Too expert?

Last Updated: Wed, Nov 24, 2010 04:00 hrs

Hedge fund raids: The FBI is stabbing at soft hedge fund tissue. Monday’s raids of several funds’ offices owe something to tracking the firms’ use of third party "expert networks," according to the Wall Street Journal. Almost by definition, these consultants risk unwittingly aiding the exchange of verboten information.

One such firm is Broadband Research, a technology industry specialist based in Portland, Oregon. In late October John Kinnucan, a principal at the firm, emailed clients with a tale of a visit from two "fresh faced eager beavers" from the FBI, according to the Journal. Despite the agents’ entreaties Kinnucan had, he said in the email, declined to wear a wire while talking to his hedge fund clients.

Connecticut firms Diamondback Capital Management and Level Global Investors got their visits from the FBI on Monday, with Boston-based Loch Capital Management also targeted, according to the Journal. These raids aside, dozens of fund management and trading firms have been contacted as part of a broad investigation.

The feds may yet come up empty, but the world of expert networks is a reasonable place to poke around. The business is based on putting paying investors in touch with experts on companies, industries or countries they want to know more about — even including current employees of a given company. Both investors and the networking firms in many cases have strict procedures for avoiding conversations that could stray into illegal territory. But it wouldn’t be surprising if occasional nuggets slip through the net — perhaps to a less aware junior analyst at a hedge fund.

There’s nothing yet to suggest that happened at any of the firms raided. It’s also possible for there to be smoke without fire. For instance, despite regular scrutiny over the years, SAC Capital, the big hedge fund run by Steven Cohen - alumni of which started Diamondback and Level Global — hasn’t faced any formal charges.

Moreover, the lifeblood of many hedge funds is gathering information and insight other investors may not have. That can be the perfectly legal result of persistent legwork.

There is, however, a question whether it makes sense to contract that out, even partially. With that in mind, the immediate damage done by the FBI’s raids may be to the networking firms’ business model.

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