How Expert Networks Became the Trusted Allies of Compliance Officers at PE Firms
By Catherine Smith, General Counsel, Guidepoint Global, LLC
Compliance officers are naturally risk averse and, as such, they initially may have been cautious participants in their firms’ expert network relationships. In the last several years, however, through their exposure to sophisticated expert networks, compliance professionals have learned a great deal about how expert networks function as well as the solid compliance controls that expert networks implement internally and can apply on a custom basis for their clients. This exposure has resulted in an interesting phenomenon: Some compliance officers now have become their expert networks’ strongest supporters. In fact, a large number of compliance professionals have concluded that their investment professionals are far better served working with experts through an expert network and, in fact, will not authorize any communications with experts that do not go through their expert network service provider. While no one could have anticipated a few years ago that investment firms’ compliance personnel would become the standard bearers for expert networks, when you consider their reasoning, it makes perfect sense.
Expert networks are matchmaking firms that connect their clients, such as Private Equity firms, with subject matter experts with expertise in a broad offering of specialties. An expert may be anyone from the only neurosurgeon in the world to have performed a particular procedure to a hotel reservations clerk who can speak knowledgeably about the software program she uses to book guests into her hotel. The industry offers key support to investment professionals seeking real-time access to seasoned industry experts who can offer unique and varied insight into their investment targets.
Investment firms always have relied on advice from experts
Even before there were expert network firms, PE funds were researching their investment ideas and performing due diligence on their investment targets by speaking with experts. Typically, they would review scholarly or industry publications or mine their own or their colleagues’ rolodex to find knowledgeable, seasoned professionals who could explain technical concepts or offer insight on management’s capabilities or provide thoughtful analysis on the strength of their investment targets’ product offerings. Finding such experts was sometimes time-consuming and difficult.
The rise of expert networks
Expert networks – with large data bases of subject-matter experts located across the globe and the ability to recruit new experts tailored to specific client projects – enabled PE funds to obtain timely, practical input from numerous sources with a wide variety of vantage points. The infrastructure provided by the expert networks also permitted PE funds to focus on their investment strategy while their service providers handled every aspect of the expert relationship – from recruiting and training to payment of experts, all through a reliable compliance platform. PE funds’ use of expert networks greatly facilitated their ability to research investment targets quickly and thoroughly, and to obtain insights from well-situated individuals in every level of the investment target’s value chain.
As a result, when expert networks entered the marketplace, investment professionals were very quick to see the value they brought to the research process. In its first decade – through the support of a client base comprised almost exclusively of PE funds and hedge funds – the expert network industry experienced extraordinary growth. What started as a few individuals in New York offices trying to build their networks one phone call at a time grew into a nearly half-billion-dollar industry, with product offerings that include telephone consultations as well as surveys, in-person individual and group meetings, group teleconferences and data products. Today, expert network firms facilitate upwards of a half million telephone consultations a year and the top five firms in the industry have 40 offices spread over five continents.
Expert networks experience a brief set back
Notwithstanding their huge impact on the investment community, when they first landed on the scene, expert networks went largely unnoticed by everyone other than the firms that actually used their services. Many outside of the investment community never heard of expert networks until the fall of 2010, when the first insider trading case with an expert network component came to light. The weeks and months immediately following that initial report were filled with misinformation and confusion and there was some uncertainty surrounding the future of expert networks. Consistent statements from law enforcement supporting the use of expert networks, coupled with investment firms’ independent conclusion that expert networks provide a valuable research tool that they did not want to lose, led to renewed support for the industry, and resulted in the more established service providers revamping their compliance platforms to include stronger compliance controls and provide their compliance clients with greater tools for oversight than ever before. The handful of expert networks that seized the opportunity to invest in their legal and compliance infrastructure were able to develop the sophistication necessary to support their investment clients in meeting the challenges attendant to the new regulatory environment.
Investment firms returned to expert networks in large numbers, and in some cases brought with them new compliance requirements that the more sophisticated service providers accommodated through custom controls tailored to individual client needs. Since then, we have seen a real partnership develop between these expert networks’ compliance officers and their counterparts at their investment firm clients, resulting in stronger, more effective and more broadly applied compliance controls well engineered to accomplish their intended goals.
Expert networks provide policies and procedures that support appropriate investment research
Investment firms’ compliance officers serve as gatekeepers for all research conducted by their investment professionals. They devote substantial resources to:
- Conducting due diligence;
- Evaluating their service providers’ controls; and
- Implementing additional internal and external controls as necessary.
Compliance officers have come to rely on the more sophisticated expert network service providers to deliver a broad compliance platform and solid infrastructure to support their firms’ interactions with experts and permit real compliance oversight of all expert communications. These expert networks’ services are grounded in comprehensive policies designed to avert the transfer of material nonpublic or otherwise confidential information and internal procedures that support those policies. The policies are usually embodied in the Terms and Conditions, a comprehensive set of conservative rules to which each expert must agree in order to participate in consultations arranged by the service provider. In addition, sophisticated expert network service providers do significant vetting and training of the experts they present to their clients, and they require every expert to take a mandatory compliance tutorial to ensure that he understands the Terms and Conditions. The expert network usually also will perform some independent review of the experts in its network, either through background checks or other means, or both.
Of equal importance to compliance officers is the infrastructure that sophisticated expert networks provide with respect to compliance, expert sourcing and payments to experts. These expert networks handle all aspects of the relationship with experts, eliminating the need for the investment firm to retain – or receive – any of the expert’s personal information or make determinations concerning an appropriate honorarium for the consultation. Expert networks also keep detailed records of the consultations that they arrange, including the name and biography of the expert and the subject matter of the consultation. Because the expert network service provider is an independent third party, its records have greater reliability than the investment firm’s own records. They also are readily accessible and easily can be downloaded if they are needed for an internal audit, or to provide documents to a regulator conducting an exam.
Empowering compliance officers to shape user behavior
Perhaps the greatest benefit to using sophisticated expert networks may well be the tools they provide to compliance officers to monitor and shape their users’ interactions with experts. Through the service provider’s web portal, compliance officer clients are able to view in real time all of their users’ activity through the network, including the projects they have submitted, the experts assigned to those projects, and those experts’ bios, responses to screening questions and compliance affirmations. Moreover, compliance professionals may provide instructions that restrict the types of experts with whom their users may consult, or insert an approval layer that requires the service provider to obtain compliance officer approval for experts – either each expert selected, or specific categories of experts based on their profile.
For example, a compliance officer may decide that he wants to review and approve every expert that is employed by a publicly traded company to ensure that he understands what the investment thesis is and what information his analyst seeks to obtain from the expert. For each such expert, the service provider will send the relevant information to the compliance officer and will not proceed with arranging the consultation until the approval is obtained. Such policies and procedures provide real support for compliance officers who rely on visibility into their research professionals’ interactions with experts to implement appropriate controls.
Given the effective partnership that has grown between sophisticated expert network service providers and their clients’ compliance professionals – and the substantial resources it would take to attempt to replicate internally the varied controls implemented by these expert networks – it is pretty clear why compliance professionals are such strong supporters of the service. In this era of heightened compliance awareness and regulatory enforcement, this trend is likely to continue to gain traction.
Catherine Smith leads the Legal and Compliance departments of Guidepoint Global, LLC, which is headquartered in New York with offices in Europe and Asia. She joined Guidepoint Global in 2011 directly from the Securities and Exchange Commission, where she served as Senior Counsel in the Enforcement Division for over seven years, and was an inaugural member of the Enforcement Division’s national Market Abuse Unit. Previously, she served as litigation associate at Cahill Gordon & Reindel LLP. As a Fellow of the Regulatory Compliance Association, an international non-profit and chartered graduate level institution, Catherine participates on compliance panels attended by executives from private fund and asset management firms.