Political intelligence industry

Thanks for the Stock Tip, Mr. Senator

by Joshua Green

On April 1, 2013, an hour before the markets closed, a congressional staffer named Brian Sutter passed along to a lobbyist the kind of tip that can make a savvy investor a quick fortune: Medicare was about to raise some reimbursement rates, which would be a windfall for big insurance companies. Ten minutes later the lobbyist, Mark Hayes of Greenberg Traurig, whose clients included Humana, notified an analyst at Height Securities, a small Washington investment research firm. And minutes after that, Height issued a “flash report” to 200 investor clients, including several large hedge funds and money managers, 44 of which traded on the information and profited when shares of large insurers jumped just before the close, according to court filings by the Securities and Exchange Commission. Fifteen minutes after the bell, Medicare’s administrators announced to the public what this network of Washington insiders had long since ferreted out: Reimbursements were going up.

This episode is a prime example of the shadowy Washington business of “political intelligence”—gathering inside information on executive, legislative, and regulatory developments and selling it to Wall Street investors, who pay large sums to keep abreast of what’s going on behind the headlines and trade on it before anyone else. It’s clear such information is valuable. An August 2014 paper by two finance professors at the University of Illinois at Urbana-Champaign found that hedge funds which hired Washington lobbyists “gained an informational advantage in trading politically sensitive stocks” and outperformed funds that didn’t by 63 to 87 basis points per month. (A basis point is one one-hundredth of a percent.)

Is it legal? That’s a murkier question. SEC investigators have opened an insider-trading probe to determine whether a government employee improperly leaked the Medicare news and whether hedge funds violated securities laws by trading on the information. Humana fired Greenberg Traurig. Sutter resigned from his job on the House Ways and Means Committee staff. The SEC is fighting to subpoena him. The case has brought more scrutiny from powerful politicians skeptical of this controversial industry and sent a scare into its practitioners. “We ought to know who these people are that seek political and economic espionage,” GOP Senator Chuck Grassley of Iowa groused on the Senate floor.

Small Washington advisory groups cropped up in the 1970s, but the father of the field is generally held to be Richard Medley, a former investing partner of billionaire George Soros. A onetime chief economist for the House Banking Committee, he went on to advise Soros on political affairs before founding Medley Global Advisors, a hedge fund advisory firm, in the 1990s. Informed by his years on Capitol Hill, Medley’s analysis of politics and financial markets, delivered in reports and newsletters, was closely followed on Wall Street. “When I came to the Street in 1991, people told me to look out for his reports because they could influence the direction of the markets,” Michael Franzese, managing director at Wunderlich Securities, told Bloomberg News in 2011, after Medley’s death.

Hedge funds soon realized they needn’t rely only on newsletters and began developing in-house intelligence operations. “I first became aware of their existence when I was working in Tom Daschle’s press office in 2002,” says Jeff Nussbaum, a partner at the communications company West Wing Writers. At the time, Daschle was Senate majority leader. “Along with reporters’ calls, we started getting calls from very aggressive hedge fund managers wanting to know which bills were going to move that day. It was my first indication that these money people had bets on what was going on.”

The appetite for political intelligence was initially concentrated on such heavily regulated industries as health care, energy, and defense. A famous example of how this vigilance can pay off came one day in November 2005, when trading in shares of companies facing asbestos-related lawsuits surged the day before then-Senate Majority Leader Bill Frist announced a surprise vote on a bill to create a $140 billion public trust fund for asbestos liability claims. Traders had been tipped.

Initially the banking and financial-services industries weren’t a big focus, because they weren’t often the subject of major legislation. That changed when the financial crisis hit in 2008. The massive government intervention in the economy and the blizzard of new programs aimed at propping up banks and homeowners put a premium on insider knowledge. The intelligence industry mushroomed. By 2009 it was a $400 million business, according to Integrity Research Associates, which tracks the sector, although nobody knows the industry’s size for sure. Unlike lobbyists, political intelligence shops aren’t required to disclose their clients or revenue. Most operate in the shadows.

As demand grew, the field became more competitive and the tradecraft evolved. In Washington, it’s an industry hiding in plain sight. Its members swarm Capitol Hill receptions and think tank panels and even try to infiltrate background briefings for reporters—anything to suss out useful information. “You can recognize the political intelligence people by their designer eyeglass frames,” says Alec Phillips, an economist at Goldman Sachs in Washington. A former Senate Banking Committee aide says hedge fund managers often use their standing as big campaign donors to arrange private briefings with lawmakers; some also give money to think tanks to have access to well-connected specialists.

The targets of intelligence gathering aren’t limited to members of the government and their staffs. The most effective operatives are expert at recognizing and exploiting mutuality of interest. As I called around town to interview them—all insisted on anonymity—several pumped me for information as thoroughly as I was working them. One offered to share his research reports in exchange for my agreeing to talk to him about my published stories if he were ever interested in probing deeper into the subjects. I declined.

The premium on secrecy isn’t merely to guard tradable investing tips. The industry operates in constant fear that negative attention will prompt a crackdown. In 2012, spurred by reports that politicians were trading on inside information, Congress passed the Stop Trading on Congressional Knowledge (Stock) Act. Originally, the act called for political intelligence outfits to disclose their clients and fees to federal regulators. But then-House Majority Leader Eric Cantor stripped the provision. “It’s astonishing and extremely disappointing,” Grassley complained to the New York Times, “that the House would fulfill Wall Street’s wishes by killing this provision.” Cantor may benefit more directly than he ever imagined: After his unexpected primary loss last April, he took a job with the investment banking firm Moelis.

Although the industry has dodged regulation, the financial rewards for tradable information are a constant temptation to cross the line of what’s allowed. On March 13, House Financial Services Committee Chairman Jeb Hensarling disclosed that the FBI has opened a criminal investigation of the leak of confidential details from the Federal Open Market Committee’s September 2012 meeting, which were published by Medley Global Advisors in an Oct. 3 client report. At the time of the meeting, the Fed was about to start a third round of quantitative easing.

Perhaps as a consequence of this negative publicity, practitioners avoid describing themselves with the increasingly toxic term “political intelligence” in favor of such vague but important-sounding euphemisms as policy research, strategic advice, and economic strategy. “The spotlight that’s been focused on this issue has certainly had something of a chilling effect,” says William Baker III, a partner in the Washington law firm Latham & Watkins and former associate director of the SEC’s Division of Enforcement. “It’s made people more careful.”

Still, the work has become lucrative enough to attract not only former congressional staffers but also diplomats, White House advisers, even chief executives with the right Washington connections.

In 2012, Robert Wolf, the jovial former chairman of UBS Americas and a member of the White House Council on Jobs and Competitiveness, founded 32 Advisors, which bills itself as a boutique advisory firm for hedge funds, private equity firms, and money managers. Wolf is a close friend of President Obama’s—his UBS office was decorated with a picture of the two playing basketball. One of his first hires was Austan Goolsbee, the former chairman of the White House Council of Economic Advisers. The firm’s website even features the White House seal. Need insight on how Obama and his team view any sector of the economy? Wolf can deliver it. Just don’t ask for political intelligence. “Oh, no, we’re not political intelligence,” he insists. “That’s not what we do.” To thrive in this business, it’s wise to deny being a part of it.