Assistant US attorney warns hedge funds on political intelligence firms

22 Apr, 2013

Political intelligence firms are likely to face similar regulatory scrutiny to expert networks amid concerns financial institutions could be profiting off insider information from these organisations, the assistant US attorney at the US attorney’s office has warned.

“Political intelligence firms are expert networks 2.0. Regulators are going to be looking at whether government actors or lobbying groups have breached their duties by disclosing confidential information to financial institutions and hedge funds,” said Patrick Sinclair of the US attorney’s office, speaking at GAIM Ops 2013 in the Cayman Islands.

Political intelligence firms, which pride themselves on their excellent networks of politicians and government insiders, have proliferated in recent years as lawmakers’ actions increasingly play a major role in market movements. A growing number of Wall Street firms, including hedge funds, pay for their information and political gloss with investors spending $402 million on political intelligence firms in 2009, according to Integrity Research Associates, a search company which pairs asset managers with researchers.

This comes as the SEC issued subpoenas for emails and documents from Marwood, a political intelligence firm earlier in 2013 following allegations the company may have warned its Wall Street clientele, including several hedge funds that the Food and Drug Administration was going to delay approval of a diabetes drug. One hedge fund is reported to have taken a substantial short position in the drug company following this advice.

Meanwhile, Sinclair added there was political pressure on these organisations. The US Government Accountability Office recently issued a report, which acknowledged it could not quantify how much political intelligence was sold to clients, or how these organisations were compensated. Some Congressional figures have urged political intelligence firms be forced to register with Federal authorities so as to minimise the risk of material, non-public information being leaked.

Fears of a clampdown come several years after hedge funds faced huge pressure and investigations over their use of expert networks. Nonetheless, managers have bolstered their internal procedures for dealing with such companies since 2010. “After some initial panic, a lot of managers realised expert networks in some circumstances were a valuable and legitimate part of their research. We talk to people about best practices when dealing with expert networks and how compliance can monitor the entire process and calls. Furthermore, a lot of expert networks have been proactive in improving their compliance procedures,” said John Nathanson, partner at Shearman & Sterling.

However, it is becoming increasingly apparent that hedge funds have not necessarily adopted these standards when dealing with political intelligence firms, a point echoed by a partner at Allen & Overy earlier this year.

Furthermore, regulators are likely to review hedge fund compliance with the SEC’s Rule 10b5-1, an ancillary to Rule 10b5, which prohibits insider trading.  Rule 10b5-1 states that if an individual is aware of material, non-public information when buying or selling shares, regulators can assume that person is trading on the basis of insider information. This presents a challenge if an individual working at a hedge fund has a directorship and is therefore privy to sensitive information,  and that hedge fund has a position in the company.

“An analyst or trader may serve as a director. While these individuals have to declare their directorships and there are preventative measures in place to curb wrong-doing, we are going to be reviewing these practices further,” commented Sinclair.

US attorney's officepolitical intelligence firmsexpert networksAllen & Overy