With more than 40 student organizations at the Law School the range of student programming is broad. On any given day students are hosting academics and practitioners to discuss timely and relevant legal topics. In March, the Business Law Association hosted a panel that addressed the concern about the use of expert networks by hedge funds as it relates to insider trading liability. Professor James Park served as moderator and was joined by Marcus A. Asner, a partner at Arnold & Porter LLP, Justin Arnold, an Assistant U.S. Attorney for the District of New Jersey, and Shawn R. Singh ’02, General Counsel and Chief Compliance Officer of Calypso Capital Management, LP.
The use of expert networks by hedge funds has drawn significant scrutiny of late, particularly with the high-profile trial of Raj Rajaratnam, a hedge fund manager who was recently found guilty of insider trading with the help of expert network firms.
Professor Park began the panel by describing insider trading liability as a very fact specific inquiry as it is based in common law prohibitions on fraud, thus making it an amorphous area of law. He discussed competition in the hedge fund industry and the lack of compliance infrastructure, particularly in smaller funds, as being driving factors in hedge funds seeking more information to gain an “edge” on the competition. However, he defended information gathering and expert networks as not inherently problematic. Park pointed out that the danger of expert networks lies in the dissemination of material, nonpublic information without proper procedures in place, which may present situations where that information could be misappropriated, giving rise to liability.
Mr. Singh followed, offering greater detail about what expert networks are and the risks of utilizing them. He described expert networks as either middlemen that provide industry knowledge or experts in the field whose funds can hire consultants. These networks facilitate the efficient acquisition of otherwise available information. Singh pointed out that expert networks present significant risks for a manager. They require constant monitoring and the “headline risk” that an SEC investigation could instantly sink a fund. He also spoke about the challenges of designing policies and procedures to prevent and catch insider trading, both in terms of these policies’ inability to deter bad actors and investors’ desires to ensure they are not being cheated.
Mr. Asner remarked that expert networks present a new context for an old problem. He clarified that insider trading liability stands for the base assumption that “lying is bad, making money from lying is doubly bad, and prosecutors will eventually find a statute to fit the wrong.” Expert networks and the enforcement of insider trading represent a gradual shift in the value society attaches to information, especially in a service economy. He highlighted the fact that a definite gray area exists between expert networks seeking out corporate intelligence and engaging in corporate espionage, which may lead to liability outside the realm of insider trading.
Asner described certain strategies and difficulties that arise from defending clients in insider trading cases, describing much of the success of a case depending on the quality of particular statements, as well as the ability to cast doubt as to the materiality of the information received or the intent of the actions. For example, a trader who brings a potential conflict to the attention of his general counsel will not likely get indicted based on the “wrong call” in a gray area as the government would have a difficult time proving willful intent. Yet, among the challenges he encounters he listed the heightened focus on insider trading and the fact that juries are hardly sympathetic to the typical insider trading defendant who is often well educated and cannot plead ignorance, especially in the case of expert networks where the defendant often sought out the information.
Mr. Arnold explained how the government views expert networks and approaches insider trading cases more generally. He described his challenge as a prosecutor as having two minutes upfront to explain to the jury that the defendant was a “liar, cheater, or thief” and then meet a high burden of proof in a complex case where juries are likely to be confused. He spoke about the difficulties in proving insider trading cases on a historical basis with circumstantial evidence, especially without a cooperator, and that there are increased efforts to do more real time enforcement through wire taps to explore the resulting web of sources to avoid the problems associated with trying cases on a historical basis once the trail has gone cold.
The discussion and Q&A proved to be rich, keeping with the nature of BLA programming for the 2010-2011 academic year.
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