Should Politicians Trade Stocks? Congressional Insider Trading

Insider trading, or the act of buying or selling investments based on nonpublic information, is against the law in the United States and in most countries. At its core, insider trading benefits well connected investors at the expense of the general public and it has been illegal in the US since 1934 – at least for corporate insiders.  I made a video a few months ago on the biggest insider trading scandals, and a lot you asked in the comments section “what about politicians”?

The STOCK act was passed in the wake of some controversies over stock trades around the financial crisis of 2007-2008. Its purpose was to stop members of Congress from using non-public information derived from their official positions for personal benefit.

In March of last year four U.S. senators (Kelly Loeffler, Dianna Feinstein, James Inhofe & Richard Burr) were accused of using insider information about the coronavirus pandemic to profit in the stock market.  They dumped their stock holdings, including investments in travel companies, while telling the public to remain calm there was nothing to worry about. All four senators denied wrongdoing, insisting that they acted on public information and news reports and not on non-public information that they had received at senators-only briefings. The Senate Ethics Committee and the department of justice, looked into the matter eventually dropping all investigations without finding any wrongdoing.

Are things likely to change? Well, a bipartisan group of lawmakers have introduced a bill called the Ban Conflicted Trading Act banning members of Congress and senior staff from buying and selling stocks, most bonds and options contracts. This is intended to prevent lawmakers and high-level staffers from enriching themselves through trades based on potentially market-moving information.

Should Politicians Trade?   What should be done about Congressional Insider Trading?

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Transcript

Insider trading, or the act of buying or selling investments based on nonpublic information, is against the law in the United States and in most countries. At its core, insider trading benefits well connected investors at the expense of the general public and it has been illegal in the US since 1934 – at least for corporate insiders.  I made a video a few months ago on the biggest insider trading scandals, and a lot you asked in the comments section “what about politicians”?

Well, Members of Congress have access to all sorts of price-relevant information about companies — from color on the progress of legislation, to confidential information supplied in committee hearings, to knowledge of the attitude of regulators towards a company or sector. 

So It is kinda surprising that it wasn’t until the 2012 passage of the STOCK Act that American politicians were legally prevented from insider trading.  Up until 2012 it was totally legal.

The STOCK act was passed in the wake of some controversies over stock trades around the financial crisis of 2007-2008. Its purpose was to stop members of Congress from using non-public information derived from their official positions for personal benefit. 

Since 2012, no politicians have been prosecuted under the STOCK act, which either means the legislation is extremely effective, or entirely ineffective.

In March of last year four U.S. senators were accused of using insider information about the coronavirus pandemic to profit in the stock market.  They dumped their stock holdings, including investments in travel companies, while telling the public to remain calm there was nothing to worry about. All four senators – of course- denied wrongdoing, insisting that they acted on public information and news reports and not on non-public information that they had received at senators-only briefings. The Senate Ethics Committee and the department of justice, looked into the matter eventually dropping all investigations without finding any wrongdoing.

So how do politicians typically do with their investments? Well a 2010 study from UCLA called "Insider Trading Inside the Beltway," showed that U.S. senators outperformed the broader market by about 12% per year between 1993 and 1998. These are abnormally high returns, but at that time there was nothing illegal about their trading activities.

Before going any further, we should note, that not everyone agrees that insider trading should be illegal at all. Doug Bandow, a senior fellow at the Cato Institute argues that insider trading laws prevent the market from reflecting all available information about securities. By preventing those who know more about a stock from acting on that information, you just slow down the tendency of markets to set a fair price. He argues that stock market participants trade securities every day with incomplete information. In nearly every transaction, one party has better information than the other. Additionally he argues that it’s only possible to enforce insider trading laws when a trader decides to actively buy or sell a security. The decision to not trade a security can be just as important. If you own a stock and are about to sell it when a company insider passes you some positive information about the company, you might decide not to sell that security. That decision is actually illegal, but wrongdoing can’t be proven in court. It’s fine to rely on the best and most timely information so long as you do nothing. 

Now, The Federal Reserve Bank of Atlanta admits that insider trading laws do indeed present a tradeoff. On one hand, insider trading laws distort the market by making it more difficult for prices to reflect all available information. On the other hand, a developed and modern securities market relies on the participation of different types of investors with different motivations and levels of expertise — and without insider trading laws many of these types of investors would stop participating.  The idea is that there is a social good associated with the general public investing their savings in the stock market and seeing their wealth grow.

But back to politicians. You might be wondering if the 2012 STOCK act had any effect at all on their trading activity?  Well, a few studies have been done since then, that show politicians have not done as well with their investments since the law was enacted. So it is possibly working. 

A team at Dartmouth College even analyzed the performance of politicians trades relative to the S&P 500 around the outbreak of COVID-19. They found that broadly speaking politician’s trades in 2020 tended to lag the stock market by up to 3% or to broadly match it. This suggests that trades by politicians may not be as problematic today as they first appear.  

Now, this study doesn’t necessarily prove that the politicians didn’t trade based on inside information, it just shows that if they did, it didn’t work out for them.  A politician who dumped their stocks in February 2020 upon learning how much of a shock Covid19 was likely to be to the global economy, wouldn’t have necessarily bought the dip and profited from the rapid stock market recovery and the new all time highs that we saw months later.

So, are things likely to change? Well, a bipartisan group of lawmakers have introduced a bill called the Ban Conflicted Trading Act banning members of Congress and senior staff from buying and selling stocks, most bonds and options contracts. This is intended to prevent lawmakers and high-level staffers from enriching themselves through trades based on potentially market-moving information.

If passed it would force politicians and their staffers to sell all stocks, non-Treasury bonds, options contracts and derivatives that they own within six months of the bill’s enactment or after taking office. Lawmakers and covered staff can then ask to transfer their holdings into a blind trust and make investments in most retirement accounts.

As long as trading in individual stocks by politicians is allowed, questions about these transactions will arise. I would imagine that most politicians would welcome avoiding the political risk of clean trades being taken out of context by the public. Let me know your thoughts in the comments section.

See you next week, bye.