Investment Corruption Reportedly Reaches the Highest Levels of Government


A recent Bloomberg Markets Magazine article raises troubling questions about investment corruption at the highest levels of government. In July 2008, as market fears mounted, Treasury Secretary Henry Paulson reportedly met with a group of hedge fund managers (five of whom were former officers of Goldman Sachs, where Paulson was CEO), and described a scenario in which the government would put Fannie Mae and Freddie Mac into conservatorship, thereby wiping out the common stockholders of those institutions, according to a fund manager who attended the meeting (“How Paulson Gave Hedge Funds Advance Word,” Bloomberg Markets Magazine, By Richard Teitelbaum). But earlier that morning Paulson had provided a different message to New York Times reporters and editors (i.e., the public): that the Federal Reserve and the Office of the Comptroller of the Currency were inspecting Fannie and Freddie’s books, and he expected their report would boost market confidence in Fannie and Freddie, according to the article.

The fund manager who reportedly spoke to Bloomberg believed there was little doubt that such a conservatorship would be imposed, and he was shocked that Paulson would provide such advance notice to a select group of market participants.

Other are similarly shocked. “You just never ever do that as a government regulator — transmit nonpublic market information to market participants. There were no legitimate reasons for those disclosures,” William Black, associate professor of economics and law at the University of Missouri-Kansas City and former general counsel at the Federal Home Loan Bank of San Francisco, was quoted as saying.

A financial consultant, Janet Tavakoli of Tavakoli Structured Finance Inc., told Bloomberg: “What is this but crony capitalism? Most people have had their fill of it.”

According to Bloomberg, there is no way to discern from public records whether any of these particular fund managers shorted Fannie and Freddie based on the non-public information provided by Paulson. However, short interest in Fannie and Freddie, which was 240 million shares and climbing on the day of the meeting, reached 262 million shares by July 24.

Fannie and Freddie entered conservatorship September 6, 2008. The stock prices dropped to below $1.00 the next business day from $14.13 for Fannie and $8.75 for Freddie on the day Paulson disclosed the information to the fund managers.

Bloomberg reports that those it contacted variously said they did not trade on Paulson’s information, or could not recall details, or just had no comment. A spokesperson for Paulson, Michele Davis, former assistant secretary for public affairs at the Treasury Department under Paulson, reportedly referred all questions to Paulson’s book on the financial crisis, “On the Brink,” which makes no mention of the meeting with the hedge fund managers.

“The optics are awful; there’s no doubt about it,” University of Illinois College of Law professor Larry Ribstein was quoted as saying, adding: “Everyone knows that insider trading is a huge issue.”

According to the article, Professor Black said there was “no question that the plan to take over Fannie and Freddie — however uncertain — was material nonpublic information that could not be lawfully traded on.”

Even assuming that Paulson and/or his tippees, the fund managers, did not trade on the material non-public information, that does not necessarily excuse them from liability for insider trading under the law. Those who “tip” such information to others, who then trade or further tip the information to others, may be liable for insider trading under certain circumstances.

As the Bloomberg article pointed out, the SEC and the Department of Justice, which can bring criminal prosecutions, have said that insider trading is a high priority. As the article notes, on October 26, a federal grand jury indicted a member of Goldman Sach’s board of directors, Rajat Gupta, for tipping non-public information on Goldman and other firms to a hedge fund manager (Raj Rajaratnam), who is now serving an 11 year sentence for insider trading.

As unbelievable as it sounds, insider trading by government officials is rampant. A recent 60-Minutes report featuring Hoover Institute fellow Peter Schweizer’s recent book, “Throw Them All Out,” detailed how members of Congress are repeatedly using their positions to personally profit by trading on non-public, material (inside) information to the detriment of other investors.

Similarly, the article notes that several federal agencies are being investigated for improper disclosures and ties to hedge funds.

The revolving door between government and Wall Street enables many of these corrupt practices.

Will our government take any action to root out such corruption? As Mr. Schweizer says, probably not until we “Throw Them All Out.”

Page Perry is an Atlanta-based law firm with over 170 years collective experience protecting investor rights and fighting Wall Street greed.