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State seeks rules for ‘expert’ networks

Move follows US investigation of inside information sharing

(Pat Greenhouse/Globe Staff)
By Beth Healy
Globe Staff / April 21, 2011

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Secretary of State William F. Galvin proposed new regulation yesterday to crack down on hedge funds that use so-called expert networks to illegally obtain information on companies for stock trades.

Under the new rule, the Massachusetts Securities Division would require investment advisers who hire such firms to obtain written certification that the experts are not subject to confidentiality restrictions — and will not pass along confidential information to the investors.

The move follows a federal probe of expert networks, firms that, for a fee, arrange for executives from public companies to provide nonpublic information to investment firms. The probe has resulted in charges against employees of hedge funds, high-tech companies, and pharmaceutical firms for engaging in or enabling insider trading in numerous stocks, including Apple Inc. and Dell Inc.

Locally, stocks ensnared in expert networking schemes include storage giant EMC Corp. and band width provider Akamai Technologies Inc. A number of investment and expert firms with offices in or ties to Boston have been investigated. Galvin’s office recently charged a Cambridge hedge fund manager, Risk Reward Capital Management Corp., and its principal executive, James A. Silverman, with using inside information about drug trials to profit on trades in pharmaceutical stocks. Silverman has denied wrongdoing, as has Guidepoint Global, an expert networking firm that he hired.

“For most hedge funds that abide by the rules and are not seeking insider information, this is an additional assurance that everyone’s going to be held to the same standard,’’ Galvin said in an interview. “If you believe in a free market, you should believe in a truly free market,’’ he added, as opposed to relying on illegally obtained tips on corporate sales, earnings, or mergers. Galvin said Massachusetts is the first state to propose such regulation.

The regulation is subject to a comment period and a public hearing in late June. The new rule would affect primarily smaller hedge funds, which have come under state regulators’ purview following the federal Dodd-Frank financial overhaul. Galvin said his office will oversee about 600 hedge fund firms.

Mitch Ackles, a spokesman for the Hedge Fund Association, a Washington trade group that lobbies on behalf of small hedge funds, said it has been expected that states would take up local oversight.

Regarding their dealings with expert firms, he said, “What a gray area to try to pursue and police.’’

He said the industry needs clarification on insider trading.

“These expert networks shouldn’t be doing anything illegal,’’ he said.

Beth Healy can be reached at bhealy@globe.com.