The use of “political intelligence” by investment professionals is receiving a great deal of attention on Capitol Hill and from both the SEC and DOJ. The topic recently became front page news after trading spiked in the securities of select health insurers immediately after a broker-dealer sent an email predicting favorable government action on Medicare reimbursement rates. The email relied at least in part on information provided by a lobbyist for one of the insurers. Congress, the SEC and federal prosecutors have opened investigations into possible leaks of confidential information and the resulting trading.
This incident and the attention it has generated are powerful reminders that investment firms seeking access to political intelligence, whether directly or through intermediaries, will benefit from careful planning to minimize the risk of receiving material non-public information (“MNPI”), followed by close analysis of any resulting intelligence they obtain. This planning and analysis may resemble what firms already are doing with respect to communications with company insiders and paid experts, but it is important to recognize that government-sourced information is produced in a setting with its own unique constraints and risks. The result is that when investment professionals seek and receive political intelligence they need to be alert to the unique attributes of the original source — the government — and the resulting risks of receiving MNPI. In this note we offer our thoughts on fine-tuning a firm’s researchfocused compliance policies to address the unique risks associated with political intelligence. In doing so, we recognize that the very term “political intelligence” is open to many interpretations and can cover a wide range of information from macrooriented analyses to detailed descriptions of likely agency action. As with compliance initiatives generally, dealing with political intelligence does not lend itself to a “one size fits all” solution. Rather, there is a need to evaluate how particular providers of information operate and tailor a firm’s response accordingly.
GOVERNMENT EMPLOYEES OWE DUTIES OF CONFIDENTIALITY TO THE GOVERNMENT
Last year, in response to concerns that confidential government information was being used for private gain, Congress passed the Stop Trading on Congressional Knowledge (STOCK) Act, which prohibited government employees (including Members of Congress, their staffs, and executive agency personnel) from using nonpublic information obtained through their official positions for personal benefit.
The STOCK Act further affirmed that government employees are subject to insider trading prohibitions under securities laws, and made explicit that such employees owe a duty of confidentiality to the government. It follows that the disclosure of government-sourced MNPI by government employees to market participants may be unlawful, as may be securities trading by those who receive the political MNPI.
GOVERNMENT-SOURCED INFORMATION MAY BE MNPI
There are myriad ways in which government actions can impact investments. Obtaining unreleased information about a pending government action can give an investor a valuable advantage over other market participants, thus crossing the line between permissible discussions of political intelligence and the prohibited disclosure of MNPI.
There are at least three different sources of political MNPI: government employees; experts who consult for the government or otherwise gain exposure to political MNPI; and third parties who interact with government employees, including lobbyists and research analysts.
INSTITUTIONAL SAFEGUARDS ON CONFIDENTIAL GOVERNMENT INFORMATION CAN VARY CONSIDERABLY
Many executive agencies, including the Departments of Commerce and Treasury, have established procedures for safeguarding confidential information prior to its public release that are commensurate with the marketmoving nature of the information. By contrast, the legislative branch, while subject to various ethics rules, has not imposed on an institutional basis safeguards on the release of MNPI. To the extent restrictions have been imposed, they have been established by particular members or committees. Moreover, in government there are no prophylactic rules in place to deter potential insider trading such as Regulation FD (prohibiting selective disclosure by public companies), or Section 15(f) of the Exchange Act (requiring brokerdealer firms to prevent the misuse of material non-public information through reasonably-designed policies and procedures). Large swaths of government sources of information accordingly may not be sufficiently alert to the need to avoid sharing political MNPI with investment professionals.
ACCESSING POLITICAL INTELLIGENCE RISKS RECEIPT OF MNPI
Because individuals in government may not be sufficiently focused on safeguarding market sensitive information, there is an enhanced risk that investment professionals accessing political intelligence may receive MNPI, either directly or through intermediaries. These potential risks exist when dealing with intermediary consultant-experts, such as lobbyists or others in the business of aggregating and distributing political intelligence on an institutional basis, as well as in direct interactions with Members of Congress or their staffs.
This is not to suggest that there is anything inherently problematic about Congressional interactions. Members of Congress are in the business of disclosing information about their plans and analyses. Disclosure is a core means by which they, and their staffs, advance particular political agendas. Yet there still remains a risk to investment professionals dealing directly with Congress: a Member’s reflexive disclosure of the information may confer restricting MNPI, such as a Member’s knowledge of confidential agency actions. Hence, simply focusing on the identity of the provider of the information and not the underlying source of that information may not protect an investment firm in such interactions.
There is a second layer of risk when consulting with intermediary “experts.” Commonly, these experts wear multiple hats and so may have multiple duties — for example a lobbyist for corporate clients may have a side business sharing information and opinions with investment professionals. Such an expert might disclose, for example, how his client plans to respond to particular legislative proposals and in doing so convey MNPI. An investment firm can guard against that risk by probing the lobbyist’s other confidentiality commitments prior to retention and obtaining the lobbyist’s agreement to alert the investment firm to any new commitments that may arise.
FINE-TUNING EXISTING COMPLIANCE PROTOCOLS THROUGH PLANNING IN CONNECTION WITH THE ENGAGEMENT WILL ADDRESS THE RISKS OF ACCESSING POLITICAL INTELLIGENCE
We suggest that fine-tuning the compliance protocols in place at investment firms that address use of paid consultants in investment research will help address the risks posed in accessing political intelligence.
For example, the general screening questions many firms pose to paid consultants can be adjusted to help ensure that the firm is engaging only those lobbyists or other intermediaries who are alert to their duties of confidentiality to their other clients and are committed to the investment firms’ objective to gather political intelligence while remaining unrestricted in securities trading. Of critical importance is ensuring that any lobbyist or other political intelligence intermediary understands the rules applicable to investment professionals and is committed to following them.
Thoughtful adjustments to screening questions can be made after considering, during the planning stage of a political intelligence consultation, the likely sources of the information sought. Matters legal and compliance might address with the investment professional include:
- Do we know what duties likely attach to the information sought? Do we have reason to believe that the original source of the information is under a duty to maintain the confidentiality of the information?
- If the information originates with someone who works for a Member of Congress, how can the firm be assured that the provider of the information has been authorized by the Member to share it? While individual Members may put in place policies and procedures with respect to sharing information with select members of the public, there may not be clear ground rules in a particular congressional office and therefore it may be unclear whether the information disclosure was authorized.
- If the information originates with a Member of Congress, was the Member providing his or her own views or plans or those of a committee or a caucus? (The risk of receiving MNPI is reduced when a Member is simply disclosing what he or she thinks or is planning to do, since disclosing one’s own information does not breach duties to others and provides just one person’s input.) The Member, by contrast, may not be authorized to disclose the views and plans of the committee or caucus as a collective and doing so may convey information with enhanced materiality, since it is collated information.
- If the information comes from a government employee and would be conveyed to the firm by a lobbyist, is there reason to believe it was furnished to the lobbyist solely for the use of the lobbyist’s clients in the legislative process, and not for another person’s investment purposes?
Further, insider trading prevention training offered to investment professionals can be augmented to cover the risks of political intelligence gathering. We suggest that the training highlight the importance of, among other things: (1) planning such consultations in advance in order to consider with legal and compliance staff the appropriate persons to approach for political intelligence; (2) pre-screening lobbyists and other intermediaries for duties; (3) thinking through consultation questions to help ensure that consultants are asked, and furnish, only in-bounds information; and (4) bringing immediately to legal and compliance personnel any concerns with respect to receipt of political MNPI.
The recent publicity around the STOCK Act and political intelligence gathering will increase the scrutiny given investment firms active in the public markets by regulators and other government actors. Firms may benefit from revisiting existing compliance protocols and training to help ensure that they address the risk posed by accessing government-sourced information in connection with their investment research.