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Amid Inquiries, Experts Get a Cold Shoulder

Authorities arrested Don Chu, a Primary Global Research executive from Somerset, N.J., at 6:05 a.m. on Nov. 24. Within 24 hours, employees halfway around the world in the expert-network firm’s Manila office received a directive from their chief: stop recruiting outside consultants and do not return to work until Dec. 2.

By then, Primary Global’s Manila outpost was effectively closed, according to a former employee. A vice president, James Fleishman, soon e-mailed some senior employees in Manila, bidding farewell and complimenting them on a job well done.

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Less than a month later, Mr. Fleishman was arrested in another round of insider trading cases.

“We were shocked, personally, because we’ve got families to feed, and we knew that after the investigations, our jobs were coming to an end,” said the employee, who like others interviewed for this article spoke on the condition of anonymity for fear of reprisal or for lack of permission to speak publicly.

Now a frigid chill is sweeping the expert-network industry.

In the midst of a sprawling insider trading investigation, the Wall Street matchmakers — who connect large investors with outside experts — are struggling to hold onto clients. Many financial firms, eager to avoid the whiff of scandal, have suspended or pulled back on the use of expert networks. These firms include bulge-bracket investment banks, private equity firms and hedge funds, like Och-Ziff Capital Management Group and Balyasny Asset Management.

“We’ve completely stopped using them, indefinitely, on the advice of our legal counsel,” said an employee at a private equity firm.

Others are reviewing their policies around expert networks. Credit Suisse will continue to use such companies for equity research, but it is taking steps to bar other departments from using the services, said one person familiar with the situation. Citigroup is in the process of evaluating its rules, according to a person close to the company.

“It’s prudent to take a time out right now and reassess how expert networks are used,” said an employee at another large money manager.

The sudden cold shoulder is understandable.

Over the last two months, federal authorities have raided a slew of hedge funds and mutual funds and arrested several consultants and employees tied to Primary Global. In November, the government accused Mr. Chu of helping hedge funds obtain nonpublic information. A month later prosecutors charged Mr. Fleishman with fraud, accusing him of facilitating the sharing of confidential information.

Primary Global and Mr. Chu’s lawyer, Jeffrey Plotkin, declined to comment. Mr. Fleishman’s lawyer, Stuart Gasney, could not be reached for comment.

Although the flurry of arrests has largely centered on Primary Global, the scandal has disrupted the entire industry. Some say expert networks will have to ratchet up their compliance standards — or risk losing what is left of their business.

“Seeing people carted off in handcuffs has a sobering effect,” said Harvey L. Pitt, a former chairman of the Securities and Exchange Commission, who has advised hedge funds on expert networks. “The smart thing would be, both for the people who provide these services and the people who purchase them, to have their own clearly defined rules.”

Given the high cost of adopting strict compliance measures, smaller companies, needing resources, may struggle to keep their doors open. Only a handful of expert-network firms have annual revenue in excess of $40 million, according to Integrity Research, which tracks the industry.

The expert-network industry has blossomed in the past decade, on the heels of Regulation Fair Disclosure. The rule, enacted in 2000 by the S.E.C., bars public companies from disclosing “material nonpublic information to certain individuals or entities,” thus forbidding executives from giving exclusive information to favored investors.

Competitive pressures ...

In the absence of this spoon-fed pipeline, some money managers became increasingly dependent on expert networks for research that would give them a market edge. Since then, the industry has grown to roughly 40 companies worldwide from eight , according to Michael Mayhew, the founder of Integrity Research. Today, about 36 percent of buy-side research firms use expert networks, he estimated.

As competition has grown, so has the pressure for firms to find the best consultants with the best information. One former employee at the expert-network firm Guidepoint said the recruiters would frequently “turn a blind eye” if they suspected a prospective consultant had not disclosed a confidentiality agreement.

“It’s a legitimate business that walked a fine line,” the person said.

Guidepoint did not return calls for comment.

As the industry deals with the fallout from the investigations, Robert Weisberg, a professor of criminal law at Stanford, predicts little tolerance for lax controls.

“Boy, are you going to see ruthless self-regulation by the firms themselves, and they are going to fire people like crazy if they suspect any cheating at all,” he said.

Firms looking to adopt new rules are likely to follow the lead of the Gerson Lehrman Group, the industry’s largest player. Its outside consultants, who must complete an interactive training program, are prohibited from speaking to the same client more than three times in one year. Once experts earn $2,500, they must secure written permission from their employers to continue working.

Gerson Lehrman also regularly contacts thousands of companies to get their policies on expert networks. If a business has a ban, that company and all its subsidiaries are placed on a “do not call” list. That list numbers 13,000, according to a person close to Gerson Lehrman.

Of course, even the strictest policies may not be enough to keep a firm out of regulators’ cross hairs.

Gerson Lehrman was the subject of an insider trading investigation in 2007 by the New York attorney general. In November, authorities reportedly questioned a Gerson Lehrman consultant employed by Marvell Technology. The firm, which has never been accused of wrongdoing, declined to comment.

In the end, no set of rules will police everybody.

“The moment you put two people in a conversation and no one else participates, it creates the potential for improper information to be communicated,” Mr. Mayhew said. “These kinds of one-on-one conversations are going on all the time.”