Now that the government has gotten a conviction in the case against Raj Rajaratnam of the Galleon Group, federal prosecutors will shift their focus to expert networks — the intricate web of money managers, corporate executives and consultants at the center of another wave of insider trading cases.

Over the last few years, the Justice Department has built dozens of insider trading cases - focusing principally in and around the hedge fund industry - their managers, traders, and networks.  Prosecutions have developed mainly along two tracks:  One group of cases aimed at Mr. Rajaratnam, the founder of Galleon, and the cadre of corporate insiders and investment traders from whom he solicited confidential information. The other group has involved expert network firms, the Wall Street matchmakers who connect large investors with outside experts.

In several indictments involving expert networks, authorities claim that hedge fund managers paid outside consultants handsome fees for providing nonpublic information. The government has also charged executives at the expert network firms, the ones who brokered the connections, with knowingly facilitating the exchange of illegal stock tips. Prosecutors say the money managers often sought impending information on large technology companies, like Apple and Dell, whose stocks can turn quickly on tidbits about financial performance and forthcoming products.

On Wednesday, a former account manager at the Taiwan Semiconductor Manufacturing Company, Manosha Karunatilaka, pleaded guilty to insider trading, admitting that he leaked details about the company’s sales and shipping orders to clients of Primary Global Research, an expert network firm. (See What Went Wrong).

The insider trading investigation has had a chilling effect on the expert network industry, which is struggling to maintain its Wall Street client base. Scared of being ensnared by scandal, large financial firms are reducing their use of expert networks and reviewing their internal policies regarding outside consultants. In the last year, revenue at these firms dropped 20 to 30 percent, according to Integrity Research, which tracks the industry.

The expert network industry developed after the S.E.C. enacted the Regulation Fair Disclosure rule in 2000. The rule, which bans public companies from disclosing “material nonpublic information to certain individuals or entities,” makes it illegal for corporate executives to share information only with certain parties. Lacking that exclusive pipeline, some big investors began relying on expert networks to supplement traditional sources of research.

Now, Wall Street is distancing itself from the industry. The hedge funds Balyasny Asset Management, Millenium Partners and Och-Ziff Capital Management have suspended their use of such consultants, according to people close to the firms who were not authorized to speak publicly on the matter.

Other firms are adjusting their rules. Credit Suisse has restricted the use of expert networks to certain departments. Morgan Stanley is hammering out a firmwide policy that will effectively limit their use, according to one person with knowledge of the situation who was not authorized to speak publicly.

Some hedge funds are barring the use of consultants who work at publicly traded companies, while others are encouraging compliance officials to randomly monitor phone conversations.    [NYTimes, 5/11/11]