Channel checks: how investors run them and where the MNPI line is

A channel check is research on a company done by talking to the businesses around it: the distributors, retailers, resellers and suppliers that buy from it, sell for it or supply it. Investors use channel checks to see how a product is selling before the company reports, how much stock is sitting in the channel and how the company compares with competitors on the shelf. Wikipedia's summary notes that these interviews usually happen without the target company's knowledge, and that analysts look at things like top products, buying patterns, inventory levels and promotion plans. Channel check

Channel checks are a common research method, and the SEC has said it is legal to obtain expert advice and analysis through expert networks. Trading on material nonpublic information obtained in breach of a duty to keep it confidential is not. Most of the skill in running channel checks lies in asking questions that stay on the right side of that line.

This page is general information, not legal advice. If you work at a fund or a regulated firm, your compliance team's rules come first.

A worked example: a canned beverage brand

Suppose you are an analyst looking at a public company whose growth depends on a new line of canned sparkling drinks. The company, product and calls are hypothetical. You want to know whether the drinks are selling through to shoppers or just filling distributor warehouses. You could call:

• Sales reps at beverage distributors in three regions, about how fast retailers are reordering.
• Category buyers at grocery chains, about shelf space and promotions in their stores.
• Independent store and bar owners, about what customers ask for and what sits on the shelf.
• A former distributor manager, about how brands usually launch in this category and what early trouble looks like.

Each of these people knows something from their own business. None of them needs to tell you anything confidential to be useful.

How investors run channel checks

1. Write the question. "Is the new line selling through to shoppers at the pace the company suggested last quarter?" is testable. "How is the company doing?" is not.
2. Choose channel roles. Map who sits between the company and the end buyer, and pick the roles that see the thing you are testing. Distributors see orders and inventory. Retailers see shelf movement. Suppliers see production volumes.
3. Spread the sample. Talk to people in different regions, sizes of business and channels, so one enthusiastic distributor does not set your view.
4. Ask about their own observations. How fast are your stores reordering? What share of your shelf does the category get? What promotions are you running?
5. Record and compare. Log each answer with the person's role and region, then compare the pattern with what the company has said publicly. Investor.gov notes that a 10-K's business section, risk factors and management's discussion of known trends are all public on EDGAR. How to read a 10-K

The expert interview preparation guide covers how to structure the call itself, and what to do when two experts disagree helps when different channels tell different stories.

Where the MNPI line is

Investor.gov defines illegal insider trading as buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, on the basis of material, nonpublic information. It also covers tipping that information and trading by the person tipped. Investor.gov: Insider trading

Expert calls have been at the center of SEC cases. In 2011 the SEC charged hedge fund managers and analysts with trading on confidential information from technology company employees who were moonlighting as consultants for an expert network firm, a scheme the SEC said netted more than $30 million. The SEC's statement in that case is the clearest summary of the rule: "it is legal to obtain expert advice and analysis through expert networking arrangements, it is illegal to trade on material nonpublic information obtained in violation of a duty to keep that information confidential." SEC News Digest, February 8, 2011 By June 2012 the SEC said its expert network investigation had produced actions against 23 defendants, with alleged illicit gains of more than $117 million. SEC press release 2012-121

In practice, that means:

• Do not call employees of the company itself about its sales, orders or results. In the 2011 case, the tips came from employees of the companies being traded.
• Do not ask anyone for numbers they are bound to protect, such as a distributor's contracted volumes with the brand or a retailer's confidential sales data. Ask what they see and do in their own work instead.
• Stop if someone starts sharing restricted information. Change the subject or end the call, and tell your compliance team.
• Keep notes of who you spoke with, what you asked and what they said, so compliance can review them.

Use a call source with compliance controls

Managed expert networks build controls around these risks. GLG, for example, says its experts sign terms each year agreeing not to give clients confidential information, including material non-public information, and to stop any project that moves into subjects they cannot discuss. It says employed experts may not take part in projects about their own employer, and that clients can use a compliance dashboard to pre-approve calls or add their own screening questions. GLG compliance

If your firm requires call-level pre-approval, chaperoned calls or transcript review, a managed network is likely the better fit; the expert network companies overview compares the main firms.

Your next step

Write your channel check question in one sentence and list the three roles in the channel that would see the answer in their own work. Draft five questions about what those people observe, and have compliance review them before you book anything.

If you can describe the people you need, such as "sales reps at beverage distributors in the Southeast," Instant Expert finds people who match. You review who it finds, it sends your invitations, and you pay only for calls that get booked. The directory pages for sales professionals in beverages, procurement professionals in beverages and sales professionals in grocery retail are a place to start. For diligence on a private company, see commercial due diligence.