New York, NY – Last week the Wall Street Journal published that Washington policy research firm, Height Securities, received a tip from a lobbyist that the Centers for Medicare and Medicaid Services would reverse their previous decision on proposed rate cuts, prompting the firm to send out a report to their hedge fund clients significantly before CMS made this announcement publically. Some healthcare stocks soared in response leading various government agencies to investigate
Due to new information that has come to light, Integrity Research has decided to edit and republish this article.
Background to the Case
On April 1st, Height Securities senior healthcare analyst, Justin Simon, was contacting sources in Washington DC to determine if rumors that CMS would change its prior decision to cut Medicare Advantage payments were true. For weeks, speculation had been building that CMS would reverse its decision after senior Democrats and Republicans spoke out against these proposed cuts, and the insurance industry lobby had mounted a significant campaign opposing them as well.
At 3:12 p.m. that afternoon, Mark Hayes a Greenberg Traurig lobbyist working for health-insurance firm Humana Inc., e-mailed Mr. Simon saying his “intel is that a deal was already hatched,” to restore the Medicare Advantage payments. Height responded by forwarding Hayes’ e-mail to numerous sources in an effort to confirm Hayes’ claim.
At 3:42 p.m., Height sent out an e-mail note to its Wall Street clients notifying them that they believed CMS would reverse its prior decision to cut Medicare Advantage payments.
The Height report caught the attention of a number of large hedge-funds, including SAC Capital Advisors and Viking Global Investors, causing shares of several health-care companies, including Humana, to climb sharply before the market close.
Forty-two minutes later, at 4:24 p.m., CMS made a public announcement that it had decided to change its decision to cut Medicare Advantage payments.
Investigation Heats Up
As a result of the Wall Street Journal story, Senator Chuck Grassley (R-Iowa) has decided to investigate this case. Senator Grassley wrote a letter earlier this month to Greenberg Traurig’s outside counsel requesting internal and external communication about the April 1 announcement by the Centers for Medicare and Medicaid Services dealing with proposed rate cuts.
While Grassley has not accused either Height Securities or Greenberg Traurig of any wrongdoing, he said that the Height Securities report “raise serious questions regarding how political intelligence brokers are able to gather information for their clients in advance of market moving events.”
It is interesting to note that lobbyist Mark Hayes is a former congressional aide who served for seven years as health policy director and chief health counsel for the U.S. Senate Finance Committee Republican staff for Senator Chuck Grassley.
The Wall Street Journal has also reported that the Securities and Exchange Commission is also looking into the case.
Violation of Insider Trading law?
While we do not intend to argue whether Hayes or Height Securities violated insider trading laws in this case (there is still not enough evidence to make that decision and we are not lawyers), we do want to point out a few key issues that should be considered when evaluating this matter.
It is clear that rumors where swirling around Capitol Hill that CMS might change its mind given the pressure put on by both parties, as well as by the insurance industry lobby. However, Mark Hayes’ e-mail indicated that he had sources who told him that a decision had been made by CMS to reinstate its Medicare Advantage payment. The information about this decision was clearly not generally known by the public for seventy two minutes AFTER Mr. Hayes sent his e-mail to Mr. Simon.
It must be noted that Simon had done considerable work on his research thesis BEFORE receiving any information from Hayes, and he was leaning towards a conclusion that CMS would reverse its decision. Consequently, Hayes’ e-mail was not a new piece of info, but rather merely a confirmation of Simon’s growing view. In addition, Simon did not know who Hayes’ sources were or what they told him.
It is also obvious that CMS reversing its decision on its Medicare Advantage payments was material. The stock market moved substantially on Height’s research report indicating that they believed CMS would make this change. The big question is whether the information that Hayes provided Simon was MNPI.
The most important issue in this case is what information did Hayes get from his sources, and who specifically were these sources. This is the key to whether or not Hayes had MNPI and whether he passed it on to Simon. It should be noted that both Hayes and Greenberg Traurig have stated that Hayes did not collect MNPI.
While it is not obvious whether the information Hayes provided Simon was MNPI or not, there are a few other conditions which might have made this information completely legal to either pass on or trade on.
One question is whether the tipper benefitted from passing on this information. In our mind, a case could be made by the regulators that Hayes did benefit from passing on this information, either financially, through an enhanced reputation, or as a quid pro quo for obtaining information in the future. Clearly, the regulators have made more aggressive arguments to show a “benefit” was obtained by the tipper in recent years.
The most problematic question for regulators in trying to make the case that this was a violation of insider trading law is whether Hayes breached a duty of trust or confidence when he disclosed the fact that CMS had decided to reinstate the Medicare Advantage payment. Clearly, if Hayes’ source told him to keep this information confidential, then there was a breach.
However, most people I speak to in Washington tell me that information about these sorts of developments are generally used as currency, and that very little is held to be confidential. If this information was not meant to be kept in confidence in the CMS case, then there would be no violation of insider trading law to pass it on.
A Few Lessons We Can Learn
While it is unclear whether Hayes obtained MNPI from his sources, we think that a few lessons can be gleaned from the situation.
A few of the questions that come to mind that we might want to ask ourselves are whether a research firm like Height has an obligation to verify that its sources don’t provide them with MNPI; whether risky information should be quarantined, even if the analyst had done considerable research on the topic BEFORE the questionable info was received; and whether the research firm should withhold or delay the publication of their report until after the information becomes public.
Most compliance officers or general counsels at money management firms would tell their research and investment staff that any information that was both not public and potentially market moving should be treated with extreme caution.
In fact, most buy-side firms would also consider quarantining this information once they received it and they would make sure that the stocks in question would be included on their excluded list. In other words, they would not trade these stocks, nor would they pass on the information they received about these stocks.
What is even more amazing is that money managers would be compelled not to trade these stocks once they had received the MNPI in question, even if they had previously done their own analysis on the issue and was preparing to trade that stock independent of the MNPI they received.
In fact, the courts threw out Raj Rajaratnam’s argument that he had done his own independent analysis on the stocks he eventually obtained MNPI on, and thus the MNPI was not the reason for his investment. Once he received MNPI on these stocks, he could not trade on them.
Of course, investment research providers are not generally expected to act exactly like money managers in dealing with MNPI. However, we do think research providers need to think through how they address these topics in developing their own compliance policies and procedures.
At this point, it is not clear whether Mark Hayes, Justin Simon, or Height Securities did anything wrong in their early reporting of the fact that CMS would reverse its decision to cut Medical Advantage payments. We will have to wait and see whether further light is shed on the questions surrounding who Hayes’ sources were and what they told him (if anything).
However, we do think that any research firm that wants to mitigate some of the uncertainty of a case like this could do so by proactively obtaining attestations from their sources that they will not provide them with material non-public information. A move like this from a research firm would quickly address any regulatory or press concerns that they were trying to obtain and distribute “insider tips” to help their clients turn a quick profit.
As importantly, we think that a step like this could go a long way to convincing a research firm’s money management clients that they were actively trying to avoid obtaining and passing on risky information. Ultimately, this would help manage the headline risk associated with a case like this.