Has Congress Been Scared Straight On Insider Trading?
As a follow-up to yesterday’s Page One Wall Street Journal story about possible insider trading by Capitol Hill Staffers, the WSJ’s Deal Journal tracked down the professor whose 2004 study started the controversy over political insider trading.
A bit of background. It had been suspected for years that lawmakers engaged in insider trading. Anecdotally, there were plenty of stories about lawmakers going long stocks that might benefit from legislation or shorting stocks that could be hurt.
But In 2004, Alan Ziobrowski concluded several years of study with a report that found stock picks by US Senators beat the market by about 12 percent each year, while regular folks underperformed the market by about 1.4 percent.
The implication was that either we had elected a bunch of really good stock pickers to the Senate or the Senators were front-running legislation or trading on information they learned in their capacity as lawmakers. Since not many Senators leave to become hedge fund managers, it seems pretty clear it’s not their stock picking prowess that explains the results.
It comes as a surprise to many people to learn that insider trading by lawmakers may not be illegal. The Senators might have been trading on non-public information but they aren’t classic insiders: they don’t work for the companies whose stock they bought. What’s more, they aren’t the kind of alternative insiders that the court also tags under a theory it labels “misappropriation”: people who owe duties of confidence and loyalty to an employer that forbids them from trading on inside information about another company.
The classic example of this alternative insider is the financial journalist who trades ahead of the publication of a column exposing the short-comings of a public company, or who provides tips to friends who do this. (For a more technical legal discussions, see Stephen Bainbridge's article: "Insider Trading Insider the Beltway.)
In short, absent a specific statute barring Congress critters from engaging in insider trading, it’s probably not illegal. The SEC has certainly never acted to enforce insider trading against a Senator or a member of the House, despite the SEC’s aggressive interpretation of the breadth of insider trading restrictions.
No one in authority seems eager to apply my favored theory to Capitol Hill, under which insider trading by lawmakers should be an impeachable offense. In my view, lawmakers engaged in political insider trading are using their public authority to collect information and pass legislation to benefit themselves.
This is the essence of bribery, turning power meant for the public good to produce private benefit. Bearing such kinship to bribery makes it arguably one of the “other High Crimes and misdemeanors” that are Constitutionally impeachable. Incidentally, I think that this theory also implies a duty not to trade on political information, which would make the Congress critters subject to insider trading laws.
As I said, so far this theory of insider trading has no takers apart from the editors of NetNet. Given that there were no official sanctions for insider trading by lawmakers, it should come as no surprise that lawmakers apparently engaged in it. If you were given a license to beat the market with insider information, wouldn’t you use it?
Of course, just because there are no official sanctions doesn’t mean that there are no deleterious consequences to insider trading. Lawmakers could suffer losses of reputation, and possibly electoral losses, if caught engaging in what looks like shady activity. And so it seems that they’ve reformed themselves after the trading came to light.
In light of the Wall Street Journal’s Page One article today about Congressional aides profiting from timely stock trades in companies for which their bosses wrote laws, Deal Journal took a look back at two pieces of research into the fortuitously good stock-trading skills on Capitol Hill.
First, we tracked down Alan J. Ziobrowski, a professor at George State University’s business school who co-wrote a 2004 study that found U.S. senators’ stock picks beat the market by an average of about 12 percentage points a year during a stretch of the 1990s. Over the same period, U.S. households underperformed the market by 1.4 percentage points a year on average.
The study’s authors suggested the performance was so good, senators likely benefited from access to inside information, such as when a company was going to be awarded a government contract, or that a pharmaceutical treatment was about to be rejected by the FDA.
Since his study, which drew wide press attention, Ziobrowski said he has heard from other researchers that the trading performance of members of Congress no longer is wildly better than the public’s stock record. He said it may be a sign that the 2004 study scared straight some Capitol Hill types.
“I’m very proud of that for that reason alone,” Ziobrowski said. “No one went to jail, but that’s ok. It was well worth doing the paper.”
It also is now much easier to track stock holdings and trading by members of Congress. Ziobrowski said he and his co-authors took years to sift through what were then paper records of Congressional stock trading, and enter them into computer databases. Now, watchdogs like the Center for Responsive Politics have searchable databases of lawmakers’ financial disclosures.
Well, that sounds like good news to me.
But there is another way of interpreting this. Perhaps insider trading based on non-public information available on Capitol Hill just became more difficult. This would also explain the failure of lawmakers to out perform other investors.
How would political trading become more difficult? Some possibilities:
- Legislation over the last six years may have been less effective at moving share prices;
- Information provided to lawmakers may be less reliable as a guide to the stock performance of companies involved;
- Outsiders may have become more attuned to the value of political information, and therefore more market participants are using the information to trade;
- And, finally, its possible that the financial acumen of lawmakers has declined, making them less able to translate their non-public information into tradable ideas.
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