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Insider Trading Bill Looks to Hold Congress to Corporate Standard

Image has not been found. URL: /wp-content/uploads/2008/10/wall-st-bull.jpgFlickr: entobox

For Wall Street tycoons and corporate insiders it would be a dream come true: A hole in insider-trading laws allowing investors to profit from their access to sensitive information before the rest of the world is aware of it — like knowing the winning lottery numbers an hour before the drawing. But on Capitol Hill that dream is currently the reality.

While federal laws aim to restrict insider trading in the corporate world, neither securities law nor ethics rules prevent congressional lawmakers and their staffs from benefiting financially from the non-public information they gather from their daily routines on the Hill. That loophole, studies reveal, has allowed lawmakers to reap significantly higher Wall Street returns than other investors.

Congress.jpg
Congress.jpg

Illustration by: Matt Mahurin

On Monday, some Democratic lawmakers took another small step toward ending that practice, holding the first public hearing on a three-year-old bill to close the congressional insider-trading loophole. Though mired in the complexities of securities law and the politics of a Congress that doesn’t much like policing itself, the bill at its root asks a simple question: Should members of Congress and their staffs have investing privileges that the rest of the country doesn’t?

Supporters of the proposal — called the Stop Trading on Congressional Knowledge Act — have a ready answer, arguing that the loophole creates all-too-tempting opportunities for lawmakers to exploit their positions for personal gain, thereby defying the very notion of the government official as public servant.

“Members of Congress and their staffs should not be above the law when it comes to profiting from sensitive information,” Rep. Brian Baird (D-Wash.), a sponsor of the bill, said in a statement Monday. “The American people expect their public servants to represent their interests, not fatten their stock portfolios.”

Baird’s bill, sponsored also by Rep. Louise Slaughter (D-N.Y.), who chairs the House Rules Committee, would expand the scope of the Securities Exchange Commission’s insider-trading rules to prevent congressional lawmakers, their staffs and other federal employees, many of whom routinely access sensitive information, from trading on their privileged knowledge.

The proposal would also prevent lawmakers from sharing non-public information with third-party investors, while forcing members to report all trades larger than $1,000 within 90 days of the transaction, rather than the current annual disclosure requirement. Additionally, the bill would require so-called “political-intelligence” firms — which mine information from Capitol Hill to inform clients of investment opportunities — to register with Congress in the same way that lobbyists do today.

The proposal, supporters say, is particularly apt in the middle of a financial crisis through which the federal government has taken unprecedented steps to intervene in private markets. With the billions of taxpayer dollars that Congress has funneled into the same financial institutions in which many lawmakers are personally invested, they argue, the opportunities to misuse information gathered from Capitol briefings, private committee meetings and pow-wows with White House officials are nearly endless.

“Congress and the federal government are now so enmeshed in the operations of our financial markets that the potential for abuse by members of Congress, congressional staff, and federal employees is staggering,” Slaughter testified before the House Financial Services Oversight and Investigations subpanel Monday.

Because of lax financial disclosure rules — not to mention a general inattention to the issue — it’s difficult to know how prevalent insider trading is among federal employees. Earlier this year, however, SEC Inspector General David Kotz concluded a year-long investigation into two SEC attorneys suspected of trading on non-public information they gathered from their jobs within the commission’s enforcement division. Federal law enforcement officials are currently investigating those charges.

Appearing before the House subpanel Monday, Kotz said the problem is not with the SEC’s rules, which prohibit employees from trading on sensitive information, but from a lack of internal oversight.

“The SEC had essentially no compliance system in place to ensure that its own employees, with tremendous amounts of non-public information at their disposal, did not engage in insider trading themselves,” Kotz said. “The existing disclosure requirements and compliance system were based on the honor system, and there was no way to determine if an employee failed to report a securities transaction as required.”

Congress, however, has no such guidelines, and there’s evidence that congressional lawmakers for years have been using their access to non-public information to their personal financial advantage.

A series of studies conducted by Alan Ziobrowski, business professor at Georgia State University, for example, reveals that lawmakers’ access to non-public information lends them a clear advantage over other investors playing Wall Street. After examining 6,000 common-stock trades among select senators between 1993 and 1998, Ziobrowski found that the lawmakers yielded returns 12 percent better than the market as a whole.

A separate analysis of 8,000 transactions among certain House lawmakers found that the returns beat the larger market by 6 percent — the same abnormal return found among corporate inside traders, Ziobrowski told lawmakers Monday. Correcting for the possibility of dumb luck, he testified, “we can state with a 95% confidence level that some members of Congress are trading with a substantial informational advantage.”

Whether those informed trades are occurring consciously or unconsciously, many public-interest advocates argue, is inconsequential.

“Whether members of Congress are in fact cashing in on insider information, or coincidence just makes it appear so, the damage to the integrity of the federal government is the same,” Craig Holman, government affairs lobbyist for Public Citizen, said in a statement Monday.

Not all business experts agree that congressional insider trading is a problem to be addressed by extending the SEC’s reach — or even that it’s a problem at all. V.W. Verret, associate professor at George Mason University’s School of Law, told lawmakers Monday that leaks and data mining surrounding government activities can eliminate market-crippling uncertainties. Verret urged lawmakers that, if they must tackle the issue, they should approach by way of internal ethics rules rather than SEC regulations.

“Don’t ruin the securities laws to try to deal with this,” Verret said.

But Peter Henning, law professor at Wayne State University and former SEC attorney, said that empowering the securities commission with clear oversight of congressional insider trading will go a long way to keep lawmakers honest. The House proposal, Henning testified, “recognizes [that] information with the potential for significant market impact can come from a variety of sources beyond just the company whose securities are traded.”

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