SEC Probes Hedge Fund Research Firm


Did a Washington securities research firm illegally obtain information about an imminent government health care policy change? Did hedge funds knowingly trade on such inside information? Those are the two main questions that SEC investigators are focusing on as they examine scores of emails and trading timelines in an effort to unravel the “coincidence” — or possible regulatory violation — surrounding trades that followed a 2013 investor email alert.

Federal Policy Reversal

On April 1, 2013, at 4:22 p.m., after markets had closed, the Centers for Medicare and Medicaid Services (CMS) that, among other things, allocates funding to private health insurers, issued a press release announcing that it was reversing its current policy and restoring previously cut funding to private health plans. The only problem was, at 3:42 p.m. that same day, a well-known Washington securities research firm had already sent an email to more than 150 investor clients in which it predicted the government announcement. Was this a matter of really good securities research intel or a really leaky government source?

Sharing Research Data Not Illegal

Sharing the research data with 150 clients was not in itself a violation of any securities laws. However, illegally obtaining such insider information would be a violation, and, if the clients traded on that information knowing  — or if they should have known — that it was illegally obtained, then under that set of circumstances their use of the information would also violate securities laws.

Political Tipsters and Insider Information

At issue for SEC investigators is whether the fine line between providing political tips — a flourishing industry in Washington — and leaking insider information to investors had been crossed. In this case, the tip — or leak — boosted health insurance companies, and their stock prices took off upon dissemination of the pending policy change alert.

Defining the Insider Trading Rule

In order to prevail in an insider trading prosecution, the SEC must prove that an investor traded on the basis of nonpublic information that was obtained in violation of a duty, or that there was a reckless disregard of the substantial risk that they were trading on such information.

According to Justin Shur, a former federal prosecutor:

“To pursue charges against the trader, the government would need to prove that he knew or had reason to know that the original tipper breached a duty by disclosing the information. Thus, figuring out what the trader knew about the source of the information is critical for prosecutors.”

At the present time, the SEC has not determined whether information relayed by the research firm violated securities rules, and it is continuing to investigate whether anyone at the federal agency broke insider-trading rules.