The Securities and Exchange Commission (SEC) has fined Marwood Group Research, a political intelligence firm, $375,000 for providing non-public, material information to hedge funds.
The firm was accused of providing information to hedge funds relating to policy issues and pending regulatory approvals at the Food and Drug Administration (FDA) and Centers for Medicare and Medicaid despite the firm having written policies prohibiting the disclosure of confidential information to third parties.
Political intelligence firms liaise closely with politicians, civil servants and other government insiders. A number of financial institutions including banks and hedge funds routinely employ them to provide additional colour around political mechanics and workings which may influence their businesses. Given the enhanced role of policymakers and regulators in determining market movements, political intelligence firms have flourished since the crisis.
However, this can also result in political intelligence firms deliberately or inadvertently providing non-public material information to financial institutions, which could lead to insider trading or averted losses. As such, many have called for closer scrutiny of these organizations.
The focus on political intelligence comes following several years after the clampdown on expert networks. Expert networks provide institutional investors such as hedge funds with access to sectoral specialists.
These sector specialists are supposed to provide their analysis on sectoral trends and issues, but are not allowed to disclose privy information which could give market participants a material advantage. However, there is often a fine and highly subjective line between thorough analysis and insider information.
Expert networks were subject to scrutiny and played a major role in the insider trading cases against Galleon and SAC Capital. Since these high-profile cases, hedge funds and other institutional investor have erred on the side of caution when utilizing expert networks.
Many hedge fund compliance teams now insist conversations between traders or analysts and expert networks be recorded, or even have a lawyer present during the proceedings so as to minimize the risk of insider trading.
The SEC has also conducted on-site examinations and questioned numerous managers about their use of expert networks. As such, it is crucial that managers have firm-wide policies and procedures in place monitoring employee interactions with expert networks. This could involve regular staff training on best practice dealings with expert networks. Given the recent events at Marwood, it is advised that this also be applied to political intelligence firms.