Insider Trading on the Taxpayer Dime
Volume XIV No. 40: October 2, 2009
One year ago, Congress was busy passing the Troubled Asset Relief Program (TARP), a $700 billion bailout of the banking and financial industry. With the nation’s economy teetering on the edge of an abyss, then Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke met with a small group of congressional leaders to warn them of the dire consequences of failing to take monumental action.
Wouldn't it have been nice to have been a fly on the wall at the meeting – a few tweaks to your portfolio and a lot of the painful losses most investors faced this past year could have been avoided. Well, there is evidence that Congressmen who were in that meeting did just that, pulling their investments out of funds that eventually tanked by as much as 50 percent.
Though it is illegal for corporate insiders to trade on their knowledge of their own companies, there is no such restriction on using political knowledge to trade for personal gain. And as Washington, DC becomes the center of the nation’s financial and banking universe, political information is an increasingly valuable commodity.
But this is nothing new. Evidence shows that for years members of Congress have routinely beat the market average by as much as 1 percent per month. Alan Ziobrowski, a business professor at Georgia State University, conducted a painstaking study of members’ financial disclosures and found that investments by members of Congress beat the market on average by one half of one percent per month; senators did even better, beating the market by a full percentage point per month.
Maybe this doesn’t seem like much, but an extra six or twelve-percent gain per year is not only an enormous advantage over the average investor, it’s so good as to be considered “abnormal returns” according to Ziobrowski. In fact, your average member of Congress did as well as or better than your average corporate insider did when trading his own company’s stock.
At the moment, there is no law preventing politicians, their staffs, or even lobbyists from using their insider information when it comes to stock trading. In fact, the financial information coming out of Washington has become a sellable commodity. For instance, Michael Bagley, a former congressional staffer recently started the OSINT group, which sells insider political information to hedge funds.
At least one piece of legislation would address this situation by making it illegal for members of congress to benefit from the insider information to which they are privy. The Stop Trading on Congressional Knowledge (STOCK) Act, sponsored by Rep. Brian Baird (D-WA), would change the Securities Exchange Act of 1934 to prevent purchase of stock by holders of nonpublic information.
This is just one idea put forward to deal with this issue. A recent hearing by the House Subcommittee on Oversight and Investigations Hearing entitled “Preventing Unfair Trading by Government Officials” brought up alternative approaches to deal with this issue and suggested substantive changes that would improve the STOCK Act, including real time disclosure by members of their stock purchases and sales.
We rely on congress to confront and solve the nation’s biggest problems, but that does not mean that these members should be allowed to use their position to gain from the market at much higher rates than the rest of us can ever hope to achieve. This is just another example of political power resulting in personal gain, and a solution must be found to help prevent this activity in the future.
Let us know what you think.