Even inside information from an ‘expert network’ would not have helped.
–Yves Smith, Naked Capitalism
Not even an expert network would have helped, says Yves Smith of the earthquake in Japan, rather blithely suggesting that an expert network is nothing more than a vehicle with which to exchange material non-public information. Would it were the case. If only inside information equated to expert networks, imagine how easy enforcement of insider trading would be! Shut down the networks, Smith might say, and we will purge the rot of a rigged game from the system.
But inside information and expert networks are different things. To conflate them is a failure of analysis and a lazy view on the role of expert networks, the problem of inside information, and research in general.
Insider trading happens. The allegations against Raj Rajaratnam and the more than 25 related guilty pleas aside, there is no question that suspicious trading happens frequently, and perhaps more often than not, it’s not just a question of serendipity. Someone got illicit information from another, placed their bets, and waited for the market to price in what to them would not be a surprise. An M&A lawyer stealing corporate documents, sending summaries to a middleman, who directed yet another party on trading decisions. An unscrupulous fund manager who cajoled and enticed a doctor to share the results of a drug trial and, indeed, look forward to doing so. An auditor sending confidential financial data to relatives overseas who would play out a trading strategy based on the systematic acquisition of inside information.
It’s right to condemn these examples and the effect it has on the markets, transparency and the sense that it’s a rigged game. But it’s shortsighted to see it as a problem of expert networks.
Expert networks are in the business of connecting people who need information with those who have it. It’s a risky proposition. Some people want information they shouldn’t have, and others may want to provide information they shouldn’t share. Because of this basic tension, they must, for the sake of their survival, invest heavily in compliance systems, procedures, and policies that will flush out bad actors and provide a safe environment for one in need of expertise to connect with one in possession of expertise. Expert networks may appear to be in the business of connecting just about anyone, but they aren’t. They’re in the compliance business, and they’re specifically adapted and designed to fostering appropriate connections for the exchange of appropriate information.
The recent FBI/SEC dragnet of the investment industry surfaced more than 25 guilty pleas and allegations related to insider trading. Many of these stemmed from individuals and their “research” that operated outside the connections made by expert networks. They entailed bad actors doing bad things. Each of the cases mentioned above demonstrated a failure of oversight and would have benefited from the systematic approach to compliance provided by an expert network operating in good faith. One might even suggest that Smith’s consulting business, Aurora Advisors, would benefit from these systems when they are doing sensitive research on sensitive areas, such as researching the “current business performance and prospects, including financial information” of a firm in direct acquisition talks with their client. There is no doubt that Smith would bring the highest ethics to such a situation, but what’s wrong with a little more tracking around who’s talking to whom?
It’s true. No expert network could have helped predict the earthquake in Japan. It was an exogenous risk, made manifest terribly, and of which we will long feel the effects. But expert networks do have a role in the recovery. Questions about rebuilding supply-chains will filter through management consultancies to expert networks. Investors will need to understand the new corporate and economic landscape, so they can allocate capital. Indeed, the sudden and dramatic changes brought on by the earthquake pose a particular opportunity to capture the unique abilities of an expert network: to connect those in need with those in possession of expertise, quickly.