One hopes the SEC never leaks.

Photographer: Joshua Roberts/Bloomberg

Political Firm's Intelligence Was a Little Too Good

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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Here is a basic model of the law of investor relations:

  1. A company's managers work for the shareholders.
  2. If the shareholders want to talk to them, who are the managers to say no?
  3. But managers shouldn't tell one shareholder something that they haven't told other shareholders, because that would be unfair.
  4. But the shareholders can ask.
  5. If, in the course of an ordinary conversation, a manager tells one shareholder something that she hasn't told other shareholders, the shareholder wins. That is why he called in the first place. He can happily go off and trade on the information. (In theory, the manager gets in trouble for this, though not, like, prison trouble. )
  6. On the other hand, if a manager tells one shareholder something that she hasn't told other shareholders for corrupt reasons -- like, because the shareholder bribed her -- and the shareholder trades, then the shareholder gets in trouble. Bad trouble. Prison trouble. That's called insider trading. (In theory, the manager also gets in trouble for this, also possibly prison trouble. )

The most important thing about this model is that no part of it is legal advice, but it is perhaps a useful guide, for entertainment purposes only, to recent developments in insider trading law.  It is also only so useful: The boundaries between ordinary and corrupt conversations are unclear, and no one has quite found the right balance between the need for fairness among investors and the need for companies to communicate with their owners. 

But it is fun and possibly instructive -- or possibly dangerous! -- to apply this model to "political intelligence." Like:

  1. Government bureaucrats work for the people.
  2. If the people want to talk to them, who are the bureaucrats to say no?
  3. But bureaucrats shouldn't tell one member of the public something that they haven't told other members of the public, because that would be unfair.
  4. But people can ask.
  5. If, in the course of an ordinary conversation, a bureaucrat tells one member-of-the-public-who-is-also-an-investor something that she hasn't told other people, then ... what? Can the MOTPWIAAI go off and trade on this information? (Or, if the member of the public is actually a "political intelligence" employee, can he go tell the information to other people, who then go and trade on it? ) One assumes that's why he called in the first place. Does the bureaucrat get in trouble for this? Or what?
  6. Presumably if you bribe a bureaucrat everyone goes to prison, come on.

As is so often the case when securities law intersects with politics, it gets a little weird. Can it really be a crime to call up a public servant and ask her what the government is going to do? (I mean, outside of spy stuff, etc.) Sure, if her agency has confidentiality rules, she might get in trouble for telling you things, but why should you get in trouble for asking? Asking the government what it's up to is a basic democratic right, and it feels a bit strange to punish people for asking, or even for getting answers.

Anyway here is a Securities and Exchange Commission case that resolves none of these questions. According to the SEC order, Marwood Group Research LLC is "a regulatory and legislative policy firm ('a political intelligence firm'), and registered broker-dealer" that, among other things, provides "regulatory and policy updates ('research notes') to hedge funds and other securities market participants concerning likely outcomes of future government actions." It does this by, among other things, calling up government employees and asking them what they're going to do. Which seems to me like quite a reasonable way to figure out the likely outcomes of future government actions. The SEC disagrees:

"Government employees routinely possess and generate confidential market-moving information. When political intelligence firms like Marwood Group obtain information from government employees, they must take the necessary steps to prevent the dissemination of potentially material nonpublic information obtained in the course of their research,” said Andrew J. Ceresney, Director of the SEC’s Enforcement Division.

This obviously makes no sense at all. Marwood's customers pay it to give them valuable insights into what the government will do. To get those insights, Marwood calls government employees. Presumably those calls are not purely social. If they never generated information with economic value for Marwood's customers -- information that was not publicly available elsewhere -- then why would Marwood make those calls? "Marwood’s account representatives and managers highlighted Marwood’s successes to current or prospective clients, and highlighted Marwood’s relationships with, and connections to, government decision makers." What would Marwood be selling, if not insight into what the government would do based in part on talking to the government about what it would do? 

But, you know, there are things you are supposed to say, so everyone says them. Marwood too:

During 2010, Marwood had a written insider trading policy that prohibited its employees from using or disclosing any MNPI if they had obtained such information in the course of their employment. The policy specifically identified as potential MNPI “knowledge or awareness of the specific terms of any pending but not yet publicly proposed or approved action by a regulatory or other government agency.” The Marwood policy further stated that if an employee had any doubt as to whether he or she had obtained MNPI from any source, the employee was to refrain from using or disclosing the MNPI, and was to consult with Marwood’s compliance department.

But that policy was not fully effective, and some Marwood employees got material nonpublic information about drug approval decisions from the Food and Drug Administration, and about drug coverage decisions from the Centers for Medicare and Medicaid Services. Then they put that information in research notes, which I guess they were not supposed to do, though on the other hand what on earth were they supposed to do? (Again: Their business is to give "regulatory and policy updates ('research notes') to hedge funds and other securities market participants concerning likely outcomes of future government actions.")

And now Marwood is in strange trouble, not for insider trading, but for failing to "establish, maintain, and enforce written policies and procedures reasonably designed, taking into consideration the nature of such broker’s or dealer’s business, to prevent the misuse in violation of… [the Exchange Act] or the rules or regulations thereunder, of material nonpublic information by such broker or dealer or any person associated with such broker or dealer.” For this, Marwood "agreed to admit wrongdoing and pay a $375,000 penalty," and to do a bunch of dancing around with a compliance consultant who will presumably improve its anti-insider-trading policies. I have no idea what the new consultant-approved policies will say, though I'd be interested to find out.

Did Marwood insider trade? I mean, it didn't trade. But according to the SEC, it passed material nonpublic information on from the government to its clients, "including clients likely to trade the securities of the company whose product or service could be impacted by impending government activity." The SEC seems not to have bothered to find out if any clients did trade on that information, presumably because, if they did, that would only open a bigger and stranger can of worms. Like: If Marwood got its information from government employees who never received any "personal benefit" for their tips, was that illegal insider trading? (It's not under the normal rule for corporate insider trading, and there's no allegation that anyone got any personal benefit here.) Or: If it was insider trading, should the clients get in trouble as well as Marwood? I mean, they hired a political intelligence firm; what did they think they were paying for? 

But those questions will remain unanswered, and instead Marwood will go off and improve its policies to ... do ... something. What? Here is my guess at a list of things that won't be in the new policies:

  1. Marwood employees can't call up government employees and ask them what they're going to do.
  2. Marwood employees can't write notes to their clients containing their best guesses at what the government will do.

It would be a bit extreme for the government to forbid either of those things! And yet the combination feels sort of icky. That icky feeling, though, seems to be about as far as the law of political intelligence goes.

  1. Ha no kidding, come on.

  2. This is Regulation FD, which seems to me to be sort of gently enforced.

  3. Though there seems to be a trend of corporate tipsters getting punished more leniently than their tippees. Consider Mathew Martoma's doctor tipsters, or the unprosecuted sources of information in the Newman/Chiasson case. 

  4. We have talked about elements of it, e.g., herehere and here.

  5. What if the member of the public is instead a member of the press, and publishes the information? What if he sends it only to paying subscribers? What if those paying subscribers trade on it?

  6. That is overdetermined; both the bribe and the trading seem like crimes. Even beyond bribes, there are various sort of unofficial-slash-corrupt relationships that will get you in trouble; consider the New York Fed employee who passed confidential information to his former co-worker who left for Goldman.

  7. I mean, it does other things too. Like: Hire former government employees. "In making hiring decisions, Marwood also considered, in part, a prospective employee’s professional experience at a particular agency as well as contacts within the government."

  8. From the order:

    Marwood shall retain, within 60 days of this Order, at its expense, a Compliance Consultant not unacceptable to the Commission’s staff, to conduct a review of the enforcement of Marwood’s supervisory, compliance, and other policies and procedures under Section 15(g) of the Exchange Act and Section 204A of the Advisers Act, insofar as they relate to the obtaining or use of potential Material Non-public Information (“MNPI”).

    Marwood shall provide to the Commission staff, within thirty (30) days of retaining the Compliance Consultant, a copy of an engagement letter detailing the Compliance Consultant’s responsibilities, which shall include reviews to be made by the Monitor as described in this Order. The Compliance Consultant’s responsibilities shall include the review of Marwood’s enforcement of its policies and procedures regarding the obtaining and use of potential MNPI.

    It goes on and on in this vein.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matt Levine at mlevine51@bloomberg.net

To contact the editor responsible for this story:
Zara Kessler at zkessler@bloomberg.net