Institutional investors, hedge funds, and analysts are using increasingly clever techniques to obtain valuable corporate information before anyone else. Now the Securities and Exchange Commission is taking notice.

First, in January the SEC charged more people and entities in its now-notorious SEC v. Galleon insider-trading probe, including a New York hedge fund advisory firm, the firm's hedge fund manager, an analyst at the fund, and others who allegedly tipped inside information on a client that allowed the hedge fund to enhance its trading strategies. Then in a separate probe in February, the SEC charged six “expert network consultants” with insider trading for illegally tipping off hedge funds. Four of them worked at technology companies—including AMD, Dell, and Flextronics—and moonlighted as consultants to Primary Global Research, an expert network.

These are interesting developments for compliance officers to consider against the larger canvas of Regulation Fair Disclosure. Reg FD turns 11 this year, and with only 11 enforcement actions since its inception, it's clear that most corporate executives follow policies designed to avoid unauthorized disclosure of material non-public information. But in many cases, including the ones I just mentioned, the people charged don't sit in the C-suite—and therefore fly below the radar of Reg FD.

 Reg FD, after all, covers directors, executive officers, investor relations officers, and others who serve as spokespersons for the company. That's a rather small number of people compared to the bulk of employees who have knowledge and access to information vital to the interests of hedge funds, investors, and analysts. In some cases, they might not have even realized they were providing material non-public information. Still, that distinction probably won't matter much when you, the compliance officer, are staring at an SEC inquiry and explaining things to your board.

Employees who serve in the company's supply chain or in research and development departments are prime targets for those seeking any nugget of non-public information on a company. According to Integrity Research Associates, the number of so-called “expert networks” has exploded from a handful a few years ago to 38 firms today. Some have been known to recruit employees and pay them handsomely to speak with clients such as hedge funds. The recent SEC charges powerfully demonstrate the need for written policies to sanction employees who engage with expert networks and to prevent employees from speaking with analysts or investors without authorization.

A Questionable Arrangement

Another questionable practice in the “access game” is that of sell-side analysts arranging non-deal roadshows where a company's top management gives presentations to specific buy-side firms. Regulators haven't yet cracked down on the practice, but it does raise some questions. Typically, a sell-side analyst covering a company will approach the investor relations officer offering to set up a series of meetings for senior management (particularly the CEO), with selected buy-side firms. After all, buy-siders prize the insight gained in one-on-one meetings with the person who's running the company; they want to know the CEO's vision for the company and the strategy for building value.

The recent SEC charges powerfully demonstrate the need for written policies to sanction employees who engage with expert networks and to prevent employees from speaking with analysts or investors without authorization.

Sounds relatively harmless, right? The real questions are: Are sell-side analysts the right people to arrange such meetings? And are these meetings a good use of the CEO's and other top managers' time?

When you look below the surface, what you find is a quid pro quo  arrangement. Many IROs feel pressure to accept a sell-side analyst's offer of a roadshow because they worry that they might lose that analyst's coverage—in our modern era where most companies get no analyst coverage at all, that fear is very legitimate. Moreover, for IR departments on a tight budget—and most are these days—the financial arrangement appears compelling. The company pays for the airfare and lodging, and the analyst picks up all other expenses once the IRO and the CEO arrive at the city of destination.

Another influential factor: Companies aren't likely to go on a roadshow with an analyst who rates the business lower than a “buy,” and the analysts know this. Does the desire to take a company on a roadshow push the analyst to publish a “buy” rating the company might not necessarily deserve? You bet.

These arrangements are also driven by commission, which can often be a dubious way of compensation. According to Greenwich Associates, in 2010 approximately $13.2 billion in commission payments went to U.S. equity firms; 38 percent of that total went to commissions on trades of small and mid-cap stocks, up from 35 percent last year. Of the $7 billion spent on sales and research, $1.3 billion was specifically spent on “direct management access,” meaning roadshows, field trips, and headquarters visits by investors. That means a lot when an analyst sits down for his or her annual performance review.

Of course, large companies with plenty of sell-side coverage can be selective about which firms they'll meet with. Most small- to mid-cap companies aren't in that position. As former Nasdaq Vice Chairman David Weild, founder of the new issue advisory firm Capital Markets Advisory Partners, describes it, small and mid-cap companies “become canon fodder for the sell-side analysts,” more interested in hitting their commission goals than setting up productive meetings that don't waste a CEO's time. And because more meetings means larger commissions, analysts are less likely to set up meetings with firms that have a long-term investment horizon—even if that may be (and should be) a company's preference.

So, what's an IRO to do, particularly one at a small- to mid-cap company? Sophisticated institutional investors employ services that match a company's profile and characteristics with institutional investors that might have an interest in meeting. This gives the IRO the necessary information to go directly to the buy side without the analyst serving as middleman. This is a more effective process with fewer conflicts of interests, but one that relies more heavily on the communication and marketing skills of the IRO.

With the advent of Reg FD, much of corporate information has become commoditized. That drives hedge funds and other investors to seek information that gives them a competitive edge. Most use means that are legal under the SEC's disclosure rules. Some don't, pursuing a competitive edge through illegal means such as gaining material non-public information from company insiders.

IROs can play an important role in facilitating the quest for information and management access under the rules, as well as in crafting company policies that guard against illegal access. Both roles are fundamental to the functioning of fair and efficient markets.

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