Legal Insider Information

New York, NY – Last week, The Wall Street Journal published an article about a former lobbyist who is paid handsomely by hedge funds to share information regarding significant governmental developments.  While much of the information he provides is not publically available, and it might be extremely profitable to hedge funds, it is all perfectly legal to trade on.  In fact, Integrity Research has identified dozens of firms which have set up legitimate research businesses to collect and distribute these insights to institutional investors.   


An Industry Takes Shape

Over the past few years, one of the most important influences on global stock markets has been legislative and regulatory activities – whether they are in Washington DC, Europe, China, or the Middle East.  As a result, institutional investors have become increasingly interested in tracking government policy developments and how these might impact various sectors of the market.  This has led to a significant pickup in demand for policy research and other insight into the political process.

Based on our proprietary ResearchSelect database, Integrity has identified 42 research providers who provide policy research analysis.  According to our taxonomy, “policy research” firms analyze legislative or regulatory initiatives which will impact securities.  Typically firms providing policy research have analysts in Washington DC or other government centers who are available to investors to answer questions about recent developments.  Firms could focus on macro issues or specifically on certain industries.

Hedge funds have found that Washington can be a gold mine of market-moving information, easily gathered by those who are politically connected.  Consequently, funds hire lobbyists — not just to influence government, but to provide them with insight about what legislators are likely to do. As a result, lobbying firms have ramped up their “political intelligence” units to provide this type of advice, charging hedge funds between $5,000 and $20,000 a month for these tips and predictions. 

Using a variety of sources, Integrity was able to identify 17 providers of political intelligence in addition to the policy research providers we track.  Providers of political intelligence are those firms whose primary business lies outside of providing research, yet they provide investors with access to information about policy developments.  Political intelligence services tend to be one-to-one whereas policy research is one-to-many.  For this reason the majority of political intelligence providers are either lobbying firms or law firms.


Growth of Policy Research

Integrity believes that the independent policy research providers we have identified generated approximately $127 million in 2010 on a global basis.  This number excludes the revenue brought in by the policy research arms of investment banks, but it takes into consideration a proportion of the revenue brought in by large independent firms like ISI Group which conduct a wide array of varying types of research.

Integrity believes that despite the current economic environment, the policy research industry is poised to grow over the next few years – particularly given the legislative uncertainty surrounding the upcoming 2012 elections.  In this way, policy research is somewhat recession proof due to the fact that investors see a growing need to find out what is going on in Washington and how legislative changes are likely to affect them. 


Securities Laws Define “Insider Information”

One of the factors that has spurred the growth of this industry has been the fact that the information obtained from policy research or political intelligence providers is not widely available, potentially quite valuable to investors, and considered legal to collect by regulators.

US securities laws prohibit buying stocks or bonds based on information about public companies which is both material and not public if the person who provides this information has a duty to keep it secret.  Over the past ten months, numerous employees and consultants working through expert network firms, as well as hedge fund analysts have been charged with insider trading for violating these rules.

What is strange is that US securities laws traditionally don’t prohibit politicians or other governmental insiders from trading on or sharing nonpublic information about legislative developments which other investors can profitably trade on.  Because the information they share is not about public companies, nor do most government insiders legally have a duty to keep this information secret, providing or trading on this information is not deemed to be “insider trading”.


Regulators Getting Concerned

Despite the pass historically given government insiders, we have gotten some indication that US regulators are becoming increasingly concerned that political intelligence firms, the current or former lobbyists and government officials that work with these firms, or their hedge fund clients might be involved in potentially illicit activity.

Certainly the large sums of money that hedge funds pay these insiders is one reason regulators think something fishy might be going on.  Last week’s Wall Street Journal article mentions a former lobbyist, Paul Equale, who works with Gerson Lehrman Group.  His part-time work for GLG generates $600 per hour for consulting with hedge funds investors. Mr. Equale says he has done this close to 650 times since 2005, earning him about $400,000.

Another reason US regulators might be focusing on this practice is their traditional abhorrence of any unlevel playing field that exists between professional investors (particularly hedge funds) and retail investors.  It is clear that the information passed on from government insiders to hedge fund investors is not available to most investors.  It is also obvious that hedge funds find value in this information given the large sums of money they pay to obtain it.  This inequality is something that many regulators feel inherently should be eliminated.


Summary

Consequently, we suspect US regulators will continue to investigate the practice of current and former governmental insiders selling information and insight about legislative developments in Washington DC to institutional investors.  However, given current securities laws, it is unclear whether regulators will have much rationale to bring serious enforcement action against the political insiders, their clients, or the firms that facilitate this business.  

Click here to read the complete text of the Wall Street Journal article that was referenced above.

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