Monday, January 30, 2017
Although it may have gotten a bit lost in the shuffle of the POTUS's first ten days in office, the nomination of Representative Tom Price for the post of Secretary of Health and Human Services has received some negative attention in the press. In short, as reported by a variety of news outlets (e.g., here and here and here), some personal stock trading transactions have raised questions about whether Representative Price may have inappropriately used information or his position to profit personally from securities trading activities, in violation of applicable ethical or legal rules. This post offers some preliminary insights about the nature of the concerns, which are set forth in major part in this New York Times editorial from January 18, and joins others in calling for reform.
Concerns about legislators' securities trading activities are not new. As you may recall, a 2011 study (using data from 1985-2001) found that members of the U.S. House of Representatives do make abnormal returns on stock trades. A 60 Minutes exposé, "Insiders," then followed, which helped catalyze the adoption in 2012 of the Stop Trading on Congressional Knowledge ("STOCK") Act. A recently released paper catalogues this history and effects on those abnormal returns. The findings in this paper, which focuses on Senate trading transactions, are summarized below.
Before “Insiders” aired, the market-value weighted hedged portfolio earns an annualized abnormal return of 8.8%. This abnormal return comes entirely from the sell-side of the portfolio, which earns an annualized 16.77% abnormal return. Post-60 Minutes, we find no evidence of continued outperformance in our market-value weighted portfolios. On average, abnormal returns to the market-value weighted sell portfolio are 24% lower post-60 Minutes, relative to the pre-60 Minutes sample. Taken together, our evidence suggests that, Senators, on the whole, outperformed the market pre-60 Minutes, and this systematic outperformance did not survive the attention paid to Senators’ investments surrounding the broadcast of “Insiders” and subsequent passage of the Stop Trading On Congressional Knowledge (STOCK) Act.
Members, officers, and employees of the House should:
- Conduct themselves at all times in a manner that reflects creditably on the House;
- Abide by the spirit as well as the letter of the House rules; and
- Adhere to the broad ethical standards expressed in the Code of Ethics for Government Service.
They should not in any way use their office for private gain. Nor should they attempt to circumvent any House rule or standard of conduct.
Beyond these rules, however, are insider trading regulations--both generally under Section 10(b) of and Rule 10b-5 under the Securities Exchange Act of 1934, as amended, and under the STOCK Act. Decisional law insider trading prohibitions focus on trading on and tipping material nonpublic information in violation of a fiduciary or fiduciary-like duty of trust and confidence, undertaken with scienter. The STOCK Act, among other things, affirms that members of Congress have a duty that is cognizable under these federal insider trading prohibitions. Other aspects of the STOCK Act include reporting requirements and a ban on special access to initial public offering securities.
As many observers have noted, none of these rules prohibit a member of Congress from many investments and trading transactions that would or could benefit from that member's general or specific legislative activity. So, as my husband concluded in a conversation we had about this issue last week, a legislator's activities may enhance his or her personal wealth, whether intentionally or by chance, if he or she invests in securities that relate to those lawmaking activities. By making investments in those securities, legislators put themselves in an inherent potential position of conflict.
The lack of knowledge of the legislator that a trade is being made, while important for insider trading analyses, does not clear the conflict. When a broker or trustee is trading securities on behalf of a legislator, that broker or trustee may (and arguably must, under professional duties of loyalty the broker or trustee has to a client in that role) pay careful attention to the legislator's activities that may impact the value of those investments and engage in transactions on behalf of the legislator accordingly. Even in circumstances involving no communication between a broker or trustee and a legislator client (i.e., a complete blind trust), the connection between the legislator's activities and his or her portfolio compromise our trust in the legislative process. This is why executive branch appointees must divest themselves of direct investments in private firms (as Tom Price will be required to do if he is confirmed as a cabinet official)--to facilitate trust.
I do not want to get into an analysis of the individualized facts about Representative Price's various securities trading transactions here. That is not my purpose. Others (e.g., here and here and here) have begun to do that in public forums. But I do want to raise questions about whether our federal securities laws, when read in concert with legislative ethics rules, adequately protect investors and best assure the integrity of our capital markets. Our colleague Professor Donna Nagy says it best in a recent opinion piece she penned for the WaPo:
Even if Price’s stock purchases were permissible under federal securities law, his sizable investment portfolio nevertheless places his legislative judgments into question: Did personal stock holdings influence his legislative activity? That very question points to the urgent need for new legislation to guard against the possibility — or even just the appearance — of self-interested decision-making by members of Congress.
. . .
What’s needed is legislation that would, subject to some narrowly crafted exceptions, prohibit members of Congress and senior staff officials from owning any securities other than government securities or shares in diversified mutual funds. Such a proscription would hold the legislative branch to the same high standards of ethics and integrity that Congress already demands from federal judges and agency officials in the executive branch, including Tom Price — if he becomes secretary of health and human services.