Knowledge Is Money, but the Peril Is Obvious
Toward the end of 2007, Silver Lake Partners, a well-respected investment firm, made what then seemed like a curious investment: it paid about $ 200 million to buy slightly less than a quarter of a fast-growing company called the Gerson Lehrman Group.
The investment was unusual because Gerson Lehrman, a so-called expert network firm that links hedge fund investors with experts in various fields, had been under scrutiny by regulators and the press for creating a business model that some said was tailor-made to foster insider trading on Wall Street.
A hedge fund manager could call up Gerson Lehrman, ask to speak with an expert — often a current or former employee of a company that the hedge fund was considering investing in — and, for prices as high as $ 1,000 an hour, the “expert” would, with luck, divulge what he knew. A front-page article in The Wall Street Journal in 2006 provided a series of anecdotes of questionable information being sought by Gerson Lehrman’s clients.
Gerson Lehrman insisted that its business was honest, and it instituted a variety of compliance programs to prevent investors from seeking inside information from its experts. Soon after, all the regulatory investigations into the firm seemed to dry up.
Then came the investment from Silver Lake, a firm with a track record for investments in information technology and a group of founders with illustrious backgrounds in Washington, on Wall Street and in Silicon Valley. (Glenn Hutchins, one of the founders, worked as a special adviser to President Bill Clinton, for example.) So Silver Lake’s investment came across as a seal of approval. The firm, which had been a client of Gerson Lehrman, said it had done significant diligence on the firm and was more than satisfied.
And yet here we are: last week, federal prosecutors announced what they said was the largest insider trading case in its history, charging Mathew Martoma, an employee at the hedge fund SAC Capital Advisors, with using inside information about drug trials from one of these experts, Dr. Sidney Gilman, a neurology professor at the University of Michigan Medical School who had been hired by Elan and Wyeth to oversee the drug trials. The transfer of information was made possible by Gerson Lehrman, which had played matchmaker. If this expert network did not exist, it is not clear that Mr. Martoma and Dr. Gilman would ever have found each other. More on that in a moment.
The criminal case against Mr. Martoma suggests that he used Gerson Lehrman’s services repeatedly, paying a total of $ 108,000 to Dr. Gilman, who was paid about $ 1,000 an hour for his expert counsel — or his dispensing of inside information, as the government sees it. Dr. Gilman, 80, entered into a nonprosecution agreement in exchange for providing information on his discussions with Mr. Martoma to the government.
In fairness to Gerson Lehrman, the various complaints against Mr. Martoma make clear that the firm put Mr. Martoma and Dr. Gilman through a number of compliance programs and repeatedly provided them with notices — boilerplate e-mails — that Mr. Martoma was not to seek inside information and Dr. Gilman was not to provide it.
One e-mail explicitly instructed that the expert “will not reveal any information that the [expert] has a duty to keep confidential, including material nonpublic information.” The e-mail also said experts “participating in clinical trials may not discuss the patient experience or trial results not yet in the public domain.”
Based upon the complaints against him, Mr. Martoma appears to have tried to dupe Gerson Lehrman about the true intent of his requests to talk to Dr. Gilman by mischaracterizing the subjects he hoped to discuss.
And yet, the information appears to have been passed with tremendous efficiency. Each phone call between the two men was organized and documented by Gerson Lehrman, in part so that Dr. Gilman could be properly compensated for his expert advice. Gerson Lehrman, however, does not chaperon the calls.
Of about a million “consultations” the company has conducted between its clients and “experts,” this is the first time a criminal complaint has been filed against a client or expert of Gerson Lehrman. The Gerson Lehrman Group has not been charged or implicated in any way.
Still, the expert network business model is inherently perilous. Many expert network firms have gotten caught up in one insider trading case or another. Primary Global was featured in the Raj Rajaratnam case; it has since closed its doors. While Gerson Lehrman remains the leader in the business and might have the best compliance program in the industry, one of its experts was interviewed by the F.B.I. in 2010 after a client was raided. No charges were brought.
The original purpose of these firms was to provide primary information to investors looking for research after the old Wall Street research business model seemed to collapse under the weight of an industry settlement over conflicts of interest, led by Eliot Spitzer when he was the attorney general of New York. Gerson Lehrman became so popular that Goldman Sachs considered buying it, and other banks sought to copy its model.
Silver Lake declined to comment. Gerson Lehrman’s chief, Alexander Saint-Amand, said: “Professionals need to consult with other professionals to learn and make better decisions, especially as the business environment becomes more not less complex. That’s true for all of our clients — investors, corporations, law firms, nonprofits.”
So what to think of expert networks now?
On one side, there is a good argument that these firms help investors and others find one another — consider it a high-priced Facebook for consultants. Gerson Lehrman has expanded its business beyond simply working with investors; it now helps corporations looking for experts, or advertising agencies looking for help ahead of a big pitch.
There is clearly a market for matchmaking, and without a Gerson Lehrman, it is very possible that some interactions would take place over beers or expensive dinners — without the compliance efforts and audit trails that the firm provides. With the advent of LinkedIn and other social networks, there are increasingly new ways to find experts.
But investors don’t pay hundreds of thousands of dollars a year for information that isn’t material — at least, material to them. In the best of worlds, the expert network business model is about pushing clients as close to the “line” as possible without crossing it. That’s a tough thing to do consistently — and a precarious way to run an enterprise.