Saturday, November 12, 2011

"The 99%" of Us Get Fined and Go to Jail for Insider Trading, But the Exempt "Political 1%" Can Get Rich

Congressional Inside Traders Are Above the Law

(CBS News) -- "Martha Stewart went to jail for it. Hedge fund honcho Raj Rajaratnam was fined $92 million and will go to jail for years for it. But members of Congress can do the same thing -use non-public information to make stock trades -- and there's no law against it. Steve Kroft on "60 Minutes" reports on how America's lawmakers can legally make tidy profits on information only they know, simply because they won't pass a law against themselves. The report will be broadcast on Sunday, Nov. 13 at 7 p.m. (watch preview above).  

If senators and representatives are using non-public information to win in the market, it's all legal says Peter Schweizer, who works for the Hoover Institute, a conservative think tank. He has been examining these issues for some time and has written about them in a book, "Throw them All Out." "Insider trading laws apply to corporate executives, to Americans...If you are a member of Congress, those laws are deemed not to apply," he tells Kroft. "It's really the way the rules have been defined... lawmakers have conveniently written them in such a way as they don't apply to themselves," says Schweizer.

Efforts to make such insider trading off limits to Washington's lawmakers have never been able to get traction."

MP: Maybe the OWS protests should direct some outrage at the greed of the political class "who get rich off insider stock tips, land deals and cronyism that would send the rest of us to prison" (from the front cover of Peter Schweizer's book)?

Update 1:  A 2011 research article in the journal Business and Politics ("Abnormal Returns From the Common Stock Investments of Members of the U.S. House of Representatives") found that the stock portfolios of House of Representative members outperformed the overall stock market by 55 basis points per month, or 6.6% on an annual basis between 1985 and 2001, suggesting that lawmakers have a "substantial informational advantage" over the general public and even over corporate insiders.

Update 2: The chart below illustrates how an additional return of 6.6% per year for House Members would have affected an investment in the stock market between 1985 and 2001. A $1,000 investment in the S&P500 at the beginning of 1985 would have grown to $6,043 by the end of 2001, earning an annual return of 11.16%.  In contrast, adding a 6.6% premium for lawmakers due to their informational advantage would have generated an annual return of 17.76%, and a $1,000 investment in 1985 would have grown to $16,172, or roughly 2.7 times as much as an investment in the S&P500. Not bad.  Insider trading has its advantages.


27 Comments:

At 11/12/2011 12:10 PM, Blogger Hydra said...

I don't see the problem here as long as the law is consistent. Anyone who wants to can compete for a seat can get the same benefits.

 
At 11/12/2011 12:18 PM, Blogger juandos said...

The WSJ had an article last month on how congressional staffers had access to information normal folks don't have: Congressional Staffers Gain From Trading in Stocks

Here's a more in depth, multi year study:
Abnormal Returns From the Common Stock Investments of Members of the U.S. House of Representative

 
At 11/12/2011 12:34 PM, Blogger Alan said...

Martha Stewart didn't go to jail for insider trading. She went to jail for lying to investigators. She wasn't an insider, and if she hadn't lied, she'd probably have been fine.

 
At 11/12/2011 12:44 PM, Blogger Tom said...

Proposed Amendment to the US Constitution.

Congress shall make no law that applies to the citizens of the United States that does not apply equally to the Senators and/or Representatives; and, Congress shall make no law that applies to the Senators and/or Representatives that does not apply equally to the citizens of the United States .

 
At 11/12/2011 1:46 PM, Blogger Buddy R Pacifico said...

The multi-year study referenced by Juandos highlights the proposed STOCK act. STOCK stands for Stop Trading on Congressional Knowledge.

If the STOCK act were to pass it might force "Political Intelligence Firms to register as lobbyists. Currently, political intelligence firms gather information from congressional insiders. Who are their customers? Hedge funds.

 
At 11/12/2011 2:01 PM, Blogger Reliapundit said...

great post

 
At 11/12/2011 3:53 PM, Blogger Jon said...

Maybe the OWS protests should direct some outrage at the greed of the political class "who get rich off insider stock tips, land deals and cronyism that would send the rest of us to prison"

Anything to distract people from going after banksters and corporate cronies that pay the bills at AEI. Look, this is a fine thing to object to. But was Mark saying to the tea party "Instead of focusing on Social Security and health care, why don't you go after war profiteers? Why don't you go after Goldman Sachs? Why don't you go after the banksters." Mark was saying nothing of the sort. What the tea party objected to was the same thing that concentrated wealth objected to, so Mark was good with that. Concentrated wealth doesn't like the things OWS is talking about. So Mark brings up other injustice as a distraction. Don't do anything that upsets my wealthy backers. Only talk about things banksters are comfortable with.

Tough. We're talking about how finance has capture our political process. You want to talk about the kinds of injustice that corporate types like to focus on? Go ahead. We'll stick with trying to bring democracy to this country for now. After we've solved that we'll look at other things.

 
At 11/12/2011 4:27 PM, Blogger juandos said...

"Anything to distract people from going after banksters and corporate cronies blah, blah, blah"...

Oh! So jon you're talking about the groups that financially supported Obama's run for the presidency, right?

Or are you talking about Obama's present day collection of crony capitalists?

 
At 11/12/2011 5:06 PM, Blogger Jon said...

Oh! So jon you're talking about the groups that financially supported Obama's run for the presidency, right?

Or are you talking about Obama's present day collection of crony capitalists?


Both.

 
At 11/12/2011 6:08 PM, Blogger J H Schumacher said...

It's honest graft. As George Washington Plunkitt said "I seen my opportunities and I took them."

 
At 11/12/2011 10:18 PM, Blogger Taojonz said...

With Cellular carriers being allowed by the FTC and SEC to charge consumers $50 to add add a new line and put a new phone on their old number, we have a collusion to defraud the market and make it look as though the cellular industry is growing subscribers when in fact we are simply repackaging a family to serve everyones self interest. The stock value and measures used to predict and value cellular companies is based on new phone numbers added. What we measure improves and what numbers we "cook" are an allowance of insiders to defraud and steal from the Global economy. Taojonz!

 
At 11/13/2011 8:49 AM, Blogger Methinks said...

I don't see the problem here as long as the law is consistent. Anyone who wants to can compete for a seat can get the same benefits.

I don't see the problem with insider trading at all.

Anyone who wants to can compete for a position within a company where they are privy to insider information.

Anyone who wants to buy insider information can compete to do so.

I am (seriously) all for decriminalizing trading on material non-public information.

I am, however, against criminalizing the act and then exempting politicians.

That you don't understand the difference says a lot about you, Hydra.

 
At 11/13/2011 9:04 AM, Blogger Emil said...

"The stock value and measures used to predict and value cellular companies is based on new phone numbers added."

What a load of crap. The value is based on the cash that they are expected to generate. One of the inputs to that is revenues which is made up of p and q. No financial analyst is stupid enough to look only at q.

 
At 11/13/2011 9:47 AM, Blogger rjs said...

who has gone to jail for insider trading?

as far as i know, Michael Milken was the last white guy to be sentenced...

 
At 11/13/2011 10:32 AM, Blogger PeakTrader said...

Methinks says: "I don't see the problem with insider trading at all."

Methinks is a type of fool I'd want to bet against.

 
At 11/13/2011 10:48 AM, Blogger PeakTrader said...

Jon's methodology for solving a problem:

1. Ignore the cause of the problem.
2. Focus on the problems the original problem caused.
3. Create more problems attempting to solve the problems the original problem caused.

 
At 11/13/2011 4:53 PM, Blogger VangelV said...

Insider trading laws should be repealed. Let everyone be on the same playing field and let those with the best information make the most amount of money.

 
At 11/13/2011 6:54 PM, Blogger PeakTrader said...

VangelV, some people can guess better than others. However, when a small group knows the outcome with certainty, it's unfair, even to the best guessers.

 
At 11/13/2011 10:30 PM, Blogger VangelV said...

VangelV, some people can guess better than others. However, when a small group knows the outcome with certainty, it's unfair, even to the best guessers.

Why? If the Enron insiders knew the company was in trouble and acted to profit from it the stock price would have started to decline much sooner and the losses would have been much lower. If the Apple insiders knew that their new release would be a major breakthrough they would have began to buy shares earlier and those selling would have realized a price much closer to its true market value. Whenever anyone with good information can act to take advantage of that information the prices moves to a fairer level that reflects that knowledge. How can that be considered a bad thing?

 
At 11/14/2011 2:07 AM, Blogger PeakTrader said...

VangelV says: "...How can that be considered a bad thing?"

Because there are buyers and sellers, and when buyers win, from insider information, sellers lose, and vice versa.

A simple example is if insiders know a stock will be bought-out at $50 (and own no shares), the stock is trading at $20 (and they begin buying), and an outsider has a selling price target of $25 (and bought the stock at $15), then the outsider lost $25.

 
At 11/14/2011 5:53 AM, Blogger Ian Random said...

This is one of the reasons I wish I could go into political office. The question is which party makes the most. The killing (shorting?) of the toy business a few years ago or DOD appropriations (going long)? I imagine there is a book out there that details how to profit from actions of one party or another.

This reminds me of the political blackmail someone mentioned. They'd introduce measures to tax an industry and then repeal it once enough campaign contributions had been made. So you could fund your re-election and make enough for retirement at the same time.

 
At 11/14/2011 8:17 AM, Blogger VangelV said...

Because there are buyers and sellers, and when buyers win, from insider information, sellers lose, and vice versa.

But you are missing the way that anonymous markets work. When insiders who have better information than the general market player make a bid for a stock they increase the price. The sellers that provide them the shares get a better price than they otherwise would have. To say that getting a better price is bad for the seller you have to assume that without the buyers bid price the seller would not have sold. But that cannot be true because a transaction takes place only if the seller decides to sell. So how is getting a better price better for the sellers of the shares?

Look at it from the other side. The insider knows that the shares are overvalued and shorts the stock. Well, that lowers the price for people who want to purchase it. They wind up paying less and losing less. How is that bad for the buyers?

A simple example is if insiders know a stock will be bought-out at $50 (and own no shares), the stock is trading at $20 (and they begin buying), and an outsider has a selling price target of $25 (and bought the stock at $15), then the outsider lost $25.

No. If I held the stock and wanted to sell it at $25 I would have sold it at $25 and gotten the price that I wanted. But if I wanted to sell at the market, which is where most transactions take place I will get a higher price as bids by insiders cause the price to increase. As I wrote above, I see no way to argue that giving a seller a higher price than s/he otherwise would have gotten is a bad thing for that seller.

 
At 11/14/2011 9:29 AM, Blogger David said...

VangelV, I feel that there is another factor to consider. It seems to me that legalizing insider trading can lead to some serious moral hazard. Imagine a situation where an individual in a company can:

1. Take a reckless high-risk high-reward gamble that would on average be harmful to shareholders.
2. Find out the outcome of the gamble before others.

If he could buy or sell shares of his company's stock, he could profit handsomely regardless of the gamble's outcome. And so he would be incentivized to take the great gamble.

I think I agree with you that insider trading motivated by information is a good thing for the markets, but allowing for decisions motivated by insider trading could be bad.

 
At 11/14/2011 9:35 AM, Blogger Mark J. Perry said...

David: Legalizing insider trading doesn't mean that corporations wouldn't have their own restrictions on employees trading stock of the company.

 
At 11/14/2011 9:44 AM, Blogger VangelV said...

I think I agree with you that insider trading motivated by information is a good thing for the markets, but allowing for decisions motivated by insider trading could be bad.

If you are looking at that form of motivation I think that you overestimate the ability of insiders to do great harm for their own benefit. Simply put, it is hard to keep a secret in a company so you will have the information front-run the insiders hoping to profit from it to the point that there will be little profit for the people who are running the company. Enron did not just have senior executives. Those executives had spouses and friends. They had assistants and analysts who worked for them. There were bureaucrats at all levels of the organisation. There were board members, large shareholders, etc. And all were in a position to watch.

No, posted I said above, if we look at the detail we find that the information moves the price closer to its fair market value (and yes, I know that value is subjective). That means that in an anonymous auction market the knowledge is useful to both sides of the transaction even if one side is not aware of it.

Now you could talk about motives but there are all kinds of motives in the current system. If anything, the current rules actually protect the incompetent and dishonest managers even more because they do not allow their true value to the company to be determined in a timely manner. That gives them incentives to double down on lousy bets and take on more and more risk when things are not going well. They would never get that chance if insider information allowed the price to adjust more efficiently.

 
At 11/14/2011 7:09 PM, Blogger PeakTrader said...

VangelV, if the seller had the same information as the insider, he wouldn't sell at $25. He'd hold or buy more.

The $25 sell target is based on known information, not new information.

 
At 11/14/2011 11:40 PM, Blogger VangelV said...

VangelV, if the seller had the same information as the insider, he wouldn't sell at $25. He'd hold or buy more.

People are always buying and selling shares. Even if they don't have the information those that have the better knowledge are driving the market price closer to the fair value. If you want to sell you will sell. The question is are you harmed because you got a better price, even if the person buying has more information. I would say no because you were selling anyway.

The $25 sell target is based on known information, not new information.

Yes it is. It still does not change the argument. You are still better off getting a better price.

 

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