Insider Trading Gets Political: Trading on Political Intelligence

Some things are better left unsaid. Especially, it seems, when they involve political intelligence shared by a congressional aide with a lobbyist linked to a political intelligence firm serving Wall Street traders.

The sharing of political-insider scoop has recently caused Congress to be subpoenaed for an insider trading investigation that will likely test recent legislation enacted to curb trading on non-public political information. The SEC subpoenaed Rep. David Camp (R., Mich.) for records, and the Justice Department subpoenaed Camp’s aide Brian Sutter, staff director of the House Ways and Means Committee’s healthcare subpanel, to testify before a federal grand jury.

Regulators have never charged a political research firm, member of Congress, or congressional aide with insider trading, but in light of the grand-jury probe a case appears likely.

At the vortex of the investigation is political research firm and broker-dealer Height Securities, which is regulated by the SEC. On April 1, 2013, the firm predicted a dramatic change in health care policy mere minutes before the market closed. This was no April fool’s joke, but it was probably foolish nonetheless. The Wall Street Journal reports that the alert was based on information that Mark Hayes, a “former congressional health-care aide turned lobbyist,” provided to the firm. Mr. Hayes purportedly received the tip from congressional aide Mr. Sutter.

The alert notified investors that the U.S. Center for Medicare and Medicaid Services was no longer planning to cut payments to insurers that offer Medicare Advantage, contrary to what it had previously announced. If the cut had gone through, it could have cost insurers up to $8 billion. This news was disclosed by Height Securities before CMS announced it. The surge in health insurance companies’ stock prices — and the Wall Street Journal report that followed — got investigators’ attention.

Whether the alleged tip is illegal appears to be murky in large part because of the nature of the information at issue. Insider trading laws were not designed to stop politicians from exchanging non-public political information with lobbyists and outside experts.

But the purchase of stock based on this kind of information may not be legal. The 2012 Stop Trading on Congressional Knowledge (“STOCK”) Act warns members and employees of Congress that they are not exempt from the insider trading provisions under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. By incorporating the federal securities laws, the Act appears to prohibit members of Congress and their employees from: (1) tipping (2) material, non-public information learned through their positions or gained through performance of their responsibilities (3) in breach of the duty “arising from the relationship of trust and confidence to the Congress, the United States Government, and the citizens of the United States” (4) for the tipper’s personal benefit, including reputational benefit. In carrying out these actions, the tipper must possess the requisite scienter: “a mental state embracing intent to deceive, manipulate, or defraud.”

Mr. Hayes and Height Securities face potential liability under the misappropriation theory of insider trading if they were entrusted in confidence with material, nonpublic information and they breached a fiduciary duty to the source of the information to gain a personal profit in the securities market.

Trading on non-public political intelligence not only is unintelligent, but may also be illegal.