Former Treasury Sec. Allegedly Gave Hedge Fund Managers Insider Info. Before '08 Crisis

The actions that led up to the financial crash of 2008 were arguably filled with errors and miscalculations. However, what many Americans are just starting to find out is the fact that several individuals involved in the crash either profited or otherwise behaved in a fashion that many would view as criminal.

Add former Treasury Secretary and Goldman Sachs CEO Henry “Hank” Paulson to the list of implicated crash-related individuals.

Richard Teitelbaum of Bloomberg has just published what some have referred to as a “bombshell” report that claims (via Business Insider):

. . . in July 2008, then-Treasury Secretary Paulson met with several hedge fund managers and told them that a government takeover of Fannie Mae and Freddie Mac was a very real possibility.

Why is this shocking? Consider the fact that just a week before informing hedge fund managers that the Fed would be moving in on Fannie and Freddie, Paulson testified before the U.S. Senate (as well as various media outlets) that government intervention in Fannie and Freddie was near “impossible.”

And of course the government did indeed intervene on behalf Fannie and Freddie, at a great cost to the taxpayer.

Business Insider reports:

. . . the group of managers could have profited off the the information Paulson gave them, but it is not clear if the hedge funders at the meeting were trading Fannie and Freddie shares at the time and it is near impossible to track "firm-specific short stock stales" using public documents. There has been no evidence that the managers traded on Paulson's information.

These facts have led various law professors to conclude that, although questionable, Paulson did not explicitly engage in illegal behavior.

But it doesn’t change the fact that he disclosed sensitive, non-public information to a group of men who stood to profit from said disclosure.

William Black, associate professor of economics and law at the University of Missouri-Kansas City, "can’t understand why Paulson felt [compelled] to share the Treasury Department’s plan with the fund managers,” reports Bloomberg.

“You just never ever do that as a government regulator -- transmit nonpublic market information to market participants,” says Black, who’s a former general counsel at the Federal Home Loan Bank of San Francisco. “There were no legitimate reasons for those disclosures.”

Janet Tavakoli, founder of Chicago-based financial consulting firm Tavakoli Structured Finance Inc., says the meeting fits a pattern.

“What is this but crony capitalism?” she asks. “Most people have had their fill of it.”

Needless to say, for a government official to leak market-sensitive information, even if by accident, is highly suspicious and oftentimes unethical.

“There’s a lot of government information out there, and the hedge funds are trying to get it,” says Richard Painter, a law professor at the University of Minnesota who advised the Bush administration on Paulson’s sale of his Goldman stock when he became Treasury secretary. “It’s a huge problem that has to be addressed.”

As Peter Schweizer has pointed out in his new book “Throw Them All Out,” various members of Congress have also been legally profiting from private market information.

How is it legal?

“The rules for what can or cannot be disclosed by government officials are often either unclear or nonexistent,” writes Teitelbaum.

Makes sense. Think about it: if you are a government official engaging in behavior that otherwise would be illegal, but is only legal because you “failed” to make a law against it, what are the voters going to do? Call a cop?

“The bottom line is that senior-level people in Washington, in the name of keeping in touch with their stakeholders, are tipping their hands,” says Adam Zagorin, a senior fellow at the Project on Government Oversight, a Washington watchdog group, in the Bloomberg article.

“You can’t prosecute them for insider trading if they didn’t trade the shares. You may not be able to even reprimand them. What the hell are the rules?”

Some argue that there is no case against Paulson.

An official such as the former Treasury Secretary has no legal obligation to keep material nonpublic information to himself, says Phillip Kaplan, partner for litigation at Manatt Phelps & Phillips LLP, where he specializes in securities and class-action cases.

“I don’t think a government person is liable,” he says. “He didn’t profit from the information or trade on it.”

Nevertheless, Paulson's actions (along with several others [Pelosi, Boehner, Bachus, Kerry, et alia]), has started a national conversation on the limits of political privilege in regards to the market.

“In the rapidly evolving world of insider-trading prosecutions, [the rules for politicians] could change,” says the University of Illinois’s Ribstein, adding that the U.S. Securities and Exchange Commission is retooling the laws regarding insider trading. “SEC Enforcement Director Robert Khuzami, who can bring only civil cases, and the Justice Department, which can mount criminal prosecutions, have cast their net wide,” Ribstein says.

Was Paulson's admission just an honest mistake or is this just another reminder that many in Washington D.C. believe they are above the law?

Read the full Bloomberg report here.