Insider Trading – Hypocrisy, Thy Name Is Congress!

June 2, 2010

Remember when Martha Stewart got into criminal trouble back in 2003 for lying to authorities about her alleged insider trading in securities, based on a stock tip from her broker? The SEC, the Justice Department and Congress were all outraged that the entertainment and publishing maven would try to make money off of information about an investment not available to the general public.

The Ultimate Hypocrisy

A bad thing, insider trading – that is unless you are privileged enough to get elected to Congress.

Once inside the Capitol Building, you can break these laws to your heart’s content. Members of Congress, responsible for enacting our laws, are the one group of people exempted from punishment for insider trading.

Insider trading is the conduct of profiting from insider information concerning a publicly traded stock. Say, for example, a corporate employee knows that secret talks have resulted in a merger with another company that when announced publicly in a few weeks will cause the stock to soar. If she were to use that inside information, not yet available to the general public, to buy extra stocks and cash in on the future rise, or to pass the tip along to her brother-in-law for him to cash in, a crime will have been committed.

Insider Trading is a Crime for Most

After the stock market crash of 1929, and the enactment of the Securities and Exchange Act of 1934, stock frauds were outlawed. The courts soon interpreted the law to mean that insider trading by a corporate insider was a form of stock fraud, subject to SEC regulation (Rule 10b-5). In 1961, this interpretation was expanded to include corporate “outsiders” (e.g., the brother-in-law). In 1984, insider trading was made a separate crime.

Congress has seen fit, however, to exempt itself from this limitation imposed on the rest of us. All sorts of confidential information come to the attention of lawmakers conducting hearings and investigations or corresponding with their constituents. Such lawmakers are immune from regulations or laws prohibiting insider trading, and are thus, free to profit off of secret information you and I are not privy to.

Congressional Portfolio Outperforms Average

All of this might help explain why congressmen are so much better at picking stocks than you or me. One study showed that during the 90’s U.S. Senators outperformed the average market gains by more than 12%, while average households barely held their own. A 2004 Georgia State University study similarly revealed that Senators received annual investment returns 25% higher than that of average households.

Congressional members have many opportunities to obtain nonpublic information that could affect a stock’s price. They may, for example be aware of impending tax legislation that will pass and which will affect a company’s stock positively or negatively. Similarly, they may be aware of imminent approval of a new drug or the award of a new government contract.

Ah, Ethical Shmethical

Congressional staffers are subject to ethical rules prohibiting them from profiting off of any information confidentially received in the course of their duties. In one year, for example, the top aide to then Republican Majority Leader Tom DeLay was criticized for reportedly engaging in a flurry of stock trading, greatly increasing his net worth.

Some members of Congress feel guilty about their privileged status. In 2006, a bill was introduced in Congress to prohibit congressional insider trading. It went nowhere fast. Again in 2009, a bill, the “Stop Trading on Congressional Knowledge Act,” was introduced by three members of Congress to prohibit lawmakers from profiting off of insider trading. The bill only gathered seven co-signers and was referred to seven different House Committees, never to be heard from again.

Members of Congress are the first ones to demand that wrongdoers be put in jail, whether these criminals are illegal immigrants or the Martha Stewarts of the world. They are good at holding hearings to point the finger at those responsible for the 2008 financial crisis (all the while ignoring their own role in the issues), but when it comes to cleaning their own house, they’re suddenly much too busy.

So the next time you sell that stock that doesn’t seem to be doing too well, it might just be a congressman’s portfolio that bought the stock knowing it’s value would soon soar. Too bad, sucker!