Reports shows Representatives in Congress beat the stock
market by 12% a year
Hedge funds connected with lobbyists, relative to
non-connected ones, outperform by 1.6 percent to 2.5 percent per month in
politically sensitive stocks compared to nonpolitical stocks. These results
suggest that hedge-fund managers exploit private information, which can be
an important source of their superior performance.
A study of the results of stock trading by United States Senators during the
1990s found that that Senators on average beat the market by 12% a year. In
sharp contrast, U.S. households on average underperformed the market by 1.4%
a year and even corporate insiders on average beat the market by only about
6% a year during that period. A reasonable inference is that some Senators
had access to – and were using – material nonpublic information about the
companies in whose stock they trade.
Government officials have recently been scrutinized for using information
acquired in the performance of their official duties to gain market-trading
advantages. Lobbyists have similarly been criticized for collecting material
nonpublic political information from Capitol Hill contacts and selling it to
their clients - notably hedge funds - who presumably use the information in
their market transactions. Is this insider trading? Most likely not. Should
it be? A few members of Congress have responded by introducing legislation
in the past three Congresses that would bring trading on this “political
intelligence,” by government insiders and outsiders, under the umbrella of
the federal securities laws. Unsurprisingly, the legislation has failed to
garner significant political support.
Under current law, it is unlikely that Members of Congress can be held
liable for insider trading.
Is Congress Guilty of Insider Trading?
Stock or commodity trading on "inside information" has been illegal since
the early 1960s. Yet there is one group that frequently has access to
nonpublic information that can greatly affect stock prices, to the extent of
making or breaking a company or even an industry, and these "insiders" are
considered exempt from prosecution by the Securities and Exchange Commission
(SEC). The insiders I refer to are members of Congress and their staffs.
They have prior knowledge about which companies or industries will or will
not be "bailed out," have their taxes raised or lowered, be subject to
costly new regulations or exempted from such regulations, receive government
contracts, etc. However, because the members of Congress and their staffs do
not obtain their information from employees of the companies affected, they
are not considered insiders.
There have been a number of recent news stories about how the average member
of Congress showed an increase in net wealth over the past couple of years,
while the average American was losing net wealth. The obvious conclusion is
that members of Congress knew things the rest of us did not and acted on
this knowledge to their own advantage — no surprise.
A new study that empirically demonstrates this, "Capitalizing on Capitol
Hill: Informed Trading by Hedge Fund Managers," has just been published by
the Social Science Research Network. The authors of the study, Jiekun Huang
and Meng Gao, found that hedge funds connected with lobbyists, relative to
non-connected ones, outperform by 1.6 percent to 2.5 percent per month in
politically sensitive stocks compared to nonpolitical stocks. These results
suggest that hedge-fund managers exploit private information, which can be
an important source of their superior performance.
We are in the process of finding out what actually was in the
2,000-page-plus healthcare bill and financial "reform" bill. Those bills
have many winners and losers which previously were known only to the
lobbyists and the members of Congress and their staffs who put in the
specific deals.
This is why House Speaker Nancy Pelosi famously said, "We have to pass the
bill so that you can find out what is in it." It will never be known who
gained financially from the inside information that was acted on as these
bills were being passed, but you can bet the gain was in the hundreds of
millions of dollars.
A bill was introduced early in this current Congress (H.R. 682: Stop Trading
on Congressional Knowledge Act) which would prohibit the sale and purchase
of securities or commodities' futures based on knowledge gained from a
member of Congress, an employee of Congress or other federal employees. The
proposed legislation is so broad and at points so vague as to be
unenforceable in a consistent manner.
This proposed act makes the same mistake that the SEC often makes in dealing
with "inside information," in that there is an underlying assumption that
the uncontrolled dispersal of information about the health or prospects of
companies is bad and that known information can be controlled.
The recent release of highly classified information from Pentagon sources by
WikiLeaks again shows the near impossibility of controlling even the most
sensitive information.
Time and time again, the U.S. government has shown that it cannot protect
sensitive information, from atomic secrets to sensitive financial data held
by the Internal Revenue Service. Those who tell us that any information is
safe when held by the U.S. government are both supremely arrogant and
ignorant of history, including the news of recent weeks.
The SEC has a long history of not knowing what it should have known (e.g.,
Enron, Bernard Madoff) and at the same time trying to stop the dispersal of
information about companies that is necessary for markets to operate
properly. The SEC is in the process of trying to find ways to criminalize
those who (outside a firm) find better ways of doing research or modeling
what they think is going on in a firm, even though they have received no
direct, nonpublic information from real insiders.
This approach eventually could kill the whole field of securities analysis.
Only government employees at the SEC could dream up a scheme to try to keep
everyone ignorant and call it "progress."
Professor Henry Manne, dean emeritus of the George Mason University Law
School and arguably the nation's greatest scholar on "insider trading"
issues, observes that the decades of failure at the SEC show that
enforcement of insider-trader laws is not feasible and often is
counterproductive.
Also, there has never been a clear definition of insider trading either from
Congress or the SEC. Mr. Manne says it is time to "rethink any current
policies based on a view of pricing in which we exclude the best-informed
traders."
Because insider or informed "trading clearly makes the market process work
more efficiently, it aids capital allocation decisions and informs business
executives through market-price feedback of the best predictions about the
value of new plans."
Outsiders are best served in making their buy and sell decisions when all of
the information about a company is incorporated in its market price, even if
it comes from insiders.
As for Congress and their staffs, given that a prohibition of the use of
inside information is nearly impossible, the effort should focus on more
transparency. This, in part, would mean legislation being passed in small,
understandable increments so that outsiders would be able to determine who
benefits or loses when the legislation or regulation is proposed.
By
Richard Rahn
on NewsMax
Richard W. Rahn is a senior fellow at the Cato Institute and chairman of the
Institute for Global Economic Growth.
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