Insider Trading is Legal for Congressional Insiders

Bloomberg: Your senator learns that a much- maligned weapons system now has enough votes for funding. Before the news gets to a reporter, he buys shares in the arms manufacturer for a quick, handsome profit.

What’s wrong with this picture? Nothing, according to the law…

U.S. senators, representatives and congressional staffers routinely attend high level, closed briefings or engage in conversations where secrets are disclosed that might send shares climbing or slumping if widely known.

That access lets them buy low and sell high based on material, non-public information, and they can do it without concern that their remarkable prescience will alert federal investigators of possible wrong doing.

Insider trading in Congress is not new.  In 2004, I wrote about a study showing that the portfolios of US Senators "outperformed the market by an average of 12 per cent a year in the five years to 1998."

Hat tip: The Browser.

Comments

I'm not too concerned about Senators and Congressmen. They are ultimately subject to recall by the voters. My concern is about the scads of congressional staffers. As a general rule, I would prefer that congressional staff be limited to mutual funds only for any investments.

It is also legal for lobbyists, who probably know more than staff.

I think it was Lyndon Johnson that said that any Congressman who came in poor and left poor was an idiot and did not understand the system. Most of the Senators have already made their money before they get to the Senate.

"Its good to be the King."

@Rahul the difference is that the government has the monopoly power on violence ... they are not typical market actors. Congress insider trading is different than private insider trading, because Congress is making laws enforced by jail, etc.

Again, this problem stems not from the "Evil" of insider trading, but from the fact that Congress has been given too much power to intervene in normal markets.

By the way, on insider trading more generally.

For the record, I and most people I know regard it as unethical. Setting that aside....

Laws against insider trading by executives and others are probably best understood as an attempt to wrestle with agency problems, not as an attempt to protect the little guy.

If a CEO can make money through stock speculation in his own firm when the price of his company changes rapidly (either up or down) his incentives are absolutely terribly out of line with those of the owners of the firm. I.e. his income increases when he creates volatility, which is explicitly bad for shareholders (in CAPM terms it lowers the value of the investment). Make insider trading illegal (and you should) and you at least get rid of that part of the agency issue.

It's absolutely stunning how seemingly intelligent people can just laugh this off.

"Sure, these people are rampant, brazen criminals. But whaddaya gonna do? I say we raise taxes, give them more power, and heck, let them run the healthcare system."

Douglas:

We're going off topic here....

Not sure I accept that your point about what ought be changes my analysis of what is - if shareholders are benefitting it is completely plausible that the explanation I gave is an accurate one of why the rules exist.

Not sure I accept that it is in any way bad to take things that reduce economic efficiency in all or nearly all cases and move them from the realm of contract negotiations and into the realm of regulation. Society would not be hurt if a firm paid an executive an extra million bucks, but would be hurt (by reduced efficiency of bad incentives) if a firm contracted to allow insider trading. But a firm could certainly be tempted to save a million bucks by contracting instead with an ill-considered agreement to allow insider trading. We should thus not allow a firm to do this. If your economic argument relies on firms never making serious systematic errors, I'm afraid your theory is not all that good.

Like the enforcement of contract law through force, this could be an area where the state steps on liberty in order to improve economic efficiency.

Also not sure that significant increases in volatility do not negatively impact the value of a stock to equity holders. If nothing else, they reduce the viability of leveraged financing strategies.

As I explained over at my blog, the law is pretty clear that while members of Congress are not covered by current insider trading laws, it is quite clear that Congressional staffers are subject to those laws: http://www.professorbainbridge.com/professorbainb...

JCL:

Good question, though I think the wartime example is spurious as "winning a war" has a lot of other moral variables.

I think in general people have an intuition that certain kinds of asymmetry are fine to exploit (say, knowing someone's poker tell) while others are not (say, unscrupulous financial dealers conning old ladies into unduly risky investments).

Would be interesting to think through exactly where the line was, and I haven't done that. Off the cuff I'd say there is a component which is how great is the inefficiency that is created, and also a component which is how far apart the two parties are in terms of sophistication.

What would you think the line would be?

Gabe:

what leads you to believe these other government agencies lack the same rules that congress and their aides lack?

thank you very much!

"I'm not too concerned about Senators and Congressmen. They are ultimately subject to recall by the voters. My concern is about the scads of congressional staffers. As a general rule, I would prefer that congressional staff be limited to mutual funds only for any investments."

Staff are subject to the same "recall" as members of Congress. Nearly all congressional staff serve at the pleasure of the elected member that hired them (they do not enjoy the protections of executive branch civil service), and lose their job if their member leaves congress for whatever reason.

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