D.C. Insider Trading

There’s a governance revolution afoot in the world. Beltway and other capital denizens should be careful to take notice.

We posted that claim in January 2007, and 2009 has provided some interesting evidence in support. Furor over lawmakers’ fringe benefits in the U.S. and the U.K. has been a recurring theme, and now we’ve learned of a story that flew below our radar until a segment on CNBC’s “Street Signs” today. Apparently, a bill has been proposed that would subject legislative activities to insider trading rules. The following description is from the website of co-author Rep. Brian Baird, D-WA (emphasis added):

Insider trading should be illegal on Capitol Hill. While that might seem like common sense to some, there is currently no legislation that prohibits Members of Congress or their staffs from enriching their portfolios with the nonpublic information they are able to glean from their day to day jobs. [On July 13, 2009] Congresswoman Louise M. Slaughter (D-NY-28) and Congressman Brian Baird (D-WA-03) took an important step to closing this loophole by testifying before the House Financial Services Committee about their legislation: the Stop Trading on Congressional Knowledge (STOCK) Act. When passed, the bill will make Members of Congress and their staffs subject to the same regulations that the general public is subject to.

“Members of Congress and their staffs should not be above the law when it comes to profiting from sensitive information. The American people expect their public servants to represent their interests, not fatten theair stock portfolios,” said Congressman Baird. “The STOCK Act is an important step to restore integrity and public trust in two institutions that badly need it: the financial industry and Congress.”

“This bill is about transparency and fairness,” Slaughter said. “As it stands today, neither Members of Congress nor their staff can be held legally accountable for making personal investment decisions based on non-public information. This bill changes that by opening those individuals up to be included under insider trading rules.”

This is fascinating stuff, and near and dear to our hearts — it captures the importance of legislative activities and the significance of agency risk in the political domain. As we’ve argued elsewhere, actions and expected actions in the public sphere — legislative changes regarding taxes, regulations, etc — can have powerful effects on asset values, and this idea is a key part of our investment process. There is also a novel but growing body of research regarding the the performance impact of privileged legislative information, and it was reported during the CNBC segment that sizable fees are paid to lobbyists and public sector employees by private investors (alleged to be primarily hedge funds) in order to obtain access to it. However, one thing that we really like about the Slaughter-Baird bill is that it focuses directly on the conduct of members of Congress, and does not try to lay most of the blame on private parties extending fistfuls of dollars.

Our philosophical position is that an investor can benefit by (1) understanding how significant a role government plays in investment returns and (2) making well grounded assessments regarding the course and consequences of public actions. But despite what we wrote in 2007, we did not hold out much hope that the outsized investment returns accruing to political insiders and/or their private sector contacts would become the focus of regulatory or legislative scrutiny this soon. We tended to agree with the pessimistic view expressed by James Surowiecki in 2005:

[The American people] don’t seem all that interested in doing much about it…Perhaps we want to keep the insider’s advantage intact because we all want to be inside. The choice is between a system in which people get rewarded for the work they do and a system in which people get rewarded for who they know or for what they’re lucky enough to stumble into. And in Washington today that’s no choice at all.

Thus, Reps. Slaughter and Baird’s bill is a welcome and courageous initiative, even if execution would involve some degree of wind mill tilting (more detail regarding the bill is available on Rep. Baird’s website). Of course, at this point it’s just a bill, and it was also reported on CNBC that there is little likelihood of it coming up for a vote any time soon. However, where Surowiecki’s quote would seem to direct most of the blame towards the American electorate, we wonder if legislators simply enjoy too great of an asymmetry in power and information at present — in which case, while we stand by our opening quote, we don’t think that substantive reforms are likely to arrive any time soon — unfortunately.

In the meantime, if this topic is of interest to you, here are some interesting reads:

James Surowiecki, “Capitol Gains”, New Yorker 10/31/2005

Ferguson and Witte, “Congress and the Stock Market”, 3/13/2006

Ziobrowski et al, “Abnormal Common Stock Investments of Members of the United States Senate”, Journal of Financial and Quantitative Analysis, December 2004 (abstract only)

URLs:

http://symmetrycapital.net/index.php/blog/2007/01/a-seamy-trifecta/

http://symmetrycapital.net/index.php/blog/2009/06/tr2-parliament-and-congress/

http://www.cnbc.com/id/15838408/site/14081545/

http://www.baird.house.gov/index.php?option=com_content&task=view&id=960&Itemid=99

http://symmetrycapital.net/index.php/profile/#process

http://journals.cambridge.org/action/displayAbstract?fromPage=online&aid=4204676

http://www.newyorker.com/archive/2005/10/31/051031ta_talk_surowiecki