The SEC defines insider trading as buying or selling a security in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading is not isolated to Wall Street and has increasingly become an issue on Capitol Hill and in regulatory agencies, like the Federal Reserve. A 2004 study examining common stock returns generated from 1993-1998 on equity held by US Senators found that a portfolio mimicking the purchases of Senators outperformed the market by 85 basis points each month. On the other hand, portfolios mimicking equity sales by Senators underperformed the market by 12 basis points each month. The study noted that these results “suggest Senators knew appropriate times to both buy and sell their common stock.” Congress is privy to nonpublic information obtained via briefings from regulatory agencies, other Congress people and trade associates. They have access to this information as required by their position, with the expectation that they will use this data only for the good of our nation. Recent history suggests an increasing number of policymakers and regulators may be abusing their position for personal gain.
The 2008 financial crisis ignited a rash of insider trading on Capitol Hill, as confirmed by the following: on September 16, 2008, Treasury Secretary Henk Paulson and Federal Reserve Chairman, Ben Bernanke told US Congressional legislators that the economy would soon crash. Congressmen who heard this information used this nonpublic information to sell stocks in an effort to avoid losses and also used the information to purchase stocks in firms that would be bailed out by the Government. In total, 19 Democrats and 15 Republicans restructured their investment portfolios after meeting with the Treasury Secretary or the Federal Reserve Chairman. In response, Congress passed the STOCK Act in 2012 with almost unanimous support. This act prohibits members of Congress from utilizing “any nonpublic information derived from the individual’s position or gained from performance of the individual’s duties for personal benefit.” Almost immediately, the law was weakened in 2013, when financial disclosure requirements were loosened. Most recently, in 2020, 43 members of Congress violated the STOCK Act. Penalties start at $200 for first-time offenders. In the most recent incidents, egregious violators included Senator Kelly Loeffler, Senator David Perdue, Senator John Hoeven, and Senator Burr, who utilized non public information obtained as part of their congressional responsibilities on the Covid pandemic to trade stocks.
It is clear that the STOCK Act requires modification. Promising legislation, like the Anti-Corruption & Public Integrity Act, bans “Members of Congress, Cabinet Secretaries, Federal Judges, and other senior officials from owning or trading individual stock.” Another promising piece of legislation is the Ban Conflicted Trading Act. We believe there is strong public backing for proposals like these, with 52% of Americans supporting a ban on Congress members holding individual stocks in a poll by Data For Progress.
But, simply banning members of Congress from owning stock may not be enough. Tyler Gellasch, who helped write the STOCK Act, argues that Members of Congress might also be misusing nonpublic information to enhance their real estate investments. He supports the banning all significant business activities for members of Congress and limiting investments to prescreened, preapproved diversified equity, debt and real estate funds. Even with these limits, members of Congress may still be able to use nonpublic information obtained as part of their Congressional duties to profit personally. Another analyst, Brian Canfield argues that, since laws passed by Congress affect the entire economy, allowing Congressmembers access to even broad based ETFs might still influence them to vote against broadly beneficial policies such as those that might increase union membership.
We argue that compensation and benefits paid to those in government should be restructured fundamentally and that simply banning members of Congress from owning stock is not enough. Studies have shown that higher government wages are associated with reductions in corruption. Significantly increasing Congress members’ income should decrease, at the margin, their desire to obtain income otherwise. Banning members of Congress and senior regulatory officers from owning stock should be the first step in setting up an alternate reward system. While some argue that policymakers should have a stake in the economy, the damage they can do to the public’s perception of an honest, fair and equitable government is the far more important consideration, as noted by the expressed attitudes of many of the protestors who stormed the Capitol on January 6, 2021. We also know that stock ownership is increasingly unequal, with 80% of all stocks being owned by the top 10% wealthiest households. This divide is also apparent among racial lines, with 57% of white households owning stock compared to 30% of black households and 25% of Hispanic households. Finally, the Covid crisis exposed the growing gap between a booming stock market and a struggling middle/working class.
A better solution may be a bonus system that motivates regulators and Congress to improve the overall well-being of the American people. In this system, rewards are paid based on progress in meeting social goals like combatting climate change, increasing racial equality, decreasing wealth inequality, lowering unemployment, and improving satisfaction rates for the government. Such a system would more explicitly tie the financial self-interest of Congressmembers and policymakers to the well-being of the American people. While still far from the implementation of such a system, we are witnessing growing awareness that the personal financial motivations of Congressmembers and policymakers must be more explicitly matched to the good of the American people.
Sources:
https://www.politico.com/news/magazine/2020/03/25/congress-stock-trade-148678
https://nyujlpp.org/quorum/canfield-banning-congressmembers-buying-individual-stocks/
https://voxeu.org/article/higher-government-wages-may-reduce-corruption
https://www.cnbc.com/2020/06/12/heres-who-benefits-when-the-stock-market-goes-up.html