03 Aug Insider Trading by Members of Congress

“Members of Congress consistently trade on inside information. Shouldn’t that be banned?” – The Lonely Realist

Yes.

What makes “insider trading” a bad thing? After all, if someone searches for information that is not in the public domain so that others are unaware of it and pieces that information together to buy or sell stock, that’s a skill for which he (or she) should be rewarded – at least as long as he (or she) had a duty not to misuse a portion of that information. Trading on nonpublic information becomes illegal only when such information is misallocated to the trader’s personal benefit. Doing so, after all, is stealing: it is taking someone else’s valuable property and, without their approval, misappropriating it. That is precisely the definition of “illegal insider trading” – buying or selling a security in breach of a duty of trust and confidence by utilizing material, nonpublic information.

You might be shocked to learn that, even though insider trading of stocks has been illegal for everyone else since the birth of our nation, members of Congress apparently have had free rein to trade on inside information until maybe 2012 when 25 members of Congress were discovered to be making significant profits by trading on material, nonpublic information about military expenditures (as well as other information that the American public wasn’t privy to)…, which they apparently did frequently and arguably still do (as the COVID trading scandal of 2020 amply illustrates). That free ride was supposed to have been curtailed (but did not end) with enactment of 2012’s Stop Trading on Congressional Knowledge Act (STOCK Act), which prohibits the use of non-public information for private profit by members of Congress and other government employees and directs members of Congress and their spouses to disclose within 45 days any trades over $1,000. However, the only penalty for failing to disclose is a $200 fine. Because of the weak enforcement mechanism and difficulty in proving Congressional cause-and-effect, members of both Parties freely admit that they have failed to file reports on time or, sometimes, at all. It therefore is unsurprising that highly questionable insider trading occurred in 2020 when several members of Congress apparently traded on foreknowledge of the severity of the COVID pandemic.

Every few years, including this year, a few members of Congress futilely propose legislation to end Congressional insider trading abuse. In 2022, the proposal was the Banning Insider Trading in Congress Act, which would have prohibited trading by members of Congress and pressured Congressmembers to place their assets in blind trusts. In 2023, it was the Transparent Representation Upholding Service and Trust in Congress Act (TRUST Act) that more simply would have made it mandatory for members of Congress to place their assets in blind trusts. Unsurprisingly Neither proposal even made it through Committee. The 2024 proposal is dubbed the Ending Trading and Holdings in Congressional Stocks Act (ETHICS Act) which, among other things, would prohibit members of Congress, their spouses and dependent minors from owning or trading stocks, commodities or futures  in the belief that anything short of outright prohibition would be ineffective. Unfortunately, like its predecessors, its chances of becoming law range from slim to none are nil – members of Congress simply are unwilling to give up their insider trading perks. As Senator Jeff Merkley noted, “The fact that members of Congress do better than a generalized portfolio suggests that there’s privileged information that folks hear about — may not be inside information, maybe it’s early information, maybe it’s an insight that comes from working on a sector through your committee work or so on and so forth, but that is an issue.” It most certainly is!

Members of Congress have done so well buying and selling securities that a website dedicated to their activities was created to track trades reported by Congressmembers as those reports are filed. Emulating those trades has proven to be quite profitable. There also is an app called Autopilot that allows subscribers to select various members of Congress and automatically trade the same stocks as the selected member or his/her spouse. That too can be quite profitable. As an example, the portfolio of Nancy Pelosi’s husband was +45% in 2023. Autopilot’s motto is “If you can’t beat ‘em, join ‘em.” The fact is that information about the trades executed by members of Congress and their spouses provides a significant market edge. It evidences that the STOCK act, rather than serving as a check on Congressional illegal insider trading, actually has boosted it.

The disclosure requirements and ethics reforms of the STOCK Act were intended perceived as a politically-adept significant step towards ending the pervasive practice by members of Congress and their spouses of engaging in illegal or unethical insider trading. They have been decidedly unsuccessful in doing so. The reality is that members of Congress continue to engage in what are patently and provably illegal and unethical trading practices – there can be no innocent explanation for consistent outperformance by full-time politicians with no prior trading expertise or experience. Presidential candidates should be vocal in making these points and advocating for reform.

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Finally (from a good friend)