Friday, February 4, 2022
Public Servants or Parasites? Why a Broad Prophylactic against Congressional Insider Trading Makes Sense
In 2011, Peter Schweizer published a book, Throw Them All Out, in which he exposed some questionable means by which (according to one study) politicians manage to increase their personal wealth 50% faster than the average American.
According to Schweizer, trading on material nonpublic information appears to be a popular method among congresspersons for achieving outsized returns on their investments. He cites one study finding:
- The average American investor underperforms the market.
- The average corporate insider, trading his own company’s stock, beats the market by 7% a year.
- The average senator beats the market by 12% a year.
Schweitzer’s book was followed by a feature story on the CBS News show, 60 Minutes, highlighting some dubious stock trades by leaders of both political parties. These stories got the public’s attention and spurred Congress to act—adopting the Stop Trading on Congressional Knowledge (STOCK) Act in April of 2012.
The STOCK Act made explicit what many already understood as implicit—that congressional trading based on material nonpublic information acquired by virtue of their position as a public servant was a breach of their fiduciary duties and would therefore violate Section 10b of the Securities Exchange Act of 1934. The Act also expanded disclosure requirements for members of Congress, the executive branch, and their staff members.
But no sooner had the STOCK Act passed than it was quietly overhauled to weaken certain of its key provisions, and, in any event, the Act has not been consistently enforced since its adoption. As a result, public cynicism concerning congressional insider trading has once again snowballed. For example, Speaker Nancy Pelosi's stock trades are monitored by popular Twitter, TikTok, and Reddit accounts with handles like "@NancyTracker," and the search “Pelosi stock trades” hit a record high on Google in January 2022.
Of course, Pelosi is not the only congressperson the public suspects of insider trading. For example, a number of U.S. Senators were scrutinized over suspicious stock trades as the threat of the COVID-19 pandemic emerged in 2020.
So what is to be done? Just as they did in 2011, members of Congress on both sides of the aisle are rushing to get out in front of the issue. A number of congressional insider trading reform bills have garnered bipartisan support. Many of these bills propose the broad prophylactic of proscribing members of congress from trading in individual stocks. Some bills would go so far as proscribing trades by spouses and dependent children as well.
There is precedent for broad prophylactics against insider trading. Consider, for example, Exchange Act Rule 14e-3, which permits civil and criminal liability for trading based on material nonpublic information concerning tender offers, even if there is no accompanying proof of fraud.
Though I have argued for reducing the scope of insider trading liability in some contexts (e.g., where such trading is licensed by the issuer of the stock being traded), I have consistently recognized misappropriation trading (such as when a congressperson misappropriates material nonpublic government information to trade for personal gain) as morally wrong, and as warranting civil and criminal sanctions. And I think extending the scope of liability for congressional insider trading with a broad prophylactic (e.g., proscribing all individual stock trades) is warranted for the following reasons (among others):
- Congresspersons are in a unique position to affect individual stock prices by introducing (and voting for) bills directly affecting those issuers, calling on the SEC to investigate issuers, or otherwise exerting their extensive political influence to affect markets. As one congressperson notes, "one line in a bill in Congress can be worth millions and millions of dollars."
- Congress’s influence over the SEC and DOJ makes aggressive enforcement by those agencies more challenging—and when actions are brought, there will always be the specter of political motivation. The broad prophylactic would simplify enforcement, and thereby mitigate these worries.
- Given the above concerns, even legitimate stock trades by members of Congress will be the subject of continued public suspicion and cynicism. Such suspicion undermines public confidence in the integrity of the legislative branch--and the markets.
- Protestations that a broad proscription of individual stock trading would be Un-American because "We're a free-market economy" and “[Members of Congress] should be able to participate in that” are totally unavailing. People voluntarily assume roles that deprive them of rights they would otherwise enjoy all the time (e.g., by joining the military), and public service has always been understood as just such a role.
- Members of congress should not be (significantly) financially disadvantaged by a rule precluding trades in individual stocks. Given the efficient market hypothesis (roughly, that an individual stock’s price always reflects all currently available public information about that stock), members of congress should not expect their individual stock trades to outperform a similar trade in, say, a mutual fund in any event….unless, that is, they have information that is NOT publicly available.... Diversification is typically the best long-term investment strategy.
The most recent ReacClearPolitics Poll Average shows that Congress currently enjoys the approval of 21% of Americans. If Congress would like to begin improving those numbers, I suggest it adopt one of the proposed insider trading bills proscribing individual stock trading by its members. This might go a long way toward restoring the perception that members of Congress are public servants, as opposed to the current perception shared by many Americans (justified or not) that they are public parasites.