World Class Faculty & Research / January 26, 2015

Not Just for Journalists: Cashing in on FOIA Requests

SMITH BRAIN TRUST --In the last quarter of 2011, the hedge fund SAC Capital filed a Freedom of Information request asking for documents regarding inspections of plants operated by Charles River Laboratories, which conducts pharmaceutical research. SAC apparently didn’t get bad news, because it increased its shares in Charles River from about 70,000 to 240,000 during that same calendar quarter. The stock rose, and SAC sold most of it in the next quarter, thereby realizing a quick gain in the range of 26 percent to 32 percent, an extraordinary achievement.

When you think of the Freedom of Information Act, you’re likely to imagine dogged investigative reporters, not Wall Street investors. But FOIA requests for information about drug companies are a way for institutional investors to gain an edge over the rest of the market, according to a new study by two Smith School professors, Alberto G. Rossi and Russ Wermers, and a coauthor from the University of Melbourne, Antonio Gargano.

Using the FOIA, members of the public can request many kinds of information that the government doesn’t routinely make public. The resulting information falls into a gray area where markets are concerned: Public but not broadly disseminated.

The researchers looked at trades involving drug companies made by institutional investors like hedge funds and mutual funds in the same calendar quarter in which they had filed FOIA requests about the companies — from 1995 to October 2013.

Their striking findings: When investors buy stock in the same quarter that they make an FOIA request, the stock posts an abnormal quarterly gain of 5.26 percent. When investors sell a stock after FOIA requests, the stock drops an abnormal 3.09 percent. (“Abnormal” gains are those above and beyond what you’d expect given such factors as the overall direction of the market.) The authors made the reasonable assumption that trades made in the same quarter as an FOIA query were at least partly motivated by information they received.

“It’s a case of unintended consequences,” Rossi says. “FOIA was passed to make the government more transparent. Some people are taking advantage of it in a better way than others.”

In a 2013 article, The Wall Street Journal called attention to institutional investors’ using FOIA to ferret out profitable information, especially from the FDA. But this new academic paper is the first to show widespread evidence that FOIA requests are linked with substantial trading gains.

Using FOIA to study FOIA, the authors requested from the FDA records of all FOIA requests made of the agency from 1995 to October 2013. Many of the nearly 177,000-plus requests were from lawyers, journalists or firms specializing in FOIA paperwork (when such a firm is hired, the original source of the request is not easily traced). Concentrating on FOIAs filed directly by investment firms about information at specific companies led to a focus on 529 cases.

Some observers may think the finding raises issues of basic fairness, but Rossi declines to use the word “unfair.”  “It seems that most people requesting this information are very technical people,” he says. “It’s not clear that laymen like me would know what to do with the information even if they had it.” Perhaps the firms even deserve credit for unearthing information that would otherwise not be incorporated into price, he suggests.

The researchers looked at whether the high returns could be explained by the talent of the investors, by looking at investors’ performance in quarters when FOIAs weren’t filed. They could not.

Focused as it is on the FDA, the study leaves a tantalizing question for other researchers and journalists: Where else in the government are investors sending FOIA requests and making money?

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“The Freedom of Information Act and the Race Towards Information Acquisition” is a working paper by Antonio Gargano, a senior lecturer at the University of Melbourne; Alberto G. Rossi, an assistant professor at the Robert H. Smith School, at the University of Maryland; and Russ Wermers, a professor at the Smith School.

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