Trading on political information

As part of its continuing coverage of hedge funds, the WSJ reports on how lobbyists are gathering tips on Congress' activities to these funds. The strategy especially pays off with respect to legislation that's material to a small group of companies, like on the asbestos trust fund.

As the article points out, there doesn't (yet) seem to be anything illegal about the trading because the tippers aren't gaining. The lobbyists are charging for the information, but they don't seem to be breaching a fiduciary duty to anybody, which is necessary for misappropriation liability under the O'Hagan-Dirks-Chiarella line of cases.

One possible argument under this theory: the lobbyists might have gathered info under false pretenses.

Should this activity be illegal? My readers know that I favor the market efficiency-enhancing properties of trading on nonpublic information. See, e.g., my and Bruce Kobayashi's recently published Outsider Trading as an Incentive Device.

But I don't favor rules that could encourage wealth-reducing rent-seeking. Although there don't seem to have been any deliberate links by politicians and staffers, if money or favors change hands politicians or their staffers would have incentives to threaten legislation to generate material information. This would be analogous to Fred McChesney's "rent-extraction" story, except the rents from threatening legislation would come from the trading rather than campaign contributions.

However, the misappropriation theory probably already is broad enough to capture this, since trading on the information by government actors would constitute misuse of position. So we probably don't need anymore law.

Of course we can never have too many useless hearings at the tail end of a lame duck Congress, particularly if they cast aspersions on hedge funds.

Comments

[TexasRainmaker]

I guess that would explain Chelsea Clinton's new job... at a Hedge Fund: http://tinyurl.com/ufebz

[Forbes]

Wait...hiring a consultant (lobbyist) to tell you what they think is going on in Washington DC politics/legislation--and incorporating that information into investment/trading decisions--is (or may be) illegal?

Only in a world of overstuffed shirts--or the maistream media--would anyone believe that "news" is proprietary information, and only in such a world are speculations on future legislative acts turned into the jargon of tips, tipers, and tipees, as if the "tip" was material, non-public "inside information".

Media navel-gazing. Yawn.

[David Thomas Cohen]

Since this situation would fall under the misappropriation theory, it seems that liability could arise absent a personal benefit to the government actors (i.e. the initial tippers) if they passed the information along to the lobbyists in breach of some duty of confidentiality to their employer. I'm not sure if they are ever bound by such a duty (the WSJ article seemed to suggest they aren't), but for an argument that the personal benefit requirement is not (and should not be) required under the misappropriation theory, one can take a look at my recent Note. The cite is Old Rule, New Theory: Revising the Personal Benefit Requirement for Tipper/Tippee Liability Under the Misappropriation Theory of Insider Trading, 47 B.C. L. Rev. 547 (2006), and it's available at http://ssrn.com/abstract=898513.