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Congresss Phony Insider-Trading Reform wall street journalopinion

by Jonathan Macey

December 13, 2011 Members of Congress already get better health insurance and retirement benefits than other Americans. They are about to get better insider trading laws as well. Several academic studies show that the investment portfolios of congressmen and senators consistently outperform stock indices like the Dow and the S&P 500, as well as the portfolios of virtually all professional investors. Congressmen do better to an extent that is statistically significant, according to studies including a 2004 article about abnormal Senate returns by Alan J. Ziobrowski, Ping Cheng, James W. Boyd and Brigitte J. Ziobrowski in the Journal of Financial and Qualitative Analysis. The authors published a similar study of the House this year. Democrats portfolios outperform the market by a whopping 9%. Republicans do well, though not quite as well. And the trading is widespread, although a higher percentage of senators than representatives tradewhich is not surprising because senators outperform the market by an astonishing 12% on an annual basis. These results are not due to luck or the financial acumen of elected officials. They can be explained only by insider trading based on the nonpublic information that politicians obtain in the course of their official duties. Strangely, while insider trading by corporate insiders has long been the white collar crime equivalent of a major felony, the Securities and Exchange Commission has determined that insider trading laws do not apply to members of Congress or their staff. That is because, according to the SEC at least, these public officials do not owe the same legal duty of confidentiality that makes insider trading illegal by nonpoliticians. The embarrassing inconsistency was ignored for years. All of this changed on Nov. 13, 2011, after insider trading on Capitol Hill was the focus of CBSs 60 Minutes. The previously moribund Stop Trading on Congressional Knowledge Act (H.R. 1148), first introduced in 2006, was pulled off the shelf and reintroduced. The bill suddenly had more than 140 sponsors, up from a mere nine before the show. The Stock Act, as it is called, would make it illegal for members of Congress and staff to buy or sell securities based on certain nonpublic information. It would toughen disclosure obligations by requiring congressmen and their staffers to report securities trades of more than $1,000 to the clerk of the House (or the secretary of the Senate) within 90 days. And it would bring the new cottage industry in Washington, the so-called political intelligence consultants used by hedge funds, under the same rules that govern lobbyists. These political intelligence

Jonathan Macey

Congresss Phony Insider-Trading Reform

Hoover Institution

Stanford University

consultants are hired by professional investors to pry information out of Congress and staffers to guide trading decisions. Publicly, House members echo bill sponsor Rep. Louise Slaughter (D., N.Y) in saying things like: We want to remove any current ambiguity about whether insider trading rules apply to Congress. Or as co-sponsor Rep. Timothy Walz (D., Minn.) put it: We are trying to set the bar higher for members of Congress. On closer examination, it appears that what Congress really wants is to keep making the big bucks that come from trading on inside information but to trick those outside of the Beltway into believing they are doing something about this corruption. For one thing, the rules proposed for Capitol Hill are not like those that apply to the rest of us. Ours are so broad and vague that prosecutors enjoy almost unfettered discretion in deciding when and whom to prosecute. Congresss rules would be clear and precise. And not too broad; in fact they are too narrow. For example, the proposed rules in the Stock bill are directed only at information related to pending legislation. It would appear that inside information obtained by a congressman during a regulatory briefing, or in another context unrelated to pending legislation, would not be covered.
Jonathan Macey, a visiting fellow at the Hoover Institution and a member of the Institutions Property Rights Task Force, is the Sam Harris Professor of Corporate Law, Corporate Finance and Securities Law at Yale University and also a professor in the Yale School of Management. Macey is the author of several books, including the twovolume treatise Macey on Corporation Laws and coauthor of two leading casebooks, Corporations: Including Partnerships and Limited Liability Companies and The Law of Banking and Financial Institutions. In 1995, Macey was awarded the Paul M. Bator Prize for Excellence in Teaching, Scholarship and Public Service by the Federalist Society for Law and Public Policy. Macey received a PhD honoris causa from the Stockholm School of Economics. He is a member of the Economic Advisory Board to the Financial Industry Regulatory Authority.

About the Author

At a Dec. 6 House hearing, SEC enforcement chief Robert Khuzami opined that any new rules for Congress should not apply to ordinary citizens. He worried that legislators might narrow current law and thereby make it more difficult to bring future insider trading actions against individuals outside of Congress. This dont-rock-the-boat approach serves the interests of the SEC because it maximizes the commissions power and discretion, but its not the best approach. The sensible thing to do would be to rationalize the rules by creating a clear definition of what constitutes insider trading, and then apply those rules to everyone on and outside Capitol Hill. If the law passes in its current form, insider trading by Congress will not become illegal. I predict such trading will increase because the rules of the game will be clearer. Most significantly, the rule proposed for Congress would not involve the same murky inquiry into whether a trader owed or breached a fiduciary duty to the source of the information that required that he refrain from trading. If enacted, the law of insider trading will remain one of many where one reality applies to Congress and an uncomfortable and insecure reality applies to everybody else. Just as Congress is protected from the vicissitudes of ObamaCare, Congress will remain safe from the vagaries of insider trading law. The rest of us will still be vulnerable.

Reprinted by permission of the Wall Street Journal. 2011 Dow Jones & Co. All Rights Reserved.

Jonathan Macey

Congresss Phony Insider-Trading Reform

Hoover Institution

Stanford University