Political Intelligence Firms – Insider Trading and Enforcement Shifts from Wall Street to K Street

Vol. 20, No. 12 • December 2013 Political Intelligence Firms – Insider Trading and Enforcement Shifts from Wall Street to K Street By Catherine Botticelli, Jane Kanter, Adam Wasserman, and Sean Murphy nsider trading remains a top priority for the Securities and Exchange Commission (SEC) and Department of Justice (DoJ). In fiscal year 2012, the SEC filed 58 enforcement actions against 131 individuals and entities and the DoJ charged and convicted dozens of indi- I viduals.1 The regulators continued their crackdown on hedge funds and their information suppliers associated with expert networks, which began in 2010. Now, with the passage of the Stop Trading on Congressional Knowledge Act (STOCK Act)2, we are experiencing déjà vu, as the law has “teed up” a new category of experts – political intelligence firms – as the next source of potential investigations and actions in an ever changing landscape of insider trading laws. In April 2013, the press began to report decision favoring private health insurers who about an SEC investigation into possible participate in a Medicare program. The mat- insider trading based on information pro- ter also caught the attention of Senator Chuck vided by political intelligence firms.3 The case Grassley, who started investigating whether emerged when a Washington-based stock a lobbyist at a K Street law firm tipped brokerage firm, Height Securities, allegedly Height Securities with news of the government alerted clients of an imminent government decision.4 This shifting focus on the use of information provided by political intelligence firms Ms. Botticelli and Mr. Wasserman are partners is not a surprise. It is a logical progression in Dechert LLP’s White Collar and Securities of prior investigations by the SEC because Litigation practice. Ms. Kanter is a partner, and political intelligence firms resemble expert Mr. Murphy is an associate, in Dechert LLP’s networks in terms of the services provided to Financial Services Group. hedge funds and other investment firms. The IL_1213_Botticelli.indd 1 12/26/13 8:27 PM value of the information provided by politi- what information is subject to the duty of cal intelligence firms, largely collected from trust and confidence and thus would create Washington insiders, is based on the realiza- liability if disclosed. tion among market participants that decisions in Washington can move markets. And, the A. What Political Intelligence Might political intelligence industry is a lucrative Constitute Material Nonpublic industry that is said to have doubled in size in Information? the past decade, which provides added induce- ment for enforcement focus.5 The scope of what information is sub- The government recognizes that there are ject to the duty under Section 21A of the many legitimate ways to utilize experts and Exchange Act is certainly significant. For expert networks.6 And the same is certainly example, would a member of Congress breach true for political intelligence firms. However, the duty if he or she disclosed the mere intent just as with expert networks, political intel- to support a particular bill? In this regard, the ligence firms and the investors who use them STOCK Act instructed the Select Committee should be aware of the potential insider on Ethics of the Senate (Senate Committee) trading issues raised by the use of politi- and the Committee on Ethics of the House of cal intelligence and take steps to reduce Representatives (House Committee) to issue their regulatory risk. This is especially true interpretative guidance regarding the duties of given that, going forward, the STOCK Act their members and employees. potentially will provide an additional legal basis for enforcement in circumstances where 1. Committee on Ethics of the House the intelligence transmitted is improper of Representatives Guidance information. The House Committee issued guidance in April 2012 that advised House members I. The STOCK Act and their employees of their duties under the The STOCK Act was signed into law on STOCK Act.11 When identifying what infor- April 4, 2012, and explicitly extends the pro- mation might be considered material non- hibitions on insider trading under the fed- public information, the House Committee’s eral securities laws to members of Congress, guidance referenced the House Committee’s their congressional staff and other congres- Rules Regarding Financial Transactions sional employees, certain executive branch (Rules),12 which generally state: officials and their employees, and judicial officers and their employees (covered pub- Material nonpublic information is any lic officials).7 Although covered public offi- information concerning a company, cials were not previously exempt from insider security, industry or economic sector, trading laws, the STOCK Act attempts to or real or personal property that is eliminate any ambiguity with respect to not available to the general public and whether public servants may profit from which an investor would likely con- information they garner during the course sider important in making an invest- of their duties. ment decision. A good rule of thumb The STOCK Act amends Section 21A to determine whether information may of the Securities Exchange Act of 19348 be material nonpublic information (Exchange Act), to provide that covered public is whether or not the release of that officials9 owe “a duty arising from a relation- information to the public would have ship of trust and confidence to the Congress, an effect on the price of the security or the United States Government, and the citi- property. zens of the United States with respect to material, nonpublic information derived from such Thus, it is important to note that mate- person’s position … .”10 Importantly, however, rial nonpublic information need not relate the STOCK Act does not specifically identify to a specific company or security. Rather, THE INVESTMENT LAWYER 2 IL_1213_Botticelli.indd 2 12/26/13 8:27 PM according to the House Committee’s Rules variety of circumstances, including informa- and guidance, material nonpublic information tion received in a closed, nonpublic hearing; can include information regarding industries information gathered during the confidential and economic sectors more generally. stages of a committee investigation; and clas- The Rules note that much of the informa- sified national security information.” This tion available during the legislative process, guidance does not line up with the House such as information from public briefings Committee guidance in that it does not spe- or hearings, is considered public informa- cifically state that information about potential tion. However, the guidance also suggests legislation or amendments to legislation would that some information gained during the be considered material nonpublic informa- course of government service may be mate- tion, but instead focuses on information dis- rial nonpublic information, including, but seminated during a proceeding or subject to not limited to: investigation where there would be an inherent expectation of confidentiality. legislation and amendments prior to their public introduction, information B. Liability under the STOCK Act from conference or caucus meetings regarding votes or other issues, and The STOCK Act makes covered public information learned in private brief- officials liable for breaching their duty, and ings from either the public or private trading on or disclosing (that is, tipping), sector.13 certain material nonpublic information that is revealed to them during the course of their This guidance may be viewed by some as duties. Consequently, market participants troubling as it is commonplace in Washington who trade after interacting with, and receiv- for lawmakers, government officials and regu- ing information from, covered officials may lators to “float” potential legislation and ideas themselves face increased risk of enforcement for potential legislation, rulemaking or pos- under the expanded insider trading regime. sible political appointments prior to their public introduction or official announcement. The 1. Tippee Liability Rules, together with the guidance and obliga- tions under the STOCK Act, suggest that The STOCK Act creates the potential for merely communicating information regarding new insider trading “tippee” liability for pri- potential legislation may constitute a violation vate citizens and organizations that receive of a covered public official’s duty. material nonpublic information from covered public officials who disclose such information 2. Select Committee on Ethics in violation of what is now an express statu- of the Senate Guidance tory duty of trust and confidence owed by covered public officials with respect to mate- The Senate Committee issued guidance in rial nonpublic information to which they are December 201214 and noted at the outset that: privy during the course of their duties. Under traditional insider trading theories, a [The STOCK Act] is not intended … to market participant who receives material non- chill legitimate communications made public information (the “tippee”) would be in good faith between public offi cials liable for trading on that material nonpublic and their constituents, inhibit govern- information when the tippee knows or should ment transparency, or otherwise hinder have known that the person from whom he has the dissemination of public informa- received the material nonpublic information tion about government activities. (the “tipper”) provided that

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