Hedge funds use lobbyists for tips in Washington
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WASHINGTON -- As federal authorities try to crack down on illegal trading using secrets leaked from companies, some hedge-fund managers are tapping another source of information: the corridors of the Capitol.
Hedge funds are finding that Washington can be a gold mine of market-moving information, easily gathered by the politically connected. The funds are hiring lobbyists -- not to influence government, but to tell them what it's going to do. Several lobbying firms are ramping up their "political-intelligence" units and charging hedge funds between $5,000 and $20,000 a month for tips and predictions.
The Securities and Exchange Commission is looking into whether laws are being broken somewhere in the transfer of information between Congress and Wall Street. It's not illegal for lawmakers to disclose information that is not publicly known about the workings of Congress, even if it could affect stock prices. It breaks congressional ethics rules only if they or their aides profit directly. But one question the SEC is trying to resolve is whether the passing of market-sensitive information by lobbyists to investors could violate insider-trading law.
On Nov. 16, 2005, shareholders in companies facing asbestos-related lawsuits received welcome news in a speech by Senate Majority Leader Bill Frist. He promised a full Senate vote on a bill to create a $140 billion public trust fund for asbestos liability claims. The SEC launched an informal probe into whether and how information may have reached Wall Street from the senator's office because the stock prices of some companies with asbestos-related liabilities rose before the announcement.
It is unclear which stocks the SEC is looking at. But the stock prices of some companies that used asbestos, including USG Corp., W.R. Grace & Co. and Crown Holdings Inc., went up in the two days prior to the senator's announcement. The stock prices of other companies in their sectors were fairly flat on those days -- as was the market as a whole.
Amy Call, a spokeswoman for Mr. Frist, said the senator's lawyer had referred the SEC's questions to the Senate's legal office. She said an internal review of emails and phone records by Mr. Frist's staff turned up no evidence of wrongdoing. Mr. Frist, who recently quelled talk of a campaign for the presidency, is retiring from the Senate at the end of this year.
The use of lobbyists as tipsters also is drawing attention from Congress. After winning control of the Senate and House in last month's elections, Democrats are considering requiring lobbyists to disclose their political-intelligence clients -- a move first proposed by two House Democrats earlier this year. Right now, lobbyists only have to disclose their work for clients seeking to influence government, while hedge funds and other clients seeking market-beating tips can stay in the shadows. Increasingly, lobbyists acting as advocates for a company on an issue may also have a client looking to trade on information about the same issue.
Employees of publicly traded companies are tightly bound by insider-trading laws, which also ban investors from trading public securities using material, non-public information that has been passed on improperly. But in most cases, members of Congress and their aides don't have a duty under the law to keep information private. They routinely exchange information about politics and policy with lobbyists -- often not realizing that mere morsels are being sold to hedge funds who trade on the tidbits.
The growth in the market for political intelligence in the last 18 months has been dramatic, says Elliott Portnoy, a lawyer and lobbyist who founded an intelligence practice for Chicago-based law firm Sonnenschein Nath & Rosenthal LLP, and now has been elected the firm's chairman partly based on his unit's performance. "There are a lot of savvy investors who have realized that there is a lot of money to be made from what Congress does," he says. Since 2004 his unit has tripled the number of its clients to two dozen and tripled its staff to 18. He says his clients include wealthy private investors, private-equity funds, investment banks and hedge funds, though he won't disclose names.
Clint Carlson, who runs Carlson Capital, L.P., a $3 billion Dallas-based hedge fund, says the firm deals with a number of lawyers with Washington expertise in order to track public-policy developments. He adds, "You have to watch the line. If you're worried it might be inside information, it's best not to use it, even if it is legal."
Some congressional staffers say they now receive nearly as many phone calls from lobbyists asking about the status of legislation as they get from lobbyists asking to change legislation. "The amount of insider trading going on in these halls is incredible," says one aide to a Republican lawmaker.
A handful of hedge-fund firms -- including Elliott & Associates, D.E. Shaw & Co. and Angelo Gordon & Co. -- arranged to receive invitations to lobbyists' meetings with lawmakers starting in late 2003. They paid about $80,000 in annual membership fees to join a lobbying coalition, the Financial Institutions for Asbestos Reform, which advocated on behalf of financial institutions that owned large stakes in firms with asbestos liabilities.
The asbestos bill, which has never been adopted, was an important catalyst for the political-intelligence business. The bill's long gestation coincided with the growth of the hedge-fund industry. It fate could have a big impact on the fortunes of a small group of big companies. As some hedge-fund managers realized that they could make money on the changing fortunes of the bill, they also began looking to other issues, such as the Internet gaming bill, Medicaid reimbursement, foreign ownership of U.S. ports and corporate tax legislation.
At lobbying firm DLA Piper, lobbyist Matthew Bernstein estimates the political-intelligence business has quadrupled in size since 2003. That's when the firm realized the market's potential. After Mr. Bernstein and another lobbyist with the firm spoke about the asbestos bill's prospects at a financial conference in New York, dozens of hedge-fund managers and stock analysts swarmed the pair, they recall. "We were mobbed like rock stars," Mr. Bernstein says. "About 50 people literally rushed the stage. When we got back home, our phones started ringing."
Wealthy traders on Wall Street have long been able to gain an advantage in the market by getting access to better information. In the 1980s, stock arbitrageur Ivan Boesky hired a team of lobbyists in Washington to tell him if Congress would block Standard Oil Co.'s takeover of Gulf Corp. When told that the merger would be approved, Mr. Boesky cashed in. Mr. Boesky later pleaded guilty in one of Wall Street's biggest insider-trading scandals for paying for inside information about upcoming corporate mergers.
But prosecutors didn't pursue Mr. Boesky over tips received in Washington, which lobbying firms contend are legal. "None of the information that a lobbyist for one of these funds finds out is something that is not in the public realm," says Steve Elmendorf, a principal at lobbying firm Elmendorf Strategies LLC, who said he represents a hedge fund, but would not disclose its name.
One hedge-fund manager who has hired consultants in the past to dig up information says that his firm's lawyers say his fund is free to use any information it receives, even if it hasn't been released publicly. "It felt wrong, but my lawyers said it was OK, it wasn't insider information," the manager said.
Many hedge funds are most interested in moves that may have a significant impact on a small set of companies: Will Congress pass legislation banning gambling over the Internet? Will lawmakers approve new regulations for Fannie Mae and Freddie Mac? Which airline will win from the Transportation Department a new daily nonstop flight to China? Will the FDA approve a new prescription drug?
Few issues have been as closely followed by hedge funds as asbestos. For 30 years, manufacturers, trial lawyers, insurers and labor unions have been fighting over how to deal with more than 700,000 Americans who contended they got cancer from exposure to asbestos. The lawsuits clogged U.S. courts and cast uncertainty over hundreds of U.S. companies that once used asbestos in their products. Dozens of companies filed for bankruptcy due to their asbestos liabilities.
For more than four years, Congress had considered legislation that would end the asbestos difficulties by creating a trust fund to cover medical costs and resolve the lawsuits. "Every advancement or setback and every hint of activity on the bill had a direct impact on this small but well-defined group of companies," says Mr. Portnoy, who lobbied against the legislation on behalf of investors in a manufacturer that declared bankruptcy because of asbestos liabilities.
Some hedge funds, which tend to choose riskier investments that can yield high returns, saw the troubled asbestos companies as attractive. To weigh the value of their investments and decipher bankruptcy-court actions, hedge funds hired teams of analysts and researchers. When Congress began considering legislation to bail out the industry, the funds hired lobbyists to assess its prospects.
Hedge funds' membership in Financial Institutions for Asbestos Reform gave them access. Trading data shows many of these firms had large equity stakes in asbestos manufacturers, but it's impossible to tell how much they bought or sold in response to the information from lobbyists.
Sen. Arlen Specter, a Pennsylvania Republican, and Democratic Sen. Patrick Leahy of Vermont, the authors of the bill, met regularly with industry lobbyists and trial lawyers in order to try to find common ground. The senators say they never knowingly discussed the legislation with hedge funds, according to their spokespeople. WSJ(12/8) Hedge Funds Use Lobbyists For Tips In -2-
In one meeting in 2004, Mr. Specter grew suspicious that hedge-fund representatives were attending his meetings, according to people in his office. Mr. Specter's staff asked attendees to identify themselves, according to several lobbyists in the room. Aides kicked out Marc Sole, a senior vice president with D.E. Shaw.
But Mr. Specter's office apparently didn't know that several of the lobbyists who were allowed to stay also worked for hedge funds. One lobbyist was Alex Vogel. A former aide to Mr. Frist, Mr. Vogel lobbies for insurer Hartford Financial Services Group Inc. But he also works for several hedge funds, including D.E. Shaw, according to people familiar with the matter. Mr. Sole would not comment. Mr. Vogel said he was at the meeting on behalf of Hartford, not D.E. Shaw.
It took another year for the Senate Judiciary Committee to narrowly approve the bill, with several members objecting to the size of the fund. It then languished through the summer and fall of 2005. Mr. Frist, as majority leader, has sole authority to decide which bills get a vote on the Senate floor. He was loathe to do so unless he knew there were 60 votes to defeat any filibuster attempt. House leaders had said they would take up the bill only if it cleared the Senate.
In mid-November, Mr. Frist's staff quietly drafted a statement announcing a vote. Time was reserved for Mr. Frist on the Senate floor for Wednesday morning, Nov. 16. The staff was careful not to tell many people, his spokeswoman Ms. Call said, because they wanted their boss to make a splash.
One of the few people who knew of the speech was Mr. Specter. The majority leader customarily tells a bill's author that he has won time on the Senate floor. Courtney Boone, a spokeswoman for Mr. Specter, said that Mr. Specter and his staff don't "talk to anyone who is not a stakeholder." Their definition of stakeholders doesn't include hedge-fund investors -- but it does include interested lobbyists. Another aide to a Republican member of the Judiciary Committee said that it also was widely known among staffers that Mr. Frist would schedule a vote on the bill.
The day before Mr. Frist's speech, the legislation was dealt a new blow. Sen. Judd Gregg of New Hampshire, the Republican chairman of the Budget Committee, wrote Mr. Frist urging him not to schedule a vote because he thought the trust fund would go broke without paying all the claims.
That evening, a spokeswoman for Mr. Frist gave an advance copy of Mr. Frist's speech to the Reuters news service, according to Ms. Call, the spokeswoman. The reporter was told that she could not publish the news until Wednesday morning, just a few hours before Mr. Frist strode onto the Senate floor, Ms. Call said. Reuters had no comment.
On the Monday and Tuesday preceding his speech, shares of USG jumped 5.4 percent, W.R. Grace gained 4.2 percent and Crown Holding rose 3.2 percent, more than competitors in their respective sectors. The broad Dow Jones Industrial Average was essentially flat during the period. On Wednesday, USG was flat, W.R. Grace lost 0.6 percent and Crown increased 2.3 percent. USG and W.R. Grace declined to comment. Crown didn't respond to requests for comment Thursday.
SEC officials noticed unusual trading in asbestos-related stocks before Mr. Frist's speech. SEC officials asked preliminary questions about how the information could have leaked. But the agency hasn't yet followed up with Mr. Frist's office or with the Senate lawyer, Ms. Call said.
First Published December 8, 2006 12:00 am