Authorities suspect an inside game on Wall Street

Reporting from Los Angeles and New York —  The first arrest in an escalating probe of suspected Wall Street insider trading throws a spotlight on what authorities fear is a disturbing new trend by hedge funds and other big players — paying networks of well-connected corporate insiders for illegal access to privileged information.

The government appears to be building a case that the use of insiders is generating huge illicit profits for Wall Street heavyweights, at the expense of individual investors who don’t have access to the same information.

“They say that in any game of poker there’s a fool at the table — and if you don’t know who it is it’s you,” said Barbara Roper, director of investor protection for the Consumer Federation of America. “The unsophisticated nonprofessional investor is the fool at the table. Wall Street always finds a way to rig the system to their advantage.”

The government’s investigation came into sharp focus Wednesday with the arrest in New Jersey of Don Ching Trang Chu, an employee of a Mountain View, Calif., research firm. Chu was charged with conspiracy to commit securities fraud in an alleged scheme to provide hedge funds with sensitive information on publicly traded companies, including Broadcom Corp., an Irvine-based maker of chips used in iPhones and other products.

A complaint filed by the FBI in federal court in New York alleges that a Broadcom employee in Taiwan provided information about the company’s revenue before the results were publicly disclosed.

“When you ask [the employee] for Broadcom’s revenue numbers, [the employee] will give it to you,” Chu told the FBI, according to the complaint.

Broadcom was not accused of wrongdoing.

Chu’s employer is Primary Global Research, one of a new breed of so-called expert network firms that connect hedge funds with high-level sources at companies who can provide information on everything from the pace of semiconductor sales to closely watched results of clinical drug trials. Hedge funds are professional investment pools known for their often-aggressive investment techniques.

Expert networks, and an offshoot known as channel checkers, have grown in recent years as hedge funds and other big investors have scrambled for any edge they can get in picking stocks. There are 40 expert-network firms today compared with five in 1996, according to industry tracker Integrity Research Associates.

To Wall Street, the firms are simply matchmaking services that connect investors with knowledgeable industry sources.

“Expert networks are like a really sophisticated telephone book,” said Michael Mayhew, founder of Integrity Research. “They enable an investor to find experts in a particular industry or company and then allows them to typically talk to the experts on the telephone.”

Critics see something more nefarious: firms that claim to sell expertise, but that often deal in insider information in violation of securities laws.

“It’s like a market in stolen goods,” said Tamar Frankel, a Boston University law professor. “It’s a market in stolen information.”

The ultimate losers in insider trading are individual investors. Financial markets are built on the ideal of a level playing field, where all investors have access to the same information. Any profits made on insider knowledge deprive other investors of those gains.

Coming on the heels of the government’s bailout of investment firms in the global financial crisis, another scandal involving Wall Street could further disillusion millions of small investors who already have pulled back from the stock market in recent years.

Research firms say they’re simply performing the basic spadework that is expected of all investors.

“That’s what you’re supposed to do before buying a stock,” said J.P. Mark, founder of channel checker Farmhouse Equity Research in San Francisco. “You’re supposed to talk to people at the company, if you can, to find out what’s happening.”

In contrast to expert networks, which generally connect investors with higher-level contacts, channel checkers typically interview lower-level store managers, vendors and customers for signs that a company’s sales are rising or falling.

Farmhouse hires business school students and recent graduates to go to retail stores to ask managers and employees about sales trends.

Farmhouse researchers don’t pay for information, but they also don’t immediately identify themselves or disclose the reason for their questioning, Mark said. They will identify themselves later if a worker divulges “more specific information,” he said.

Chu’s arrest in New Jersey on Wednesday followed FBI raids of three hedge fund offices and subpoenas of at least two mutual fund companies earlier in the week. Chu was charged in federal court in New York with two counts of conspiracy to commit fraud. He was released on a $1-million bond.

According to the complaint, the charges against Chu were built with the cooperation of Richard Choo-Beng Lee, an employee at a hedge fund not named in the filing, and who last year pleaded guilty to securities fraud in a separate case.

Chu promised to set up meetings for Lee in Taiwan with employees from Broadcom and Sierra Wireless Inc., a Canadian firm, the complaint alleges. When Lee asked Chu whether those consultants would provide numbers as good as those provided by an earlier Broadcom employee, the complaint says Chu told him, “All depends on the person … Some guys willing to talk, some are not.”

The complaint indicates that Chu told Lee he was “nervous” about some of the transactions and expressed concern that their conversations might be recorded.

The complaint says an unidentified employee of a technology company participated in the conspiracy by providing Chu’s clients with non-public information about the firm including sales and revenue numbers. The alleged co-conspirator received more than $200,000 for talking with Chu’s clients, the government filing says.

Chu also connected hedge funds with employees of Atheros Communications Inc. in San Jose, according to the complaint.

Officials with Atheros, Sierra Wireless and Broadcom did not return calls for comment. ( Los Angeles Times publisher Eddy W. Hartenstein is on Broadcom’s board of directors.)

On its website, Primary Global Research, says it can provide investors with access to “a world-class, global network of industry professionals, selectable by experience, perspective and location across eight industry sectors.”

That network of experts, the website says, gives “institutional investors and analysts a strategic advantage when making investment decisions.”

The site describes Chu as the firm’s “bridge to Asia experts and data sources” and “just a fun person to travel with on the highways and byways of Taiwan.”

A spokesman for Primary Global said the firm had “severed its relationship” with Chu but declined further comment. Jeffrey Plotkin, a lawyer representing Chu, also declined to comment.

Chu was arrested four days before he was scheduled to travel to Taiwan, the complaint says. If convicted, he could face up to 30 years in prison.walter.hamilton@latimes.com

nathaniel.popper@latimes.com