Political Intelligence Firms and the STOCK Act: How Hedge Fund Managers Can Avoid Potential Pitfalls

Every day officials in Washington make decisions that affect the prospects and profitability of individual companies and entire industries.  Thus, it is not surprising that the use of political intelligence firms has become increasingly common among sophisticated investors such as hedge funds.  Depending on the focus of the engagement, these firms can help hedge funds in a variety of areas, including conducting research and due diligence, developing an investment idea or strategy and informing trades in financial markets.  For funds that need to follow legislative or regulatory developments closely, political intelligence consultants can serve as their eyes and ears in Washington.  By leveraging their relationships with lawmakers and agency officials, these consultants can deliver real-time “inside the Beltway” information thereby providing a competitive advantage over those simply monitoring news and data services.  On April 4, 2012, President Obama signed into law a bill that raises important issues for hedge funds that retain political intelligence firms.  The bill is called the Stop Trading on Congressional Knowledge Act, commonly referred to as the STOCK Act.  Although the primary purpose of the bill is to affirm that the insider trading laws apply to Members of Congress and other public officials, the legislation makes clear that hedge funds and their employees who trade on information obtained from a political intelligence firm can be exposed to potential liability.  The STOCK Act has also drawn significant attention to political intelligence firms and those who retain their services.  Given these developments, a heightened level of government scrutiny in this area is expected.  Federal prosecutors and regulators will likely be focused on the type of information these firms obtain, how they obtain it, who they provide it to and how it is used.  Thus, while political intelligence firms can deliver a valuable service that is entirely lawful, fund managers who employ these firms or who wish to do so should be aware of the possible associated risks.  In a guest article, Justin V. Shur, a Partner at Molo Lamken LLP, considers those risks and offers four specific suggestions as to how to manage them.

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