Views on improving the integrity of global capital markets
27 June 2013

“Political Intelligence” Trading — Where Do We Draw the Line?

Posted In: Insider Trading, US SEC
Capitol Hill

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!


Photo credit: iStockphoto/MiguelMalo

About the Author(s)
Jon Stokes

Jon Stokes is the Director of Ethics and Standards Education at CFA Institute. His responsibilities include design and creation of on-line ethics education, development and maintenance of the CFA Institute Code of Ethics and Standards of Professional Conduct, and the design and management of the CFA Institute Ethical Decision-Making and Giving Voice to Values education programs. Stokes holds a JD degree.

2 thoughts on ““Political Intelligence” Trading — Where Do We Draw the Line?”

  1. As someone who is close to (but not in) this line of work, I have a different perspective. Regulatory or legislative “intelligence” is fundamentally different than material non-public information about a listed corporation’s activities.

    In the CFA curriculum, we learn if we come into material non-public information, one course of action is to encourage the corporation to publicize the information without delay.

    The FDA is not a corporation, but an agency answerable (in theory) to the people. Outside national security, there is no reason for regulatory decisions in progress to not be deliberated transparently. As soon as a regulatory decision is made, it should be publicized immediately. The FDA has no commercial interest in secrecy.

    Don’t get me started on the Fed! Why aren’t FOMC meetings videocast live, with debates between doves and hawks (i.e. those who advocate more Wild Turkey versus those who advocate cold turkey re.: QE) showed to the world in all their glory? Why do we wait three weeks for minutes to be released?

    There is no point criticizing investors for using every tool available to understand a government that is increasingly impenetrable.

  2. Jon Stokes, JD says:

    Mr. Graham, thank you for your comment. As you say, if the regulatory process is completely transparent, with all information circulated publically as soon as its available, the “nonpublic” element of material nonpublic information is not present and there should be no issue with trading on regulatory or legislative information. That’s a big IF, and unfortunately, immediate transparency is not always the model. In that case, those with special access to confidential material information should not be selectively disclosing it to friends, family, former colleagues, or those who pay for the info. Understanding the governmental process is one thing, but trying to game the system to trade on inside information, in either the corporate or regulatory world, puts “the people” at a disadvantage and harms capital markets by creating the impression that only insiders profit to the detriment of the investing public.

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