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When Politics Is Also Securities Fraud

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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This Chris Christie securities fraud investigation is pretty strange. The story, from the New York Times, seems to be that Governor Christie's administration wanted the Port Authority of New York and New Jersey to pay for some repairs to the Pulaski Skyway, which is a road in New Jersey and not, you know, a port. The Port Authority's lawyers said no: "The Pulaski Skyway, they noted, is owned and operated by the state, putting it outside the agency’s purview." Christie's administration convinced the Port Authority to do it anyway; apparently persuading people to do things they don't want to do is a hallmark of the Christie style.

The Port Authority issues bonds, and its bond offering documents now contain this bit of industrial poetry:

In recognition of the ongoing needs of the Port Authority's facilities for efficient transportation access and egress for goods and people, at its meeting on March 29, 2011, the Board of Commissioners of the Port Authority authorized the effectuation of the Port Authority's participation, in cooperation with the New Jersey Department of Transportation ("NJDOT"), in the Route 1&9T Pulaski Skyway, Route 139 (Hoboken and Conrail Viaducts), Route 7 Hackensack River (Wittpenn) Bridge, and Route 1&9T (New Road) projects (or suitable replacement projects mutually agreed upon with NJDOT) (collectively, the "Lincoln Tunnel Access Infrastructure Improvements"), on a basis consistent with the Port Authority's budget and capital plan with certain of the funds previously allocated to the Access to the Region's Core Project (see "Access to the Region's Core Project.")

And that paragraph is apparently being investigated, by the Securities and Exchange Commission and New York prosecutors, as securities fraud under New York's Martin Act, which says that everything is fraud.

I kind of don't get it? According to the Times, "[t]he accuracy of this characterization is now a major focus of the investigations." And it appears to be perfectly accurate: The board really did authorize spending money on those New Jersey roads.

The flaw seems to be in that introductory clause: If the Port Authority voted to spend money on New Jersey roads, not "in recognition of the ongoing needs of the Port Authority's facilities for efficient transportation access and egress for goods and people" -- which would be odd, in that the Pulaski Skyway doesn't actually connect to any Port Authority facilities -- but because Chris Christie's aides pressured it to, then that clause would in fact be false.

Or something. My assumption is that any time politicians or political bodies describe their motivations, they are lying, and that the punishment for lying about your motives is that occasionally a columnist will complain about you. It's not a felony charge! It's particularly not a securities fraud charge. Port Authority bondholders, in particular, were not defrauded, and don't seem to care about this, which is why it's a Martin Act case and not a real securities fraud case. The Authority is still paying its bonds normally, and they've traded up since the Port Authority started spending money on New Jersey roads.

Meanwhile in another part of town the SEC is investigating a congressional staffer and a lobbyist for insider trading, and is fighting with congressional lawyers over what documents it can look at. The basic story, from the SEC's court filing, is that the U.S. Centers for Medicare and Medicaid Services announced higher-than-expected Medicare Advantage reimbursement rates, which was good for health insurers. The congressional staffer, Brian Sutter, was involved in, or at least aware of, this decision before it was announced, and he talked to a lobbyist for one of the companies that would be affected by the decision. (It's not clear what he told the lobbyist, but, y'know. ) The lobbyist then told an analyst at Height Securities, a research firm, that the decision was coming, Height told its clients, and they traded on the information.

Now perhaps this was illegal insider trading: Perhaps the clients paid Height for its research (they did), Height paid the lobbyist for the tip (seems to be no evidence of that), and the lobbyist paid Sutter for the conversation (again, no evidence). And it makes sense for the SEC to be fishing for evidence of some sort of corrupt arrangement like that.

But a different story is certainly possible. In this story, a lobbyist representing a constituent contacted a congressional staffer about rules that would affect the constituent. The lobbyist thought -- as did everyone -- that the rules would be bad for his client, and so he wanted to check if that was true. And, if the rules were bad for his client, he wanted to try to convince the staffer that the rules should be changed. That was his job, as a lobbyist. And the staffer, as part of his job as a government official dealing with a constituent, told the lobbyist, no, the rules are fine for your client, you don't need to convince me of anything.

And the staffer didn't get the lobbyist to sign a confidentiality agreement -- which would be weird! Why should you have to keep your conversations with Congress secret? -- so the lobbyist went off and told people who told people who traded on the information.

Would this be illegal? Ehh I don't know. But it would be sort of weird if it was, right? I mean, you may dislike lobbyists, but there is something to be said for a system of government where you (or your representative) can call your Congressman (or his representative) and talk about what the government might or will or should do. It's hard to imagine that an American citizen doesn't have the right to talk to his Congressman about pending legislation.

I suppose there are some arguments for the rule that congressional staffers can never talk to lobbyists about nonpublic information: All conversations between staffers and lobbyists would be, not forbidden, but, like, broadcast for everyone to see. There are some arguments against this rule too -- it seems a bit unwieldy -- but in any case, it's not the rule.

The rule might be "you can talk to Congress, but you can't trade on what you hear," but it's not clear that that's the rule either. Even if that was the rule: Who would get in trouble here? Sutter, who seems not to have traded, or to have known that anyone would trade? The lobbyist, who also didn't trade? The research firm, which only knew that the lobbyist's information came "from very credible sources," and which also never traded? Or the research firm's clients, who did trade, but on the basis of a report from the research firm saying "We now believe that ..." the decision would be positive, without any attribution to insiders?

You can see the appeal of these cases: Both Pulaski Skywaygate and the congressional-insider-trading thing have the feel of political corruption, of not-quite-honest officials cutting backroom deals to get what they want. Health-insurer lobbyists learn about health-insurance rules before the public does; pet road projects get funded by the wrong agency due to bullying rather than clear and transparent public debate.

But still it feels weird to go after sketchy political behavior as securities fraud. One lesson of the last few years is that securities fraud laws are a pretty imperfect way to regulate securities markets. That's hardly a good reason to extend them to regulating politics.

  1. Particularly relevant provisions of the Martin Act include sections 352 (defining securities) and 352-c (saying what's a crime). In particular, it is a crime to make:

    Any representation or statement which is false, where the person who made such representation or statement: (i) knew the truth; or (ii) with reasonable effort could have known the truth; or (iii) made no reasonable effort to ascertain the truth; or (iv) did not have knowledge concerning the representation or statement made; where engaged in to induce or promote the issuance, distribution, exchange, sale, negotiation or purchase within or from this state of any securities or commodities, as defined in section three hundred fifty-two of this article, regardless of whether issuance, distribution, exchange, sale, negotiation or purchase resulted.
    And Port Authority bonds are sold in New York, so any false statement -- or, at least, any material false statement -- in the documents can be a crime. From the Times:
    To prove a violation of the Martin Act, prosecutors do not have to establish an intent to defraud. Nor do they have to show that victims relied on a misrepresentation of fact. They do not even have to show that a purchase of securities occurred or that any damages were suffered.
  2. That paragraph is the only mention of the Pulaski Skyway in the bond offering documents that I can find. The Port Authority issues a lot of bonds; you can get the full list here (search for "Port Authority of New York and New Jersey"). There are slight variations in the disclosures but that passage seems to remain consistent; here's the first one I found dated after that March 2011 authorization, and here's the most recent one.

  3. From the Times story:

    It was around this time [March 25, 2011] that lawyers first raised the possibility of identifying the projects as roads that “approach and feed into the Lincoln Tunnel.” The rationale hinged in part on a previous finding that the Lincoln and Holland Tunnels were interdependent: If the projects improved access to the Holland Tunnel, the thinking went, then the Lincoln Tunnel would be affected, too.

    On March 29, the Port Authority unanimously approved a resolution authorizing the projects, which were referred to as, simply, “access infrastructure enhancement.”

  4. I mean, the bond that seems to me to be the one issued most closely after that March 29, 2011 decision -- CUSIP 73358WEK6 -- was issued at par (for a 4.926 percent yield) and now seems to be trading at around 109 (4.4ish percent). On the other hand, it was rated Aa2/AA-/AA- at issue; newer issues are rated Aa3/AA-/AA-, so there's been a small move down from Moody's.

    Also, I should say, the Times indicates that there's some prospect that this decision violated the Port Authority's bond covenants. Now violating your covenants is not securities fraud, but I suppose if this disclosure disguised the covenant violation then maybe that makes for fraud. Again, though, this doesn't seem like something that bondholders care about.

  5. Disclosure: One of the SEC's lead lawyers here is a friend of mine, though we have not discussed the case.

  6. I quoted this yesterday but it remains wonderful: Sutter originally told the FBI that they hadn't discussed the announcement, but the lobbyist told the SEC otherwise. Then the congressional lawyer sent the FBI a letter. That letter was the lawyery-est letter you ever will read. It went like so:

    I understand that you may have asked Mr. Sutter whether he ever had used his mobile telephone to speak with [the GT Lobbyist]. Mr. Sutter may have answered that he could not recall doing so, which would have been a correct statement of Mr. Sutter's memory at the time. With the benefit of some time for reflection, Mr. Sutter's best recollection now is that he previously may have used his mobile telephone to speak with [the GT Lobbyist] although he is not certain. It is also possible that Mr. Sutter may have made other statements in the course of his interrogation that, while an accurate reflection of his memory at the time, might merit clarification if, for example, Mr. Sutter were to review records that could refresh his memory.
  7. And, no, the STOCK Act -- the "Stop Trading on Congressional Knowledge Act of 2012" -- doesn't clearly prohibit it. As the White House put it, "The Act makes clear that Members and staff owe a duty to the citizens of the United States not to misappropriate nonpublic information to make a profit," but in this story Sutter didn't "misappropriate nonpublic information to make a profit": He talked to a lobbyist about pending rules in order to do his legislative job. The STOCK Act just says that:

    each Member of Congress or employee of Congress owes a duty arising from a relationship of trust and confidence to the Congress, the United States Government, and the citizens of the United States with respect to material, nonpublic information derived from such person’s position as a Member of Congress or employee of Congress or gained from the performance of such person’s official responsibilities.

    Which means that, if they misappropriate that information for some private benefit, they might be guilty of insider trading. But if they don't misappropriate it for private benefit -- if they just use it in performing their duties -- then they probably aren't.

    Incidentally there is some worth-reading stuff in the SEC's filing about this story. The congressional committee's lawyers are trying to prevent the SEC from reviewing documents and interviewing Sutter by claiming, among other things, privilege under the speech or debate clause of the Constitution. The SEC is not buying it:

    Neither the Commission's Human Investigation nor the Subpoenas are concerned with, nor do they inquire into, any "legislative act," and thus they do not implicate the purpose or scope of the Clause. The Commission staff is investigating whether there was unlawful disclosure and trading on material non-public information about the April 1, 2013 Rate Announcement by CMS -- and the Subpoenas are narrowly tailored to obtain information concerning that issue. Any enforcement proceeding that results from this investigation would address the disclosure of material nonpublic information regarding imminent action by an agency of the Executive Branch, not any act or conduct that fits within the definition of "legislative act" adopted by the Supreme Court.

    It's a little more complicated than that -- the executive decision was informed by what Congress was going to do, so there's a reason that Sutter knew about it in advance and probably had some role in it -- but it's a fair point. Still, while talking to a constituent/lobbyist about an executive branch decision may not be a "legislative act" for constitutional purposes, that doesn't necessarily mean that it's not a legitimate, like, governmental function for a legislative staffer.

  8. A securities-law alternative would be "or bound by a confidentiality agreement," but that's not perfect either. Again, you wouldn't really want to prohibit people from disclosing what they discussed with their Congressman.

  9. See footnote 7. We talked the other day about an argument that "he U.S. should reconsider the virtues of the parity-of-information theory and enact a more straightforward and easily enforceable regulation of insider trading based on this theory." On this theory -- which is sort of the rule in Europe, as far as anyone can tell -- you just can't trade on material nonpublic information, no matter how it was obtained. It seems a little harsh to me in this case -- it would, presumably, punish the hedge funds who traded on the research firm's report even though they didn't know that the information came from a congressional staffer, though of course they did know they were paying for political intelligence or whatever -- but that may just be my American-law bias talking.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Matthew S Levine at mlevine51@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net