In 2011, Peter Schweizer published a book, Throw Them All Out, exposing some questionable means by which politicians manage to increase their personal wealth 50 percent faster than the average American does.
Schweizer suggested that trading on material nonpublic information is one way members of Congress achieve outsized returns on their investments. He cited one study that found:
- The average American investor underperforms the market.
- The average corporate insider, trading his own company’s stock, beats the market by 7 percent a year.
- The average senator beats the market by 12 percent 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 enact the Stop Trading on Congressional Knowledge (STOCK) Act in April of 2012.
The STOCK Act made explicit what many already regarded as implicit – that trading by lawmakers based on material nonpublic information acquired by virtue of their position as public servants was a breach of their fiduciary duties and would therefore violate Section 10b of the Securities Exchange Act of 1934. It also expanded disclosure requirements for members of the executive branch and their staff members.
No sooner had the STOCK Act passed, however, than it was quietly overhauled to weaken certain of its key provisions, and in any event the act has not been consistently enforced. As a result, public cynicism concerning congressional insider trading has once again snowballed. A recent poll found that 76 percent of American voters think members of Congress have an “unfair advantage” in trading stocks. In fact, many market participants build their trading strategies on the assumption that memers of Congress are trading on material nonpublic information. For example, House Speaker Nancy Pelosi’s stock trades are monitored on Twitter, TikTok, and Reddit with popular accounts such as “@NancyTracker”. Moreover, the search “Pelosi stock trades” hit a record high on Google in January 2022.
Of course, Speaker Pelosi is not the only congressperson suspected of insider trading. A number of U.S. senators were scrutinized recently over suspicious trades as the threat of the COVID-19 pandemic emerged in 2020.
So what (if anything) 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. And a number of 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 proscribe trades by spouses, dependent children, and staff members as well.
There is precedent for broad prohibitions against insider trading. For example, Congress barred short-swing trading by “directors,” “officers,” and “principal stock holders” of publicly-held corporations in Section 16(b) of the Securities Exchange Act of 1934. Under this provision, any profits a covered insider earns from a purchase and sale (or sale and purchase) of his company’s shares that takes place within a six-month span “shall inure to and be recoverable by the issuer,” regardless of whether the covered person traded on material nonpublic information. Congress determined this broad prohibition was necessary to “curb the evils of insider trading [by] . . . taking the profits out of a class of transactions in which the possibility of abuse was believed to be intolerably great.” Moreover, Exchange Act Rule 14e-3 permits civil and criminal liability for any 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 member of Congress misappropriates material nonpublic government information for personal gain) as morally wrong and as warranting civil and criminal sanctions. Moreover, 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:
- Congresspersons are in a unique position to have an impact on individual stock prices by introducing bills directly affecting issuers, calling on the SEC to investigate issuers, or otherwise exerting their extensive political influence to affect issuers or markets more broadly. As one congressperson notes, “one line in a bill in Congress can be worth millions of dollars.” Moreover, members of Congress enjoy access as well as influence. They regularly attend confidential briefings concerning matters of great domestic and foreign import. Such nonpublic information is often market moving upon release. Consequently, just as the unique position of influence and access held by corporate directors, officers, and principal shareholders warrants a special proscription on their trading under Exchange Act Section 16(b) as a prophylactic against insider trading, a congressperson’s unique position also justifies a broad proscription on certain types of trading for the same reasons.
- Given the concerns about power and access, the public will probably be suspicious of even legitimate stock trades by members of Congress. If, as noted above, 76 percent of Americans are convinced their representatives are trading on material nonpublic information, then this perception alone (justified or not) undermines public confidence in the integrity of the legislative branch and trading markets. Prohibiting all individual stock trades by members of Congress would help to restore some of this lost confidence.
- Congress’ influence over the SEC and DOJ (e.g., control of budgets) makes aggressive enforcement more challenging. The broad prohibition of individual stock trades would mitigate this concern. Violations would be obvious, liability would be strict, and online reporting would render the trading subject to immediate public scrutiny. Moreover, the current bills do not rely on the SEC or DOJ for enforcement.
- Protestations that a broad proscription against 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. It is not uncommon for people voluntarily assume roles that deprive them of rights they would otherwise enjoy (e.g., members of the military), and public service has always been understood as just such a role.
- Members of Congress should not be 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 purchases to outperform a similar investment in, say, mutual funds – unless, that is, their individual stock purchases would be based on information that is NOT publicly available. Diversification is always the best long-term strategy.
Recent polls suggest only about 20 percent of Americans approve of Congress. If Congress would like to begin improving that figure, I suggest that it adopt one of the proposed insider trading bills that would proscribe individual stock trading by its members. Such a move would 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. In addition to restoring public confidence in the legislative branch, adopting such a prophylactic against insider trading would also help improve public confidence in the integrity of our securities markets – a goal Congress has touted repeatedly for almost a century.
This post comes to us from Professor John P. Anderson at the Mississippi College School of Law. It is based on his recent article, “Time for a Broad Prophylactic against Insider Trading,” available here.