Friday, May 9, 2008

Holding the Hot Potato: The Expert Network Burn Factor

Should we be shocked to learn that our buy-side friends are a little concerned over the compliance problems that expert networks pose? In theory, it sounds nice to be able to shop for experts who will laud your investment ideas, pushing your good measure with their stamp of approval. However, what happens when that network lets you down? The paper trail won’t lead back to an analyst and the expert network surely won’t be sweating the mistake. No one wants to be holding the potato when the music stops, but without a doubt, it winds up in buy-side hands.

Integrity Research shows that 45% of surveyed buy-side compliance professionals are somewhat or very worried about compliance problems that may arise from their use of expert networks.

It’s only a matter of time before we see the crackdown. Without a stringent vetting process, expert networks will continue to cause compliance problems for their clients. How do you qualify an expert? How is he deemed reliable? What is keeping him from supplying potentially dangerous information to institutional investors?

45% of compliance professionals may be asking themselves those questions, but what about the other 55? Are they not banking on a backlash?

Institutional investors have good reason to worry about their relationships with expert networks. When something goes wrong, if a mistake is made and the investor loses money, the investor can’t just turn to those experts and say, “He did it.” When using the expert network, an investor is forced to ‘proceed at their own risk’ and take responsibility for any errors that result. As is usually the case with the financial markets, this is a useful – and often lucrative – way to operate…right up until the point where a big trade blows up based on faulty information.

Remember: If you wind up with a hot potato, the game’s over.