Tuesday, November 23, 2010

Channel Checks, Insider Mischief, or Both?

The financial services industry gave us the term insider trading to label the illicit practice of breaching fiduciary responsibilities to benefit financially from ethical lapses. Now it adds another term to a related lexicon. “Channel checks” are to insider trading scenarios what independent research is to espionage. They represent a legitimate monitoring of indicators which theoretically yield the kind of indicators that should signal the likelihood of important activities without compromising the same activities by betraying confidences. Think of them as the equivalent of inferring a major military action is being planned because pizza orders from Domino’s have quadrupled at the Pentagon on a given night – a sure sign that people are working into the wee hours. Channel checks involve research focusing on logistics chains to uncover what high tech company is on the verge of ramping up or slowing down a major production effort. In theory, with enough of this kind of visibility into supply chains, anyone who understands the manufacturing end of a given business would be able to infer when a firm is getting ready for a new product launch or sizable venture. At least, this is the plausible explanation offered by a research consultant and adviser to investors in technology companies. Why is this explanation necessary?

The FBI descended upon such an adviser, accusing him of insider trading and allegedly attempting to use the specter of imminent prosecution to compel the adviser to turn informant against a bigger target. Details are in Wall Street Journal reporter Susan Pulliam’s November 21 article, “FBI visit exposes trade-probe tactics” (available at http://online.wsj.com/article/SB10001424052748703567304575629061523575940.html).

What did the consulting adviser do under the circumstances? He explained that he makes his living channel checking, not insider trading. Then, instead of cooperating as an informant, he fired off a broadcast e-mail alerting his clients of his circumstances. While he claimed he was honor-bound to do this, the action also foreclosed his viability in his chosen field. No client is now making contact with him, out of fear that this 50-something consultant will have his communications intercepted by the FBI even if they are above-board. Who wants to seek out even a cameo appearance in a federal investigation and trial that would likely mean the kind of lost productive time that is anathema to entrepreneurs? Worse still, what if the same entrepreneurs recognize their own fallibility and concede that they do not want their unguarded speech making a media debut as the result of a federal wiretap?

There is another facet to this event that goes beyond speculation on whether the activity under scrutiny exemplifies illicit insider trading or scrupulous channel checking. What is it? It is the flowering of a cover story that can be tailored and embroidered to mask insider trading in the future. Henceforth, if this is not happening already, the most flagrant of insider traders can spend a little attention to clipping news articles and gathering odd bits of information after the fact to store in a Pearl Harbor file calculated to make the case that he was brilliantly analytical, not crooked, when he drew the identical conclusion that only an insider would be able to do in the past.

-- Nick Catrantzos