A trade is often only as good as the information on which it’s based. Some hedge funds have been searching for profit-spinning information in a less-than-obvious location: public, mostly federal information released by government departments and agencies known as Freedom of Information Act (FOIA) requests. That information, argues a new study, can be a valuable investing tool — if the searcher knows what to ask for and how to parse the results.
The study, The Freedom of Information Act and the Race Towards Information Acquisition, by Alberto Rossi, assistant professor of finance, and Russell Wermers, professor of finance, both at the University of Maryland’s Robert H. Smith School of Business, and Antonio Gargano, a senior lecturer at Australia’s University of Melbourne, reveals that institutional investors, mostly hedge funds, are big users of FOIA requests. These funds seem to particularly target the Food and Drug Administration, the Environmental Protection Agency, the Department of Energy and the Securities and Exchange Commission.
The Freedom of Information Act was grudgingly signed into law in 1966 by President Lyndon Johnson, and he wasn’t all that keen on the idea of allowing public access, mostly by journalists, to details of government actions. Today there are a number of ways to make a federal FOIA request. One FOIA website currently links to 12 federal government departments and agencies to which requests can be made. The FDA website has its own FOIA page, and requests for the Department of Justice and 30 other departments and agencies can be made at FOIA.gov. Information brokers and lawyers will also request information for clients. (Fees vary depending on the information requested and may be waived in some cases — for example, for journalists or academic researchers.)
The authors of the study limited their focus to 529 FOIA requests made to the FDA between January 1995 and October 2013. The number of FOIA requests that fit into their requirements increased from six in 2000 to 75 in 2012. Questions about a stock’s valuation seemed to be the predominant motivator.
The FDA tracks all data relevant to the life cycle of agency-approved pharmaceuticals and devices, including data on research and development, clinical trials and post-approval results. For instance, hospitals report to the FDA any problems experienced by patients after a drug is approved. These issues, in large-enough numbers, can affect a pharmaceutical company’s stock price.
The original motivation for the study, says Rossi, was to identify the relation between the request for information and target stocks. Rossi acknowledges that their data set is imperfect, since it’s based on quarterly 13F filings. “Our data is very limited in the sense that we don’t really have the positions of the institutional investors at each point in time, we only had it every quarter,” he says. “But we wanted to see quantitatively the phenomenon.”
What they discovered is that 29 percent of FDA FOIA requests are followed by purchases of targeted stocks, 31 percent by sales and 40 percent remained unchanged. If the fund buys the stock after a FOIA request, the shares tend to rise by an average 5.26 percent in the following quarter; a FOIA-induced sale produces a -3.09 percent return.
Of course, many factors potentially contribute to decisions to make a trade, says Rossi, and the information gleaned from a FOIA request may add only nominal value. But the study results do suggest that FOIA requests may tip the scales. “What we think is quite interesting is that whenever we controlled for manager skills, we can still find that the decisions that seem to be associated with the FOIA request is slightly better than ones not associated with them,” says Rossi.
Once investors begin using FOIA requests, they appear to stick with that method of information gathering. Some of the institutional investors identified by Rossi and his co-authors actually have accounts with the FDA — frequent FOIA users can set these up on the agency’s website — suggesting a consistent stream of requests. The paper identifies Ridgeback Capital Management, a New York–based health care fund, Denver’s Janus Capital Corp., New York distressed company–focused Bridger Management and Sigma Capital Management, once a part of Steven Cohen’s SAC Capital Advisors in Stamford, Connecticut, as active FOIA requesters. “One of the very interesting aspects about the FOIA requests is that you know exactly what info is requested and when it was requested,” says Rossi. “This makes it kind of unique because you know this information was activity sought after.”
Playing the FOIA game isn’t for everyone. The information obtained from the FDA is full of technical details, which often requires a specialist, or at least someone familiar with pharmaceuticals, to decipher. A requester must ask for specific information in a certain way to get the best results, says Rossi. The paper includes a case study concerning SAC’s use of FOIA requests in December 2011 to obtain information about Charles River Laboratories, a Wilmington, Massachusetts–based pharmaceutical R&D company.
SAC has since been reorganized into Point72 Asset Management, Cohen’s family office, which focuses on long-short equity. SAC returned capital to investors as part of a deal with the government related to insider trading charges.
SAC specifically requested FDA inspection letters (known as 483s) for specific facilities over a fixed time period. “I would consider this kind of activity a part of generating alpha from managers,” says Rossi. “I’ve been asked before if this is money left on the table, and it really isn’t in the sense that it is not obvious how to interpret this kind of information.”
There are also companies that specialize in FOIA submissions; they make the request under their own name, not that of their clients. Law firms also request information on behalf of clients. “It is very difficult to quantify how widespread this phenomenon is because it is not very hard for someone to hide if they want to,” says Rossi.
FOIA requests can be frustrating because of the time it takes to receive desired information, says Scott Hodes, a Washington-based attorney and past president of the American Society of Access Professionals. Hodes, who makes FOI requests for clients, says the issue is one of supply and demand — there are more requests than agency staff can fulfill, and the 20-day statutory period for responses often passes without any action. For investors, that means planning ahead. “If you’re counting on making a trade tomorrow and you’re making a request today, it isn’t going to happen,” he says. “It’s a long-term search type of thing.”
The practice of using FOIA requests as an investing tool sits in an indistinct zone of private and public information, says Rossi. He’s aware of suggestions that the system would be more equitable if all FDA information was posted on its website, but that’s not feasible, he says. There are thousands of reported cases in the FDA’s Adverse Event Reporting System each quarter. Posting all of them would require enormous resources just to redact the personal information.
“For academics it is very important to have this information because in finance we always talk about the efficient market hypothesis and public information and private information,” says Rossi. “But this is a tricky type of public information in the sense that it is not clearly disseminated to the entire marketplace and yet it is not private because the government controls it.”
Apart from the skill of the requester, the efficacy of FOIA requests as an investment tool depends in part on scarcity. If everyone did it, its usefulness would be diluted. “The moment this becomes widespread knowledge, then everybody is kind of playing the same game,” says Rossi. “It becomes much harder to process this information and maybe benefit from it.”
The study was researched, of course, by using FOIA requests to reveal the nature of FOIA requests. “In one case we reported, an investor’s FOIA request asks who is asking the same information that he was asking,” says Rossi. “It’s like this never-ending vicious cycle.”
