Members of Congress shouldn’t be allowed to buy individual stocks (while in office), but they should be allowed to sell them. Before I get into why, let’s discuss why we are all here—Nancy Pelosi.
Last week Speaker of the House Nancy Pelosi argued that members of Congress should be allowed to trade individual stocks because “we’re a free market economy.” Pelosi’s comments come after an investigation by Business Insider found that 52 members of Congress “failed to properly report their financial trades.” While not reporting trades isn’t great, the real issue is that they are allowed to trade despite their access to privileged information.
I was first tipped off to this by RampCapital after he highlighted the extent to which some members of Congress trade individual stocks. But this is nothing new. Over the past decade Jason Zweig and his colleagues at the Wall Street Journal have done an incredible job documenting just how widespread the practice is.
For example, they discovered that members of Congress can make decisions that affect industries where they have a vested interest, that some members trade quite a bit, and that many of them aren’t even that good at it. But instead of rehashing the existing research, we will examine, what’s wrong with Congress trading stocks, some proposed solutions to this problem, and what I think should be done.
What’s Wrong With Congress Trading Stocks?
The primary issue with members of Congress trading stocks is that they have access to inside information which they could profit from. Of course, insider trading by members of Congress is illegal under the STOCK Act of 2012, but it isn’t easy to prove when it occurs.
Legality aside, the real issue with Congress trading stocks is that it seems so unfair to everyone else. It’s unfair that a group of people with access to inside information also has no restrictions on their investment behavior. For crying out loud, every large financial institution in the U.S. has restrictions on what their employees can buy/sell, but not Congress.
You might argue that members of Congress are special and should be allowed some extra privileges. I am all for that as long as these privileges don’t adversely impact anyone else.
“Oh, you used to be in Congress? Come speak at my event for $10,000.”
I don’t have a problem with this (though you may), but I do have a problem with members of Congress being able to trade stocks without any sort of restrictions. Unlike an increased speaking fee or a fancy job offer, other market participants could be harmed by this privilege. As a result, we need to make a change.
So what kinds of solutions have been proposed thus far?
What Are Some Proposed Solutions?
Of all the proposed solutions I have read related to regulating Congress’ trading behavior, Tyler Gellasch’s is probably the most comprehensive. Gellasch, one of the original drafters of the STOCK Act, wrote in an opinion piece for Politico:
Congress should consider prohibiting significant outside business activities for all members, and limit any securities trading to diversified funds, with all trades first precleared by an appropriate ethics office. That kind of process is common at investment banks and other firms where employees are often in possession of material, nonpublic information.
While this kind of regulation would definitely end insider trading within Congress, it seems a bit too restrictive for my tastes. How do we define “outside business activity”? What is allowed and what isn’t? How long does it take to pre-clear trades? All of this and more makes the costs seem greater than the benefits. Is there a less costly solution?
George Loewenstein, a behavioral economist at Carnegie Mellon University, suggested that members of Congress put their assets into a blind trust while they are in office. While this would prevent insider trading and other undue influence, such a solution would be too restrictive financially, especially for less wealthy members of Congress.
I just can’t imagine telling an incoming member of Congress with less assets that they have to cede control of what little they have to an independent trustee because of this regulation. Is there a simpler solution? I think so.
My Solution: Ban Buying, Not Selling
My solution to this problem is very simple—ban buying of all individual stocks, options, and securities not on a pre-approved list. That’s it. Members of Congress can sell whatever they want, but they can only buy diversified index funds/ETFs that provide broad exposure to global asset classes.
Why do I suggest banning buying and not selling?
Because buying shows intent. Selling doesn’t.
There are a multitude of reasons why you might sell an asset. Maybe you had to rebalance. Maybe you had to raise funds for a downpayment on a home. Maybe you had a financial emergency. Whatever it is, we cannot prove that your sale has anything to do with your beliefs about the future price of that security. We cannot prove that you were insider trading.
But this isn’t true when it comes to buying. When you buy an asset you are inherently suggesting that you expect it to increase in price in the future. After all, why else would you buy it? Since the intent is so undeniable with buying (and not with selling), when we ban buying, we get rid of the most obvious form of insider trading that could exist.
More importantly, banning buying would be easy to implement and track (compared to the solutions proposed above). It wouldn’t require members of Congress to change anything about their current finances or their existing assets. They simply couldn’t buy new assets that weren’t on the pre-approved list.
Of course, this solution isn’t perfect. Members of Congress could, in theory, still insider trade by selling a company’s shares after getting access to privileged information about that company/industry. However, those shares would have been acquired before they were in office. So even if this kind of behavior does occur, it will be far less impactful.
The same goes for selling diversified index funds. Yes, members of Congress could, in theory, sell off their diversified funds after getting word of bad news, but the impact (and expected profit to the individual) would be severely reduced.
The Bottom Line
Whether or not you agree with my proposal above, we need to have more regulation around how members of Congress transact in financial markets. Allowing people with obvious access to inside information to trade whatever they want whenever they want is an invite for illicit behavior. It’s not that I believe that most members of Congress are bad people, only that the temptation to cheat is too strong for some.
As public servants, members of Congress shouldn’t be focusing their attention on how to trade their financial portfolio and should instead be working on how to improve the country. My proposed rule to ban the purchase of certain securities is easy to implement and will allow members of Congress to conduct their financial affairs with minimal interruption/hassle. The hardest part of my proposed solution is getting Congress to enact it in the first place.
Until then, happy investing and thank you for reading!
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This is post 273. Any code I have related to this post can be found here with the same numbering: https://github.com/nmaggiulli/of-dollars-and-data
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