Tag Archives: hedge fund expert network

States to Begin Proposing Rules on Expert Networks

Massachusetts Proposes Compliance Rules for Using Expert Networks

Expert networks have been a major topic over the last few months and we are seeing the states, in addition to the SEC, focus on this area as a compliance issue for investment advisers.  Massachusetts recently revoked the state investment adviser license of a manager who was using expert networks to gain inside information and then trade on that information.  Massachusetts is now proposing regulations which would require state registered managers to develop certain policies with respect to use of expert


The proposed regulation provides generally that investment advisers may not use expert network services unless the adviser receives a signed certification from the consultant (sourced by the expert network firm) that:

  • describes the confidential restrictions the consultant has regarding confidential information and
  • the consultant affirmatively states that he will not provide any confidential information to the adviser

In addition to this new compliance requirement, the proposal codifies the general prohibition against trading on inside information.

The full text of the proposed regulation is printed below and can be found here.  The Massachussets Securities Division will hold a public hearing on these and other proposed regulations on June 23 and will accept written comments until June 24.


Preamble to Proposed Regulation

Investment Advisers Using Matching or Expert Network Services – Dishonest or Unethical Conduct in the Securities Business

The Division proposes to add a new section under 950 CMR 12.205(9)(c)(16) to the existing list of dishonest and unethical practices. The Division believes this addition is necessary to address the rising use of expert network firms by investment advisers to facilitate paid consultations between investment advisers and industry experts.

As alleged in In the Matter of Risk Reward Capital Management Corp., RRC Management LLC, RRC BioFund LP, and James Silverman, Docket No. E-2010-057, some investment advisers have paid expert networks and consultants to access confidential information about

publicly traded companies. The rise of expert network firms, and the number of abuses which have been addressed by regulators, make it clear that additional measures are required to ensure that confidential information is not being accessed and traded upon. The Division's proposed regulations, while not altering investment advisers' existing duty not to trade on insider information, seek to provide investment advisers with greater clarity as to what is impermissible conduct when paying consultants for information.


Proposed Regulation

Investment Advisers Using Matching or Expert Network Services – Dishonest or Unethical Conduct in the Securities Business

Add the following new subsection (16) to 950 CMR 12.205(9)(c) (non-exclusive list of practices by an investment adviser which shall be deemed “dishonest or unethical conduct or practices in the securities business”):

16. a. To retain consulting services, for compensation that is provided either directly to the consultant or indirectly through a Matching or Expert Network Service, unless the adviser obtains a written certification, signed by the consultant that:

(i) describes all confidentiality restrictions that the consultant has, or reasonably expects to have, regarding Confidential Information; and
(ii) affirmatively states that the consultant will not provide any Confidential Information to the adviser.

b. Notwithstanding section (a) an investment adviser who comes into possession of material Confidential Information through a consultation is precluded from trading any relevant security until such time as the Confidential Information is made public.

c. Definitions. For purposes of this section:

(i) “Confidential Information” means any non-public information, which one is bound by a confidentiality agreement or fiduciary (or similar) duty not to disclose.
(ii) “Matching or Expert Network Service” means a firm that for compensation matches consultants with investment advisers.


Cole-Frieman & Mallon LLP is a boutique hedge fund law firm.  In addition to investment adviser registration and compliance, we provide expert network compliance consulting services to SEC and state registered hedge fund managers.  Bart Mallon can be reached directly at 415-868-5345.


Massachusetts Proceeds Against Fund Manager Using Expert Networks

Revocation of Investment Adviser License & Disgorgement of Profits

Managers are becoming more aware of the various securities laws and compliance issues involved with the use of expert networks.  While the SEC has recently been active in this area (both in the RR insider trading complaint and the recent expert network action), the states are also becoming more aware of the potential issues involved with expert networks.  Recently the Massachusetts Securities Division instituted an administrative complaint against a Massachusetts state registered fund manager who utilized expert networks to gain inside information.  This post will provide an overview of that compliant.


James Silverman was registered as an investment adviser representative for a Massachusetts registered IA firm which was managing the RRC Bio Fund, LP (“Fund”).  The IA firm was subject to a routine announced examination by the Massachusetts Securities Division (“Division”).  During that routine examination, the examiners found a number of violations of the various state securities laws including the fact that Silverman was trading on inside information obtained from an expert network firm.

The examiners found that Silverman started using the expert network firm after the Fund suffered a long period of losses.  After utilizing the expert network firm, the Fund posted consecutive years of gains in excess of 50%.  During the course of the relationship with the expert network firm, the Fund paid $80,000 a year to the firm so that Silverman could have access to certain consultants in the biotechnology industry.  Many of these consultants were either insiders or otherwise bound to confidentiality agreements with respect to their activities in the industry.  The expert network firm did not monitor their consultants in any way but, pursuant to the firm’s policies, the consultants’ had a duty to identify and avoid any disclosure that would violate a confidentiality agreement.  The agreement that Silverman signed with the expert network fir

m provided that Silverman agreed not to elicit or otherwise obtain any “material nonpublic or otherwise confidential information” from the expert consultants.

In addition to the insider trading, Silverman and the IA firm engaged in either blatantly illegal or egregiously sloppy business practices, especially once the examination began.  For example, the complaint states that Silverman did the following:

  • deleted notes containing study results prior to producing the notes to the Division in response to its subpoena
  • deleted certain documents and correspondence
  • failed to maintain required records
  • made false filings with the Division
  • violated minimum financial requirements
  • violated document retention requirements
  • improperly assessed performance fees
  • left client data vulnerable

The Order

The consequences for breaking the securities laws, whether at the state or federal level, are severe.  The Enforcement Section of the Massachusetts Securities Division sought the following items in its action against Silverman:

  • accounting and disgorgement of all ill-gotten gains as a result of insider trading
  • disgorgement of direct and indirect remuneration from the insider trading
  • revocation of the IA registration for the firm and Silverman
  • enjoining Silverman from performing any investment advisory services for compensation on behalf of any person or entity within the Commonwealth of Massachusetts
  • imposition of a fine

Protecting Your Firm – Developing Compliance Programs

This case and the earlier SEC actions do not mean that fund managers can no longer use expert network firms.  However, managers need to be careful and the best practice is for managers to develop compliance policies for all interaction with expert network firms.  These policies and procedures need to be tailored to the business practices of each manager and need to be followed consistently.


Cole-Frieman & Mallon LLP is a boutique hedge fund law firm.  We provide hedge fund compliance and registration services to SEC and state registered hedge fund managers.  Bart Mallon can be reached directly at 415-868-5345.