Insider Trading, Congressional-Style

The silly effort to stop senators and bureaucrats from trading on their inside knowledge.

Illustration by Mark Alan Stamaty. Click image to expand.

Alert! Apparently, people in Washington are trying to make money by trading on information about the legislative process. To end such shocking, shocking activities, Rep. Brian Baird, D-Wash., and Rep. Louise Slaughter, D-N.Y., last week introduced the “Stop Trading on Congressional Knowledge Act, or STOCK Act.” The goal is two-fold: (1) to make it illegal for congressional and federal workers to use knowledge gleaned on the job to trade stocks; and (2) to regulate “political intelligence” research shops, which essentially gather information from Capitol Hill and retail it to hedge funds and other money managers.

Given all the problems that demand congressional oversight and activity—the subprime lending mess, Iraq, the Justice Department—it’s difficult to see why this far-reaching legislation, which would direct the Securities and Exchange Commission to punish violators, is necessary. Yes, it’s absurd that it’s apparently legal for junior staffers and members of Congress to day trade from their Capitol Hill offices based on knowledge of a speech a senator will give tomorrow. And, yes, isolated news accounts—i.e., that Tom DeLay staffer Tony Rudy was doing a lot of day trading out of the then-speaker’s office and that buildings-supply company USG saw its stock rise ahead of a 2005 speech by then-Senate Majority Leader Bill Frist about the potential creation of an asbestos trust fund—have engendered suspicions. So too has academic research such as this 2004 paper, which found that senators’ investments chalked up abnormally high returns and concluded “senators trade with a substantial informational advantage.”

But the evidence isn’t fully convincing. It’s hard to believe that the mass of professional and amateur investors are continually outsmarted by shrewd Washington insiders. (It could be, for example, that senators’ investments did abnormally well in the 1990s because good brokers and money managers were eager for their business.) Any concern that senators are slinging stocks could be allayed through a system of more or less instant disclosure of trading activity. (Voters would thus have the opportunity not merely to support Sen. Hillary Clinton but to trade alongside her.)

Even if Capitol Hill is plagued by widespread trading based on a perceived informational edge, it doesn’t require the same sort of insider-trading charges that are filed against Wall Street malfeasants. Defined by the SEC, insider trading occurs when people act on access to material, nonpublic data relating to a regulated company. If an insider at Company X gets wind of an impending takeover for $45 a share from Company Y, he knows that he will certainly be able to profit based on the trading. In insider trading, the connection is direct, and the profit is sure.

But with legislation, the link between advanced knowledge of a senator’s position on an issue and the certainty that a specific stock will benefit as a result is much more tenuous. Sure, activity in Washington has the potential to affect companies, sectors, and entire markets—the Federal Reserve moving interest rates, the Food and Drug Administration rejecting a pharmaceutical application, the Pentagon placing an order for jet fighters. Advance knowledge of a congressional speech by the majority leader proposing an asbestos trust fund can certainly move a stock. But it might not. The Wall Street Journal noted that back in 2005, “the stock prices of some companies that used asbestos, including USG Corp., W.R. Grace & Co. and Crown Holdings Inc., went up in the two days prior to the senator’s announcement. The stock prices of other companies in their sectors were fairly flat on those days.” And just because language is included in a speech or in a bill doesn’t mean a company can count on the benefits. A lot of things can happen: Multiple committees weigh in; there’s the possibility of a filibuster or a veto. (Nothing ever came of that Frist-proposed asbestos trust fund, by the way.) Unless he’s a brilliant trader, a Hill staffer who buys options today on a company that he thinks might benefit from something his boss might say next week will have a tough time profiting.

The STOCK Act also takes a curious swipe at the First Amendment with its attempt to regulate so-called political intelligence firms, which, Baird and Slaughter say, “provide investors with inside information about impending legislative action that can be used to inform investment decisions.” They want to require firms in this industry “to register with the House and Senate, much like lobbying firms are now required to do.”

Again, a probably harmless idea. But who, precisely, is in the “political intelligence” industry? Think about all the professionals who make their living peddling information about what goes on in Washington: law firms, consultants like this guy, lobbyists, and researchers pitching glorified tip sheets to investors. Oh, and news organizations. The “political intelligence” shops aren’t doing anything much different than, say, the Washington Post, National Journal, or the Wall Street Journal. After all, these companies employ Washington-based operatives who spend their days working government contacts to unearth information that isn’t available to the public. The companies then sell that information exclusively to people who feel that knowledge of such information is important to their businesses. Will Slate’scrack Washington bureau staffers be required to register as well?