As these cases illustrate, and many other illustrations can be found,11 experts haveallegedly been used by money managers to obtain material nonpublic information subject toconfidentiality obligations. This has led to prosecutions with devastating impact on the
reputations of firms and extremely harsh penalties for individuals.
In response to these prosecutions, expert networks have made efforts to enhance theircompliance systems to address regulatory concerns. For example, former OCIE Director Carlo
Di Florio has recommended certain compliance procedures for expert networks and theircustomers.12 Expert networks have made efforts to screen experts before retention, to train themon legal requirements, and to impose contractual obligations upon them.
8

SEC v. Longoria, et al (S.D.N.Y. Feb. 3, 2011), available at https://www.sec.gov/litigation/complaints/2011/comppr2011-40.pdf
9Id., page 10, paragraph 38.

10Id., page 11, paragraph 41.

11

The SEC has published a list of such cases filed since 2009.
http://www.sec.gov/spotlight/insidertrading/cases.shtml
12

Speech by Carlo DiFlorio (March 21, 2011), id., “Front-end controls could include suchthings as reviewing the terms of agreements with expert network firms, having adviser staff
read and acknowledge the adviser’s insider trading policies, and pre-approving every
conversation with an expert. It might mean having, at least occasionally, “chaperoned”
conversations -- that is, a compliance person is a silent listener to the conversation between
the expert and the adviser’s money manager/analyst. The adviser might also want to conduct anevaluation of the controls that are in place at expert networks with which the adviser does business. The adviser
might also want to either avoid being involved with an expert who is an employee of a public company, or
having extra controls in place.”
http://www.sec.gov/news/speech/2011/spch032111cvd.htm (emphasis added).

© Slingshot Insights 20155

At first glance, it may seem that these restrictions have “reformed” the expert network
industry. However, despite all of the compliance efforts, an unresolved gap remains in thecompliance system for expert networks - the secrecy of the communication between the expert
and the client. The actual communication between the expert and the user is usually oral, is
usually unsupervised, and is usually unrecorded. The conversation between the expert and theuser is only selectively monitored by a legal or compliance officer because it is too time
consuming and disruptive to the legal or compliance officer’s daily schedule to chaperone every
such conversation.
Because of the secret nature of the typical conversation between the expert and the client,
if improper information is conveyed by the expert, this is usually unknown until it is too late,after illegal trading has occurred and prosecution is imminent. The private nature of thecommunication between the expert and the user also can embolden the expert who wishes toconvey information improperly. The customer may also be emboldened by the private nature of
the communication to induce the expert to convey information improperly. Indeed, in thePrimary Global case, described above, the secrecy of the expert consultations was actually used
as a sales point to induce prospective clients to retain the experts.
Ultimately, the system permits a couple of “bad seeds” to limit the dissemination of
information while retaining a system that can still be exploited by individuals who choose to do
so. In order to achieve maximum value of expert consultations and thus more efficient pricing of
securities, a system should be designed to support the best quality of expert consultations withthe lowest risk of material non-public information being disclosed. It is time to consider what
additional tools are available to improve compliance and risk mitigation in expert networks.
III.

Reimagining Access to Expert Insights in a Technology Driven Society

When reimagining expert network compliance one must consider how technology can
reduce illegal conduct and provide a greater number of investors with access to information. We
live in a time where it has never been easier to access information; over 3 billion people haveaccess to the internet and social media connects the world. In contrast, in 1995 only 1% of theworld’s population had access to the internet.13 As the world evolves, expert networks can takeadvantage of these technological advances, recording and transcribing expert calls and making
them available online to a larger group.
Recording the consultation between the expert and the user and posting it online, making
it available to a larger community of analysts and investors, would bring transparency to all such
communications. On the premise that “sunlight is the best disinfectant,” this step, by itself,
should deter an expert from revealing information improperly and also should reduce thetemptation of an investor to coax the expert to reveal information improperly.
This compliance solution also has potential economic benefits. First, with moreparticipants, the cost for each call is reduced, thereby increasing the total number of participantsthat can access the information. This allows a larger group of investors to “ferret out”
information, working independently to draw conclusions. Second, recorded calls and transcripts
13

http://www.internetlivestats.com/internet-users/© Slingshot Insights 20156

eliminate the repetitive nature of the calls thus limiting the opportunities for an expert tomistakenly disclose information; a single call can replace what was previously dozens ofrepetitive interviews.
Additionally, having online call recordings and transcripts should permit the user’s
compliance officer efficiently to monitor expert consultations after the consultation so that any
improper conversations can be addressed quickly. In this proposed system, the “sunlight”
concept would be a facet of every call. This contrasts starkly with the current system wherecompliance officers and regulators spot check expert network consultations at random. And, as
has been dramatically illustrated in the recent prosecutions arising from expert consultations, thepotential loss of secrecy in the communication between the expert and the client does not
outweigh the compliance benefits.
Finally, enhanced transparency may also permit the communication of information that
other models currently bar. For example, some expert networks arbitrarily bar consultations withan expert about a company for a full year after the expert has left the employ of that company.
This arbitrary rule reduces certain compliance risks, but also potentially deprives customers ofuseful information that could be obtained legally. In addition, because of the compliance risks
associated with the current expert network system, many clients of the expert networks have
imposed individually tailored restriction of the consultations, which creates a system that isneedlessly inconsistent and complex. In the proposed model, additional legal information can beconveyed because of the greater transparency and compliance protection that a more transparent
model provides.
IV.

Utilizing Technology to Channel the “Sunlight” of a Crowd

Slingshot Insights offers an approach to expert networks that incorporates the “sunlight”
concept.
Slingshot Insights publicizes the expert interview in advance and attempts to recruit as
many participants in the expert consultation as possible, removing the veil of secrecy that is often
associated with expert calls. All calls are systematically recorded, transcribed, and stored on thesite for access at any time. It is a feature of the system, not an option for the customer. This
information is available to the public at large as anyone can sign up for the site for free, and usersthat wish to participate on a call or access executed calls can do so for a clearly defined fee.	
  	
  With this approach to expert networks, a self-policing community is created. Material
nonpublic information subject to a confidentiality obligation is less likely to be divulged in a
public forum that is recorded with multiple parties in attendance. Slingshot Insights also
provides the ability for all members and their compliance officers to flag any project in which
confidential information is suspected to be shared. These flags are visible to all users who areadvised to trade at their discretion.
Slingshot also may permit the communication of information that other models currently
bar. As Slingshot’s model is by nature more transparent and public, there is less need arbitrarily
to restrict the dissemination of expert knowledge out of fear that there will be disclosure of© Slingshot Insights 20157

material nonpublic information subject to a confidentiality obligation. This results in investors
having more access to information to inform their investment theses.
The deficiencies recent criminal convictions have exposed in the historic expert network
system have rightly served as a moment of reflection for the industry. However, the steps taken
by existing networks to promote compliance have resulted in a system that does not fully address
the underlying compliance gap in the expert network model and arbitrarily restricts
dissemination of legitimate information. The system created by Slingshot Insights is one
solution that uses technology and innovation to enhance expert network compliance and address
the yet to be closed gap in that compliance.

© Slingshot Insights 20158