So, what’s worse about this — that they’re getting wealthy off of inside info, or that its potential effects on their portfolio is influencing their legislative decisions?
28 thoughts on “Congressional Insider Trading”
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So, what’s worse about this — that they’re getting wealthy off of inside info, or that its potential effects on their portfolio is influencing their legislative decisions?
Comments are closed.
umm.. I’ve never understood what laws again “insider trading” are trying to achieve. Sometimes it seems they’re just trying to ensure speculation is no better than gambling.
Scenario 1. Bob hears that company A is going to buy company B. Knowing that the shareholders of company B are likely to get paid out at higher than the current buy price, he acquires some shares. The merger is announced and other speculators rush to do the same. Bob makes slightly more money than the other speculators. So what?
Scenario 2. Claire knows the quarterly sales numbers are in a slump, she decides to sell her shares in the company. Later that week the quarterly sales report is released to shareholders, and many of them also decide to sell their shares. Claire loses slightly less than the slowest of the shareholders to sell their shares. So what?
Is there a scenario where a clear victim can be identified? I get the feeling there’s no justification for these laws that doesn’t invoke some synonym of the word “fair” – that is, they’re just ideological nonsense.
Many big brains agree with you. Milton Friedman did. It’s one of his least persuasive arguments, IMO.
My view is that-
1. The best way to get information into the market is to make a public statement (like an 8K or 10Q), not to have insiders trade on their knowledge.
2. Insiders are Agents of the corporation, not third parties like you or me. They are given access to inside information solely so that they can perform their function as an employee, and for which they are compensated by the owners of the company with salary, bonus, stock options, etc. They aren’t given the information so that they can speculate on the stock.
3. When the Insider profits (or avoids loss) by trading on insider knowledge, they do so at the expense of a member of the public. This erodes trust in the market.
4. Financial incentives. A CEO shouldn’t be allowed to escape the consequences of bad quarter by selling a ton of calls right before a bad earnings report comes out. He should be 100% focused on the long term value of the stock, and the best way to do that is to make him long on the stock and lock in his position.
5. Information incentives. Don’t give a CEO reasons to withold information.
Some interesting points.
A public statement is best in that it is a piece of text that can provide context, a rationale etc. But trades are better in that the trader has a personal financial motive, so if an executive buys shares that might be an indication that he truly believes shares will go up. Why not allow both?
Why not simply leave it to employment contracts to state all trades have to be public and that an executive cannot engage in trades that would allow him to profit from drops in share prices without prior permission from shareholders a remuneration committee? Company bylaws could even state this as a precondition.
They aren’t given the information so that they can speculate on the stock.
It is true that this isn’t the reason, but why should that be a problem? Additionally, insider trading is also a way of getting information out sooner.
When the Insider profits (or avoids loss) by trading on insider knowledge, they do so at the expense of a member of the public.
To the degree this is true, it is true of all trades. Stock exchanges are among other things a price finding mechanism. This is a legitimate and very important function of stock exchanges.
He should be 100% focused on the long term value of the stock, and the best way to do that is to make him long on the stock and lock in his position.
Absolutely, and this is the core of the problem: it is an agency problem, not a problem of morality. To what degree agents of a company are free to have latitude to pursue their own private interests should be a matter of negotiation. This should be left to the market. To the degree it doesn’t at present that is because shareholders’ rights have been limited by law. Those limitations should be removed.
Don’t give a CEO reasons to withold information.
A good goal, which can probably be accomplished by requiring all trades to be public and in the company’s best interests and by firing executives or entire board that provide too little (or too much) information.
So who is accused of engaging in it? I see several people from both sides of the aisle. A particularly egregious case singled out by 60 minutes is Spencer Bachus, a Republican representative from Alabama. But Pelosi and Boehner have also been implicated. And apparently the investments of congresspeople tend to beat Wall Street by significant amounts over time.
The victims are the people who didn’t have inside information who were taken for a ride by those who did.
Trading in stocks is supposed to be a free exchange with open information. If I’ve got secret information because of my position and I use it to take advantage of other people, then not only do those people unfairly lose, but they get disgusted with the corruption in Wall Street and stop investing, hurting the economy as a whole.
As for the original post, having politicians scamming the system is far more damaging because of their political decisions than is their ill-gotten gains. The money they gain is just a small percentage of the money that’s being affected by their decisions. So they might make a law to net them personal millions out of many billions elsewhere affected. Secondly, it means that laws are being passed not based on any sort of wisdom about legal, economic, or business issues, but on their personal investment portfolios. Not only does this situation cause vastly more measures to be passed, meddling with the economy by picking winners and losers, but over the long term it means our regulations are essentially random, based on what stocks particular politicians happened to hold at particular times.
It is one of the worst possible systems of economics and government, nearing a form of merchantilism where policy is set by lobbyists bribing ministers.
Who says it is? I’m sorry, but every transaction in a market based economy is done with imperfect information. That’s kinda the point. The guy who goes and buys a ton of potatoes because he knows that there’s a distillery he can get for cheap is not obligated to tell the potato farmer that his product is worth more than the farmer is offering them for because he thinks the only market for potatoes is as a side dish for sausages. Imperfect information is what makes trade work.
But the politicians may not have imperfect information. For example, they may know exactly who is going to win a big weapons contract before it is formally announced, allowing them to short sale the loser and/or buy stocks in the winner on the cheap. This allows them to profit substancially based on insider info.
But the potato farmer can find out about the distillery. Insider trading laws concern things that the public can’t find out because they’re still corporate secrets, and people who hold those secrets must either disclose them to the public or refrain from trading on them.
The laws were enacted to prevent fraud, but Congress was exempted, leading to the current mess, like Pelosi buying millions in VISA stock while knowing she would hold back a regulatory bill that the market expected would pass.
Nonsense. The sale of the distillery could also be a secret, and it wouldn’t be against any law to speculate on the price of potatoes as a result.
I know what the law says, I’m asking you to justify it without resorting to some childish definition of “fairness”. Please, make a god damn argument.
The farmer selling potatoes doesn’t fall under insider trading because he’s just selling potatoes, not buying shares in the company building the distillery.
Insider trading is considered fraud because the executives of a publically traded company are selling shares, and the people who buy those shares are investors, in essence, part owners. If the executives kept the construction of the distillery a secret, then they are keeping it a secret from their shareholders. That keeps the price of their stock artificially low, allowing them to buy it at a falsely low price from their investors, and when they announce the new distillery they will sell that stock back to their investors and what should been the real price all along. They’re hoodwinking their own investors.
Consider that the investors are the actual owners of the company and the executive are chosen and employed by them (through voting shares) to oversee the day-to-day operations. If the executives (the employees) keep their owners in the dark so they can scam money from their employers (the shareholders), how is that different from a clerk or bartender stealing money from the register and lying to the owners about the amount of sales?
Isn’t it the case that it’s fraud if an employee lies (even by omission) to the owners to steal their money, or takes advantage of the conditions of their employment to make money on the side without the knowledge or consent of the employer, or scams innocent people by abusing access to the employer’s intellectual property, thus damaging the reputation and financial position of the employer?
Selling shares in a company also carries responsibility, such as the resposibility not to just steal all the investor’s money and run off to the Carribean with it. It’s not just selling a product in the market, it’s selling a share in a business. If you were in a partnership, do you think it would be okay if your business partner kept a lucrative new contract secret from you, told you, his partner, that the business was going belly up, and convinced you to sell out to him, knowing that it was about to make a fortune? What if he lied not just to you, but to thousands of partners? What if he wasn’t even a partner, just some bookkeeper you hired?
There are two closely related reasons why insider trading is banned. First, it provides a large information advantage to those insiders. They know when many big changes in stock valuation will occur and can make low risk, profitable bets at other traders’ expense.
Second, it gives them more incentive to manipulate the stock price for short term gain. For example, a government official could actually make decisions that change the price of a company’s stock, merely to profit from the change.
I don’t have the article in front of me but I recall something about Congressional aides getting a 20-some-odd percent larger rate of return on investments when compared to the rest of the population. That’s a somewhat large disparity between the two investing groups.
The laws were originally supposed to protect investors from the following: The Company (hereafter: The Company) is going down the toilet, and no one but some officers and Board members know it — and none but they can know it. They quietly dump their shares, and emerge with great wealth while the poor schlubs who invested with the best information available lose their shirts.
Congressman have an additional advantage. They can know that a piece of legislation is going to hit that will either enhance or demolish a business. That’s more than insider trading, it’s genuine market manipulation — by force of law (a.k.a. force of arms). It’s abuse of office of the type which used to be punished by burning at the stake. I think that practice should be revived.
The Flea Baggers, of all people, should be leading the charge against such gross injustice.
So? You’ve yet to make an argument.. you’re just appealing to fairness. Why shouldn’t I be able to bow out from a bad investment? Why shouldn’t I be able to capitalize on the work I put in by being a member of the board? Why should someone who isn’t a member of the board get preferential treatment by an external agent? Why can’t he look after his own interests? If they’re silly enough to buy a pig-in-a-poke then what do they expect?
If it’s so wrong to punish a man who has done nothing wrong then why is it okay to reward a man who has done nothing right?
It’s only wrong if the board member’s employment contract didn’t allow it (as it likely wouldn’t unless shareholders rights have been limited by law), or if it affected the member’s decisions. As a shareholder you don’t want your executives to be able to profit from deliberate (or even inadvertent) mismanagement, anymore than you would want a football player to be able to gain from throwing a match. Betting that your team will win should be legal.
It is wrong because it is a form of bribery, in which public companies will win (space) contracts and private companies will not.
Two companies compete to build the BFR (big f rocket). One public, one private. The congress critter makes sure that the public company gets the deal, because otherwise he can’t make a killing on the insider knowledge.
The only way to prevent these psuedo kickbacks/bribes from effecting the decision making process is to disallow them.
The problem with insider trading is not information disparity per se, it is that the insiders can create the information. They are only allowed to buy / sell under very strict conditions to prevent market manipulation, not to prevent them from getting rich.
For example:
day 1 – CEO shorts stock
day 2 – CEO releases a memo saying: “I’ve decided we will merge with the worst company in the industry, and use their managers.”
day 3 – CEO covers position
day 4 – CEO releases a memo saying: “I’ve changed my mind.”
The CEO will make far more in this scenario then he could ever be paid for his work. Note that the CEO in this case never planned on following through, he just wanted to momentarily decrease the stock price.
This is exactly what congress has been doing for the last 4 years.
The effect on their legislative decisions is worse – insider trading is an agency problem. Insider trading by a board of directors is a corporate governance issue, you would expect a company to require all trades by its executives in the company’s stock, bonds and such to be public. If a company doesn’t do that, then that suggests that corporate governance laws have been rigged to disadvantage shareholders.
Which shareholders can read before buying the shares. I don’t see how special laws are required here.
I’m not arguing in favour of special laws that give shareholders extra rights, I’m merely arguing against special laws that take them away.
ok, what would they be? Insider trading laws are, by definition, a limitation on trade.. they exist to prohibit trades that would otherwise be made.
Laws that get in the way of letting shareholders deal with the agency issues instead of having to rely on special legislation. Boards tend to have more power than they would have under a system where market forces determine who has how much power. In many jurisdictions it tends to be hard for shareholders to appoint or dismiss individual directors or to have much influence over the contents of their employment contracts.
If a legislator has access to information that BY LAW a shareholder does not (e.g. information that is classified) his freedom to trade on that information should be restricted. (It may be today, I don’t know) If for no other reason than national security.
Trent, you sound like you’re arguing that the “problem” of a legislator whose legislative VOTES are influenced by personal gain can be addressed at the ballot box. No special rules/laws are required. Is that correct?
Trent, you seem to have picked a very strange hill to defend. Do you own any stocks?
All liquid assets of any elected official should be converted to index funds, or portfolio of mutual funds, or some other investment type if necessary, to avoid this sort of thing.
On the other side of the equation (the profit side), I would favor if Congressman were paid handsome bonuses for GDP growth. I’d be fine with them making seven figure salaries if they could get growth up to (and unemployment down to) 5% (assuming restrictions on deficit spending and protections for Constitutional rights are in effect). I think a nice bonus for each of the ten years following a Term in office would give them the proper long-term view.
Blind trusts.
I’d like to see congressional pay tied to a function of median private sector income. Hard for them to manipulate that in their favor beyond doing their jobs well.
How many of them got rich off their nominal salaries? They get rich by selling influence. Deny them inventory.
If you don’t see a problem with insider trading, then you shouldn’t object to fixing horse races, slot machines and the lottery.