Investors and the investment professionals they hire are always looking for an edge — that one bit of information or insightful analysis that will give them an opportunity make an astute, and profitable, trade. As a result, the expert network industry has grown up, paying knowledgeable industry sources to give investors the benefit of their opinions and expertise. But for some it turned out that the insightful information was really inside information — like an early peek at earnings numbers that “experts” disclosed for a fee. The SEC had something to say about it. A line had been crossed.
But the search for advantage continues. Investors are not just looking for industry expertise but political intelligence that can help them make shrewd investment decisions. What bills are being considered, the likelihood of new regulations, an upcoming vote on a particular issue, and other potentially market moving information. The political intelligence industry gathers insider knowledge through interviews with contacts in government to provide investors with analysis of federal actions, and the likely policy ramifications of those actions, to help make trading decisions — kind of the opposite side of the street from lobbying but in the same seamy part of town. And the neighborhood’s getting bigger. Political intelligence is reportedly a growth industry that has expanded substantially in the last five years to become a $400 million dollar a year business.
But this practice has come under regulatory scrutiny after a Wall Street Journal report earlier this year that a top health policy congressional aide-turned lobbyist emailed an investment research firm that he “heard from very credible sources” of a government decision to drop planned cuts in funding to certain insurers. The research firm, in turn, sent out an alert to clients. The report supposedly caught the attention of hedge funds managers who placed trades, allegedly based on this information, betting that health care stocks would rise. And they did. The SEC is investigating. Subpoenas for everybody.
But did these “insightful” investors trade on material nonpublic information disclosed in breach of a duty? Is the information “material” — information the average investor would want to know before making an investment decision? A lot depends on how specific or certain that information is. If the impact of the information is uncertain, nonspecific, or if its impact is hard to predict, the less material it becomes. Is it nonpublic? According to a Washington Post reporter investigating this situation, the staffers providing political intelligence consider disclosing this information part of business as usual. “In their minds, they talk to constituents all day, they talk to lobbyists, they talk to reporters — they’re just saying what they would say to these same people. And so in their mind, this information is actually public because it’s available and they’re just trying to be transparent about it.” But some are more equal than others. Those who have the contacts and can afford to pay seemingly benefit over the “ordinary investor,” and suspicions arise. And the Stop Trading on Congressional Knowledge (STOCK) Act imposes a fiduciary duty on high-ranking U.S. government officials not to disclose confidential information they have access to because of their positions. Investors who trade on information disclosed in breach of this duty could easily find themselves on the wrong side of the law.
Investors pay professionals big money for research that will give them an edge in the markets. Good research analysts scour the earth looking for information they can use to help form a “mosaic” that will help their clients make intelligent and profitable investment decisions. But there is a fine line between what information is acceptable and insider information. Investment professionals should take care when using political intelligence firms to make sure that the information they are receiving is not being disclosed in violation of the fiduciary duty imposed on public officials not to disclose confidential information obtained by virtue of their positions.
Some of a certain generation might remember the old Dan Aykroyd/Eddie Murphy movie Trading Places in which the evil Duke Brothers plot to learn the contents of the government crop report ahead of its release so they can make big money trading orange juice futures. Aykroyd and Murphy’s characters thwart the plan when they substitute a fake report showing opposite information. When the brothers make the trade, they are ruined and the heroes end up rich. (Hey, isn’t their trading just as illegal as the Dukes’?) Only in Hollywood! This type of confidential and specific information seems to be the type that would be considered material nonpublic information, the use of which would garner regulatory scrutiny. In fact, Section 136 of the Wall Street Transparency and Accountability Act prohibits using misappropriated government information to trade in the commodity markets. This has become known as the “Eddie Murphy Rule,” after the movie. Only in Washington!
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