Wall Street in Washington: Insider Access
Nearly a dozen senior staff at the Centers for Medicare and Medicaid Services (CMS), the giant agency that administers hundreds of billions in federal health care dollars, had been called to a meeting. After a discussion with five Wall Street professionals that lasted nearly two hours, one senior CMS analyst filed an ethics complaint that later went to the Office of Inspector General (OIG) of the Department of Health and Human Services (HHS).
His beef: that a handful of deep-pocketed investors had won a private hearing to probe whether the agency would allow Medicare reimbursement for specific medical devices manufactured by companies in which they already held a stake or might put new money. The market for one device, already approved for Medicare, was rapidly heading toward $1 billion annually; the agency’s impending decision to reimburse competing devices could have major market impact, a shift potentially worth hundreds of millions of dollars.
“This meeting forced agency staff to redirect their attention toward a select group from Wall Street, when neither competing investors nor patient-oriented stakeholders were present,” the whistleblower told the Project On Government Oversight (POGO). “They got to probe us for hours in private about what we planned to do and how we approached procedures for reimbursing medical devices, the mechanics and psychology of CMS decision-making, in general and with respect to these specific devices.”
The meeting was set up by a former CMS employee working for the Marwood Group, an asset manager that counsels big health-care industry investors, the whistleblower says. The firm’s president is Edward “Ted” Kennedy Jr., son of the late Massachusetts senator and a major supporter of President Obama’s health care reforms, and includes Kennedy cousins Robert F. Kennedy, Jr. and Stephen E. Smith, Jr., as senior advisors. The firm’s website highlights its staff recruitment among Congressional aides, the Executive Office of the President and CMS. One CMS veteran who joined Marwood after the 2009 meeting with Wall Streeters is Barry Straub, the agency's former Chief Medical Officer, who is also an expert on Medicare reimbursement, the website says. A company spokesman had no comment.
A supervisor at CMS’s Coverage Advisory Group, which decides which services the agency will pay for, also helped organize the session with investors. The whistleblower says he was told by a supervisor that such get-togethers are “a routine practice at CMS.” At the time, in 2009, CMS’s top administrator had an aide with the title, “capital markets advisor,” tasked with tracking investment community activity in Washington and elsewhere.
At the investor meeting, Wall Streeters asked a range of questions “about confidential CMS information.” The whistle blower says he does not believe they received illegal disclosures, though they peppered CMS analysts with queries about the agency’s decision-making process and other sensitive matters which, if answered, could have violated the law or related regulations that bar the sharing of internal deliberations and decisions.
The whistleblower first filed his complaint in April 2009. He was terminated in 2011 for being disloyal to the agency mission after he made a series of internal protests, including the objection to what he calls a pattern and practice of unfettered access to CMS staff by Wall Street investors. He says he is currently fighting his dismissal through all available legal and administrative channels.
Contacted by POGO, CMS would not “comment on pending personnel matters.” A spokesperson added that, “After a thorough review, the Ethics Office determined that for the meeting in question, there was no misuse of government time and resources, and that the meeting was held consistent with agency rules on contacts between CMS staff and members of the public.”
CMS does have a set of “Open Door” policies and affords a variety of avenues for public access. The disclosure of payments to physicians and teaching hospitals by pharmaceutical companies and other interests are required under President Obama’s health reform. In practice, however, the public, not to mention competing investors and stakeholders, rarely get the kind of information and insight available in meetings like the whistleblower described.
Tip of an Iceberg?
However the case turns out, it’s another recent example of how Wall Street investors—hedge fund mavens, private equity executives, mutual fund analysts and others—gain special entrée to Washington’s vast federal bureaucracy.
As Americans debate reforms that deal with the financial and health care crises, the status of the nation’s capital as a one-stop-shop for market-moving inside dope is growing rapidly. Following a wave of recently approved laws and regulations and the prospect for more, the private sector and especially Wall Street is seeking more intelligence on government activities. The collection effort includes, but is not limited to everything from stimulative shifts by the Treasury Department and the Federal Reserve, to rule changes for Medicare and Medicaid, the Education Department’s regulation of for-profit schools, and programmatic shifts at the Pentagon, all of which can impact the bottom line of publicly-traded and private companies.
Some of these Wall Street efforts raise troubling questions, but in many cases may not violate current rules, regulations, guidelines or laws.
“The information gathering is on the rise because prosecutions for insider trading are inadequate, the information to be had is potentially very valuable, and rules often go unenforced in the private sector, while they are unclear in the public sector, especially for federal employees,” notes William Black, the former litigation director of the Federal Home Loan Bank Board and senior deputy chief counsel of the Office of Thrift Supervision.
Just a few weeks ago, Washington was atwitter over revelations on CBS’s 60 Minutes that prominent members of Congress may have used their official positions to gain knowledge that helped them make a killing in the stock market.
Just as significant, though, is the fact that Wall Street is boosting its cadre of hired guns in Washington, not just to focus on elected officials, but to harvest information, some of which is likely to be confidential or unavailable to others. Many are not registered lobbyists, so the most rudimentary lobbying disclosures are not made. On top of the well-documented revolving door between a variety of federal agencies and interested parties in the private sector, this additional activity is largely unseen and undectable by the public.
The Wall Street Journal touched on this theme in a recent article, “Hedge Funds Pay Top Dollar for Washington Intelligence.” The newspaper details how big investors are enlisting Washington insiders to give them a leg up. There’s always been lobbying to influence government decision-making, but the growing focus in Washington is on the acquisition of information, some of which can be non-public. It’s unclear to what extent, if any, this inside dope is being used to trade in the shares of publicly-held companies or to invest in private ones.
Those lending Wall Street a hand include unsurprising big names like former Federal Reserve Chairman Alan Greenspan and former Treasury Secretary John Snow. Reuters reported last year that nine of 30 commissioners to leave the Securities and Exchange Commission (SEC) at that time, including two former chairmen, Harvey Pitt and Arthur Levitt, have done advisory work for hedge funds. But the WSJ cites a lesser-known firm, the Gerson Lehrman Group Inc, for honchoing a so-called “expert network” that hooks up clients with specialists at fees reportedly as high as $1,000 per hour. Hedge funds and others can also pay just under a quarter million dollars per year for unlimited access to Gerson’s full stable of specialty advisors, said to number more than 300,000 worldwide. The firm knows what big investors want – it was founded by two veterans of the mega-hedge fund, Tiger Management Corp.
There’s no evidence that Gerson, or similar “expert networks” in Washington, their clients or contractors are involved in anything illegal.
That said, the “expert network” industry has grown dramatically in the last ten years, with estimates that roughly one-third of institutional investors employ networks to help them make decisions.
“There is nothing inherently wrong with or bad about hedge funds or expert networking firms or aggressive market research, for that matter,” said Preet Bharara, the U.S. Attorney for the Southern District of New York, when he announced prosecutions of private sector defendants involving “expert networks” earlier this year. “But if you have galloped over the line, if you have repeatedly made a mockery of market rules, if you have converted a legitimate enterprise to an illegal racket, then you have done something wrong and you will not get a pass.”
That is the logic that drove non-Washington cases like the take-down of Silicon Valley’s Primary Global Research, where a number of staff were convicted of insider trading earlier this year.
Lack of Bright Lines
One important issue emerging in Washington is that the rules for information-sharing by federal employees are often ambiguous, obscure and inconsistently applied. In the name of reaching out to stakeholders, to gather intelligence for the government, or to avoid surprising markets, officials from across the federal bureaucracy hold regular meetings with senior Wall Street executives, among others, with results that raise questions. A number of recent examples illustrate the point:
Advance Word to Hedge Funds?
A story just out in Bloomberg Markets Magazine carries the headline, “How Paulson Gave Hedge Funds Advance Word.” It describes a 2008 New York meeting between then- Treasury Secretary Henry Paulson, and prominent hedge fund executives. The morning of the meeting, Paulson had told reporters that the financial health of Fannie Mae and Freddie Mac, the giant federal housing agencies, was likely to improve. But later in the day, as he sat down with hedge fund kingpins, Paulson apparently disclosed or strongly hinted at Treasury plans for a takeover of Fannie and Freddie, a move would make their publicly-traded shares almost worthless.
According to Blooomberg, a hedge fund manager who attended the meeting was “shocked that Paulson would furnish such specific information—to his mind leaving little doubt that the Treasury Department would carry out the plan.” In so doing, he afforded his rapt audience with advance knowledge and the chance to make a bundle by shorting stocks of the two troubled housing agencies.
Those seated around Paulson that day included at least five Goldman alumni, the former Treasury Secretary’s alma mater. Immediately after the meeting, one hedge fund executive told Bloomberg that he called his lawyer, who informed him that Paulson had made a material, non-public disclosure, and that he should not trade in Fannie and Freddie shares.
There is so far no evidence about whether any other of the meeting participants traded on what Paulson told them, and Bloomberg cites the opinion of law professors that, “Paulson himself broke no law by disclosing what amounted to inside information.” Several months later, of course, the Treasury did what Paulson had sketched at the meeting, taking over Fannie and Freddie, killing their stock market value.
The Fed Quietly Alerts Wall Street
The Wall Street Journal recently reported that only ”hours” after an August 15 meeting with Federal Reserve Chairman Ben Bernanke, a prominent Wall Street economist and vice-chairman of the International Strategy and Investment Group, Inc., sounded an alert to clients that the Fed was about to initiate a strategy known as “Operation Twist” that would make long-term bonds a much more attractive investment.
“Over the next five weeks, prices on 10-year Treasury bonds soared, offering double-digit returns in an otherwise dismal year,” the newspaper reported, “By the time the Fed announced its $400 billion Operation Twist on Sept. 21, the window for quick profits had all but slammed shut.” So much for allowing other investors an equal shot.
Investment Tips From the Pentagon
New York Times columnist Joe Nocera weighed in earlier this year about the growing number of “investor” conferences staged by the Pentagon, many of which are not open to the public, and where at least one senior official in effect handed out stock tips. In an article headlined, “From Pentagon, a Buy Rating on Contractors,” Nocera singled out Ashton Carter, currently deputy secretary of defense, the Pentagon’s second most powerful official, but at the time, under-secretary for acquisitions, technology and logistics—in effect, America’s chief weapons buyer.
Nocera followed with a description of Carter informing a roomful of Wall Street investors and U.S. weapons producers of the Pentagon’s intention to promote mergers and takeovers among small- and mid-size firms, while discouraging any consolidation among the big five defense contractors, Lockheed Martin, Northrop Grumman, Boeing, Raytheon, and General Dynamics.
Nothing like a top government official delivering market signals to a select group of insiders. And it was not advice to be taken lightly, for, as Nocera pointed out, “even in an era of tighter budgets, the Pentagon is going to make sure the military industry remains profitable.” That has been true for years, but then Nocera quotes the weapons-buyer-in-chief telling his audience: “Taxpayers and shareholders are aligned.” Really?
Incidents earlier this year involving giant, for-profit education firms like the University of Phoenix highlight how difficult it can be to know whether federal employees are crossing the line. According to a POGO report and other recent accounts, senior staff at the Department of Education gave Wall Street short-sellers what appeared to be non-public information on the timing and substance of department regulations impacting for-profit education companies, which enjoy annual revenues of more than $70 billion, nearly all in the form of government-guaranteed student loans.
Subsequent publicity drew the attention of Senators Tom Coburn and Mike Enzi, both calling on the SEC to investigate. The agency is not commenting, but a variety of experts interviewed by POGO said they’d be surprised if the SEC had not already opened a formal investigation.
The Department of Education’s own Inspector General (IG) is conducting a separate inquiry. In an interview with POGO, the IG said she would scrutinize what duty, if any, Department officials had to limit their disclosures. She also said that if she found evidence of violations, she would not hesitate to refer the matter to the SEC, or the Department of Justice, or both.
A Legislator’s Concern
The ranking Republican on the Senate Judiciary Committee, Charles Grassley, has also written to Education Secretary Arne Duncan asking specifically about contacts between hedge funds and senior staffers at his department.
Just as important, Grassley believes the problem with Wall Street investors may extend well beyond education, potentially involving activities across the federal government, both in Washington and elsewhere. As a result, he could decide to ask for hearings on the subject, or even propose a government-wide code of conduct to guide federal employees.
Is There a Solution?
Insider-trading statutes prohibit investors from profiting from material, non-public information. And, of course, government employees are not allowed to hand out classified material, private data pertaining to individuals or trade secrets belonging to companies.
Yet critics, including POGO, have complained about the overuse of these restrictions and the limits they sometimes impose on the free flow of information necessary to inform the American people.
By the same token, Cabinet officials, members of Congress, regulators and their staffs are expected to interact with, and often reach out to, interested parties impacted by government actions. Where to draw the line?
Sometimes, it can be very clear when a government employee has crossed into forbidden territory. Earlier this year, for example, a Food and Drug Administration chemist pleaded guilty to insider trading after he admitted using confidential agency information to make nearly $4 million buying drug company stocks.
But in other cases, the trip wire may be far less apparent.
The Freedom of Information Act (FOIA) provides a partial baseline for material that can be released by the government. The problem is that FOIA requests are usually processed after—sometimes long after—an event, while hedge funds and other market participants may be seeking information—via meetings, email or other communications—that are useful in real time.
Clearly, government officials should not be handing out material that could not be released under FOIA, but it’s important as well not to restrict legitimate flows of information.
A balance is necessary between the danger of too much insider access, and imposing excessive limitations. Indeed, the biggest problem with special access for Wall Street insiders is not just that they seem to get meetings and acquire information that may be privileged and non-public, but that others, including other investors, do not get a crack at the same material.
In 2000, the SEC put in place a regulation often referred to as Regulation Fair Disclosure, or Reg FD, which requires publicly traded companies to disclose information to all investors at the same time. Reg FD is often hailed as a landmark attempt to treat all investors equally by eliminating selective disclosure, an all-too-common practice that usually favored big Wall Street interests and financial institutions which benefited from client, company and other leaks.
Wouldn’t it be nice if the federal government and members of Congress also had to treat all investors equally, by adopting some public sector version of Reg FD?
Another proposed remedy comes from OpenTheGovernment.org, a coalition chaired by POGO, under which federal departments would routinely and pro-actively post to the Internet non-exempt information about issues of clear public concern for all to see, rather than passively waiting for FOIA requests to open a window on their activities. Issues might include spending, records and data, government meetings involving outside parties and the like.
But what about contacts between federal employees with Wall Street investors and others that do not involve FOIA?
“A government agency can consult with someone on the outside and share information if that sharing is for a legitimate government purpose,” points out Daniel Metcalfe, a former senior Department of Justice lawyer and expert on FOIA and secrecy. “Someone drawing up guidelines would need to consider whether government employees should restrict shared information with respect to ‘further dissemination’ and ‘use’ of that information to establish the legitimacy of the process.”
Restrictions on “use,” according to Metcalfe, would cover any trading activity or investments that market participants might want to engage in after receiving a disclosure.
Shining a public light, or simply disclosing who is meeting with government officials could curb abuses as well. When Congress passed its Recovery Act to stimulate the US economy in 2009, federal officials were required to make public their communications with outside persons regarding funds and policy related to the stimulus. This requirement might be expanded across the government to include public notice of communications about policy, federal funds, or market-sensitive information.
And who would keep track of all this, making sure restrictions are enforced?
Given the obvious concern for leakage of valuable, confidential, market sensitive information,” Metcalfe says, “then not only should there be clear guidelines, but Inspector Generals in various cabinet departments should be monitoring the process closely.
In other words, the solution is not for the government to conceal more, but rather for the government to penalize those who selectively release information to special interests and those who use that information for personal or private gain.