Last week, the U.S. Government Accountability Office (GAO) released its long-awaited report on the gathering and use of so-called “political intelligence.” While the report targets the role of political intelligence in the financial markets, it may fuel attempts to regulate this growing Washington industry by using federal lobbying laws as a model. The report also underscores the risks of trading on non-public information about potential government action.
The Stock Act
The report was required by the Stop Trading on Congressional Knowledge Act (STOCK Act), which was enacted after reports surfaced about Members of Congress profiting from trading securities based on inside information obtained while performing their official duties. The legislation mandated lengthy and cumbersome financial disclosures by government employees, which has been challenged in court.
There was also concern that investment advisers – particularly hedge funds – were able to profit from access to legislative or regulatory information (so-called “political intelligence”). The STOCK Act did not regulate the gathering and use of political intelligence (earlier versions of the bill included registration and reporting obligations by political intelligence firms), but instead required GAO to conduct a study.
The STOCK Act defines political intelligence as information:
“derived by a person from direct communications with an executive branch employee, a Member of Congress, or an employee of Congress; and provided in exchange for financial compensation to a client who intends, and who is known to intend, to use the information to inform investment decisions.”
The GAO Report noted that it is very difficult to determine:
- When “political intelligence” is based on nonpublic versus public information,
- When information is derived from a “direct communication” (is attending a town-hall meeting or a hearing “direct communication?), and
- Whether information remains political intelligence when it is mixed into a report containing analysis, media information, and other research.
Profiting from material, non-public information is a federal offense under Rule 10b-5 of the Securities Exchange Act. In the context of government information, it can be difficult to determine when information is public or not and when information is material or not.
The GAO report provided two real-world examples to highlight an obvious case that resulted in a criminal prosecution and another that raises more questions than it answers. In the first, an FDA official bought or shorted drug company stocks based on his knowledge of drug approvals or rejections. In the second, investors bought stock in companies that would benefit from legislation that would limit their liability for certain pending claims. The investors apparently purchased the stock after learning (before the general public) that a key Senator would support the bill. Although the legislation never became law, investors may have profited from their access to the information because they were able to purchase the stock before the public became aware of the Senator’s support and the stock prices did rise after the Senator spoke in favor of the legislation.
These two examples are helpful bookends for illustrating when information is material or not (it certainly was in the FDA example) and whether information is public or nonpublic (it was not public in the FDA case, but might have been in the legislative case), but there are a very broad range of examples in between. It is that range that makes it difficult to know when political intelligence crosses the line into insider trading. The report strongly reaffirms that that it is a violation of federal insider trading laws to buy or sell securities based on material, non-public information, including political intelligence.
Disclosing Political Intelligence Gathering?
The report also looked at whether political intelligence should be a regulated industry—like lobbying—that requires disclosure. The GAO Report considered the pros and cons but did not make a recommendation either way. Even some government watchdogs who provided input to the GAO questioned exactly what would be gained by disclosure.
The report is a reminder that persons who use political intelligence to inform investment decisions must take precautions to make sure their information is not “material, non-public information.” This holds true regardless of whether the political intelligence is obtained directly, or from a third party or consultant.
In addition, it is possible (if not probable) that a registration requirement will be instituted for individuals and firms that engage in political intelligence activities. If implemented, such a regime is likely to be similar to the registration regime for lobbying activities under the Lobbying Disclosure Act. Persons who use political intelligence should consider whether they are comfortable disclosing their political intelligence activities and the effect that might have on business.