Knowledge is power, but it can also be profitable. According to a recent study by academics at the Robert H. Smith School of Business at the University of Maryland, hedge funds are using Freedom of Information Act (FOIA) requests to get access to information that frequently leads to trading profits.
Most people associate the Freedom of Information Act (FOIA) with investigative reporters looking for a story, not Wall Street hedge funds. However, it turns out that FOIA requests regarding government interactions wiith drug companies are another method for professional investors to get an edge according to a new study by Univ. of Maryland academics Alberto G. Rossi and Russ Wermers, as well as coauthor Antonio Gargano from the University of Melbourne.
Members of the public (including the investment community) can request many kinds of information that the government doesn’t routinely make public using FOIA. The information received falls into a gray area in terms of financial markets as it’s generally considered public but not broadly disseminated.
Using FOIA to make profits trading stocks
The study examined 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 firms, using data from 1995 to October 2013.
When investors buy stock in the same quarter that they make an FOIA request, the stock posts an abnormal quarterly gain of 5.26%. When investors sell a stock after FOIA requests, the stock drops an abnormal 3.09%. “Abnormal” gains are those above what you would anticipate considering other relevant factors such as the overall direction of the market. The study assumes that trades made in the same quarter as an FOIA request were at least somewhat related to the information received.
“It’s a case of unintended consequences,” Rossi explains. “FOIA was passed to make the government more transparent. Some people are taking advantage of it in a better way than others.”
Back in 2013, The Wall Street Journal pointed out that institutional investors’ were using FOIA to learn profitable information, especially from the FDA. That said, this new study is the first to show strong evidence that FOIA requests can be directly connected to significant trading gains.
In a case of using FOIA to study FOIA, the study analyzed FDA records of all FOIA requests made of the from 1995 to October 2013. Most of the 177,000 requests over the 18 years were from lawyers, journalists or third party firms who specialize in filing for FOIA paperwork. Using FOIAs filed directly by investment firms about information at specific companies led to a sample of 529 cases.
See full PDF below.