Picture this: Hedge fund managers huddled with lawmakers in a "nondescript Capitol basement" to find out legislative decisions that will affect America—and the markets—hours before the public does.
Only it's not a scene from some new blockbuster. This really happened. And It's still happening.
According to the Wall Street Journal, hedge funds getting what would otherwise be called insider tips from lawmakers is not only legal, but increasingly common.
We avoid using the word "insider trading" here because that term, which refers to the buying or selling of commodities with information the average person couldn't possibly have, is a punishable crime. For instance, in October, hedge fund manager Raj Rajaratnam was sentenced to prison for more than a decade after being convicted of bribing high-ranking executive friends for information to guide his trades.
But since 2009, more and more hedge funds have been finding out about Congressional decisions hours before they are publicly announced. Hedge funds, who actively manage commodities, are constantly evaluating the market. Government decisions can affect entire business sectors, and trades can be made in a moment. Therefore, advance notice—even only by hours—could potentially allow a fund to trade ahead of the curve and make millions (or billions?).
Everyone involved insists that there's nothing shady about the exchange of information, but funds aren't required to share how they use the information ... and they don't.
A Story of Power, Money and Profit
But what types of decisions are the bankers becoming privy to—and what have they done as a result in the past?
In 2009, Congress was deciding whether a new, public health insurance plan should be created for the millions of Americans without coverage. Approval would be bad news for private health care insurers such as Aetna, whose prices would have to decrease if competing with lower-priced public services.
Deciding votes were held by a few Democratic senators, two of whom agreed to meet with hedge funds on the day of the session that would determine the bill's outcome. At the meeting, they divulged that the bill likely wouldn't pass, which was good news for health insurance companies. The funds knew that: One turned around to buy six million shares of Aetna right before its stock rose 14%, while another purchased half a million shares.
Paying for Privilege or Privileged Information?
Spokespeople for lawmakers involved in the meetings insist that the information given isn't privileged. Connecticut Senator Joe Lieberman's office issued a statement saying that the Senator doesn't "give any special information to one group that he would not share with any other group, constituent or the press." Because this information isn't technically restricted or inaccessible to the general public, it's not considered to be insider information.
It has always been a legal, acceptable practice for hedge funds to hire lobbyists to gather information in Washington, but now, these financiers are eliminating the middleman and going in person. Lawmakers are divided on the issue: Many support the meetings, claiming the flow of information goes both ways—they talk about legislative progress, and learn about potential loopholes and unforeseen consequences from hedge fund managers, in addition to soliciting their opinions to "help shape laws that spur investment."
But some are less sure the meetings are a good idea. One Senator backed out of one such rendezvous when he found out the hedge fund was paying $10,000 to the brokerage firm that set up the meeting.
Congress Is Taking Notice ... In More Ways Than One
Earlier this year, reintroduced legislation called the Stop Trading on Congressional Knowledge (STOCK) Act gained a new wave of support in Congress. The act would regulate these banker/lawmaker informational meetings in much the same way lobbyists are controlled. Hedge funds would have to disclose all activities related to information-seeking from the government, and congresspeople would be prohibited from sharing any non-public information about current or prospective legislation that they think would be used in Wall Street trades.
The Act would also revoke the current right of lawmakers to trade based on information from the legislative process. Earlier this fall, high profile lawmakers such as Nancy Pelosi and John Boehner were accused by the television program 60 Minutes of "soft corruption" for making personal trades based on information from pending legislation. (Read this for more on the fallout.)
The immense gray area clouding interactions between Washington and Wall Street doesn't do much to predict the future, but it does assure us of one thing: "Capitol Basement" would make a riveting movie.
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