Academic journal article Journal of Corporation Law

Insider Trading Inside the Beltway

Academic journal article Journal of Corporation Law

Insider Trading Inside the Beltway

Article excerpt

I. INTRODUCTION
II. CURRENT LAW
    A. The Doctrinal Sources of the Insider Trading Prohibition
    B. The Classical Theory
       1. The Legal Standard
       2. Application to Members of Congress and Other Government
          Employees
    C. The Misappropriation Theory
       1. The Legal Standard
       2. Application to Members of Congress and Other Government
          Employees
    D. Summation
III. POLICY
    A. Should Members of Congress be Allowed to Inside Trade?
       1. Perverse Incentives
       2. Unfairness
       3. Summary
    B. Who Should Enforce the Prohibition?
       1. A Constitutional Barrier?
       2. Prudential Considerations
IV. THE STOP TRADING ON CONGRESSIONAL KNOWLEDGE ACT
    A. The Prohibition on Trading and Tipping
    B. Reporting Provision
V. CONCLUSION

A 2004 study of the results of stock trading by U.S. senators during the 1990s found that senators on average beat the market by 12% a year. In sharp contrast, U.S. households on average underperformed the market by 1.4% a year and even corporate insiders on average beat the market by only about 6% a year during that period. A reasonable inference is that some senators had access to--and were using--material nonpublic information about the companies in whose stock they trade. Under current law, it is unlikely that members of Congress can be held liable for insider trading. The proposed Stop Trading on Congressional Knowledge (STOCK) Act addresses that problem by instructing the Securities and Exchange Commission to adopt rules intended to prohibit such trading.

This Article analyzes present law to determine whether members of Congress, congressional employees, and other federal government employees can be held liable for trading on the basis of material nonpublic information. It argues that there is no public policy rationale for permitting such trading and that doing so creates perverse legislative incentives and opens the door to corruption. The Article explains that the Speech or Debate Clause of the U.S. Constitution is no barrier to legislative and regulatory restrictions on congressional insider trading. Finally, the Article critiques the current version of the STOCK Act, proposing several improvements.

I. INTRODUCTION

The common stock investment portfolios of U.S. senators beat the market by 12% a year, on average, between 1993 and 1998, according to a study by economist Alan J. Ziobrowski and his collaborators. (1) In sharp contrast, the common stock investment portfolios of U.S. households as a whole underperformed the market on average by 1.4% a year during the relevant period. (2) Even more striking, corporate insiders investing in their own company's stock only beat the market by about 6% a year on average during that period. (3)

The Ziobrowski study's results strongly imply that some members of Congress are using nonpublic information to make trading decisions. Over time, even professional investors do not systematically beat the market. (4) This basic premise of efficient capital markets theory has been confirmed by many academic studies. (5) The only important exception to the rule is corporate insiders trading in their own corporation's stock. (6) The obvious and generally accepted explanation for insiders' ability to beat the market is their access to and use of material nonpublic information about their company. (7)

It seems unlikely that U.S. senators as a group have such unique investment skills that they can outperform not only the market as a whole but also corporate insiders over an extended period. Instead, it seems more reasonable to assume that the superior returns found by Ziobrowski result from senatorial access to--and use of--material nonpublic information about the companies in whose stock they traded:

   Looking at the timing of cumulative returns, the senators also
   appeared to know exactly when to buy or sell their holdings. … 
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