Editor's Note: Luigi Zingales is Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business and author of the forthcoming book A Capitalism for the People.
By Luigi Zingales, Project Syndicate
Imagine that you are an elected member of the United States House of Representatives in the middle of the debate on the health-care reform act that was passed in 2010. In a House committee meeting, you learn before anyone else that a proposed public-insurance option - a program that would compete with private insurance - will not be included. This information will have a large impact on health-care companies’ stock prices. Can you trade these companies’ shares before it is made public?
Morally, it is difficult to separate this example from traditional cases of corporate insider trading. Yet no law prohibits the practice. The U.S. Congress - the legislative branch of the country’s government - effectively exempts itself from the normal rules of insider trading. Congress and the U.S. Supreme Court are the only federal agencies whose employees may, without restrictions, trade stocks based on non-public information. All other U.S. government employees who traded on privileged information of the type described above would be acting illegally.
Not only can members of Congress legally trade on confidential information; they do, despite the potential cost to their reputations. The U.S. television program 60 Minutes recently reported that several current members of Congress allegedly used confidential information that they acquired on the job for personal gain. While the nexus between the privileged information and the trading is difficult to prove (as it is in most insider trading cases), the timing is highly suspicious.
But it is difficult to challenge this congressional “privilege” in the U.S., in part because insider trading is an ambiguous concept under U.S. law, with no statutory definitions of the terms “insider,” “inside information,” or “insider trading.”
In contrast, the European Union has tried to define these terms in directives aimed at prohibiting the practice. According to a directive issued in 1989, “An insider is one who, due to his relationship to the company as manager, director, employee, or major shareholder, possesses inside information (material non-public facts) and knowingly uses such inside information to acquire or dispose of securities to which the information relates for his own account or another.”
But this definition, while forthright, leaves a large loophole for legislators. For example, it creates the possibility that, say, British MPs could legally trade shares on information acquired in the course of normal business, because they do not qualify as “insiders.”
In 2004, a paper published in the Journal of Financial and Quantitative Analysis showed that U.S. senators who traded stocks beat the market by 12% per year. Since even the best hedge-fund managers find it hard to achieve comparable results, we must conclude that these senators either are better than hedge-fund managers, or that they benefit from privileged information.
Even more worrying than insider trading by elected representatives is the political-intelligence industry that now flourishes in Washington, Brussels, and other major global capitals. In the U.S., former U.S. congressmen and their staffers collect privileged information and sell it to hedge-fund managers, raking in $100 million annually.
A proposal to ban insider trading by U.S. congressmen has languished in Congress since 2006. But it appears that the 60 Minutes program generated some attention; within four days of the broadcast, the number of cosponsors of the proposal increased from nine to 57, and a session was called to discuss the legislation next month.
Yet the problem is not simply Congress’s exemption from insider-trading law. The real issue is that the U.S. Congress - like many countries’ legislatures - lives by rules that are very different from those imposed on ordinary citizens. In particular, the accounting, transparency, and fraud rules that govern businesses do not apply to elected representatives.
It is a problem that goes well beyond insider trading. If corporate executives lie during a conference call, they can be sued. Politicians, on the other hand, lie during electoral campaigns and once in office, with few or no consequences. If the U.S. government had been compelled to abide by the same accounting rules as the private sector does, it would have been forced to consolidate Fannie Mae and Freddie Mac - the giant government-backed mortgage companies at the heart of the recent financial crisis - and to report all contingent liabilities at market value.
Rather than just extending insider-trading law to the U.S. Congress (or to other legislatures), citizens should demand that all restrictions and reporting requirements imposed on the private sector apply automatically to elected representatives as well. This would make these legislatures more credible, and their laws more just.
The views expressed in this piece are solely those of Luigi Zingales.
Nothing that the right-wing thugs in Washington do surprises me anymore!!!
"Congress’s exemption from insider-trading law", is wrong! It's seen as abuse! Members shouldn't get away with impunity.
Right Wing???? How about Pelosi, is she right wing? She is a left wing Libtard.
The "academic" research studies that cite a small premium return on the Congressional portfolios (less than 15%) are deeply flawed. The researchers were provided with incomplete data on options accounts, hedge fund investments, investment partnerships and other investments with substantially higher returns.
It is difficult to estimate what these returns would have been and the amounts of money involved as many of the accounts are held in nominee name and/or offshore accounts and/or other unidentified/unnamed accounts held by third parties for the benefit of particular Representatives and/or their family members. The same reporting, investigation and analysis needs ot be applied also to the Congressional staffs, many of who have been involved in investments that need close scrutiny.
It is reasonable to assume that there were and are many Representatives (and staff members) who have been completely "clean" in the reporting of their investment activities and have abided by both the letter and spirit of the law. It is a sad statement of America when these insider activities have been allowed to go on for decades without either disclosure or investigation.
The Nagy and Bainbridge legal arguments are interesting but the moral issue is clear: Congress and its staff members have received special priviledges to act on insider information for use of which the general public would otherwise be violating the law and subject to fines and incarceration.
The most troubling part of this is that there seems no agency nor Executive power to carry out a full investigation and pursuit of any wrongdoing. When Congress has been threatened with investigation before, it has withdrawn funding from the branch designated to conduct the investigation (e.g. the FBI). The SEC has been substantially degraded during the recent Bush administration and lacks the resources to pursue anything beyond its current workload. The government also pays too little to attract and keep first-class employees in these complex matters.
I suggest people listen again to the recent "OnPoint" broadcast on NPR/WBUR (US/Boston). The participants were well up-the-curve, and I am sure can go further.
you're obviously a lapdog who has lost his way. What are you doing here on CNN little doggy?
Can you tell me what is the basis of the insider trading exempt? Did they exempt themselves explicitly? Or is the exemption assumed?
They made the law apply for corporate executives, of which they are not. The original laws is to protect the private information of the company. The Politicos have no responsibility to private companies. So they say the law does not apply to them.
"Citizens should demand that all restrictions and reporting requirements imposed on the private sector apply automatically to elected representatives as well." Excellent!
These crooks should be thrown out of office so fast! They all just believe YOU are so stupid, that they can use privileged information for personal profit- and YOU"LL just put two and two together! Now, the Congress is just a casino for personal use! The thought that a representative of the American people thinks they can get away with this (and get reelected) just proves they think themselves above the law, and view themselves as OFFICIALS rather than humble PUBLIC SERVANTS.
And for Mr. McCarthy above- who thinks this is just a partisan issue of the right- you must not have seen the 60 mintes piece, rad this artcile, and be extremely naive. The Dems loot and steal with the best of them!
Congressmen aready have way way too many "perks".and advantages. The list is too long to go into here.
Congress hampers adequate enforcement of the securities laws, by refusing prompt public disclosure. The laws apply, but are unenforceable against elected public officials, because they refuse to disclose information in the time permitted for everybody else. The delayed reporting of securities transactions, defeats, obstructs, and impairs its use as timely evidence. If this STOCK act with long 90 day reporting times passes, it will just confirm what the people already suspect about a double standard for congressional insider trading.
It looks as though self-interested congressional officials do not want to put an end to the lucrative trading opportunities that are made available to them when they receive important nonpublic information in their official capacities.
If Martha went to jail, so should they.
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