Congressional Insiders Trade Whenever They Want

You don’t have to be a corporate insider to run afoul of laws against insider trading, and you don’t need to know any inside information about the stocks you trade. Authorities have gone after journalists, analysts, printers and lawyers, among other non-insiders, for actual or alleged violations.

But if you are a member of Congress, or if you work for one, don’t worry about going to jail for using what you learn on the job to make a killing in the market. Though there are rules to protect ordinary investors from being snookered by those with access to better information, those rules do not apply to you.

The Wall Street Journal recently reported that, in 2008 and 2009, at least 72 congressional aides traded shares of companies that their bosses helped oversee. An aide to a Republican member of the Senate Banking Committee, for instance, bought shares in Bank of America Corp. not long before stress tests on the bank were made public, prompting a sharp surge in value.

Efforts to limit such trading have gone nowhere on Capitol Hill. In 2006, only 15 lawmakers signed on to the proposed the Stop Trading on Congressional Knowledge (or STOCK) Act. Vincent Morris, a spokesman for Rep. Louise Slaughter, D-N.Y., who is a leading backer of the STOCK Act, said, “The public should be outraged there is no law specifically banning this.” But the public’s outrage has been directed elsewhere, and a more recent version of the bill attracted only nine co-sponsors.

Our lawmakers have decided that it is sufficient that they, and about 2,900 of the highest-paid congressional aides, must disclose information once a year on their finances. The disclosures show stock holdings, stock trades and other sources of income. There are no restrictions on what securities they may trade or when they may trade them.

In contrast, here at Palisades Hudson, our employees are flatly prohibited from owning or trading stocks of companies that employ any of our clients as senior executives or in other positions with access to inside information. We have very limited exceptions to deal with pre-existing positions and other unusual circumstances. All other trades in individual company securities must be disclosed quarterly, and those that involve any stocks held by our clients must be pre-cleared by our compliance officer.

Insider trading is a very serious breach of trust. From the day each employee is hired, we drive home the point that nobody should ever have reason to suspect that we might misuse information about a client’s situation to benefit ourselves.

In 1985 the Wall Street Journal writer R. Foster Winans was convicted of securities, wire and mail fraud after he revealed information from upcoming columns to two stockbrokers and a client of one of those brokers. The case went to the Supreme Court, which upheld the convictions. The court deadlocked 4-4 on the securities fraud charge, so, officially, the opinion did not set precedent on that question, but it certainly signaled a new, broader view of insider trading.

Later court cases have affirmed that an individual need not owe a fiduciary duty to shareholders in order to be guilty of insider trading. In the case of United States v. O’Hagan, for example, the Supreme Court upheld the conviction of a partner in a law firm who acted on knowledge he gained from a corporate client that affected the prospects of a third party. The partner acquired options in Pillsbury stock after Grand Met retained his firm’s services for a potential tender offer for Pillsbury.

Despite the wide range of conduct that can lead to insider trading charges, it is generally not too hard to know if you’ve gone astray. Where the law is unclear or too complicated to easily interpret, ethics can serve as a guide. In 2002, I interviewed Winans. He told me that, although he had very little understanding of the law surrounding insider trading, he “felt terrible” about what he was doing and knew it was wrong when he did it.

Using inside legislative information to trade securities is just as unethical as using inside corporate or business information for the same purpose. In each case, one party to a transaction has access to data that the other party does not have. Legislators and congressional aides may be privy to information on new regulations or tax changes that can profoundly impact specific industries and companies.

Senate Majority Leader Harry Reid, for example, helped pass tax legislation that widely benefitted the renewable energy industry. Reid and many of his staff members, therefore, were in the position to foresee a bright future for renewable energy stocks long before ordinary investors could be so confident. And, as it happened, Reid’s top energy policy advisor bought a substantial amount of stock in the renewable energy company Energy Conversion Devices while the favorable legislation was under discussion.

Congressional rules justify the lack of restrictions on Capitol insiders by arguing such limits would “insulate a legislator from the personal and economic interests that his or her constituency, or society in general, has in governmental decisions and policy.” We all want lawmakers to eat their own cooking, but freedom to trade on inside knowledge is like being allowed to skip the vegetables after you lick all the dessert batter out of the mixing bowl.

Legislators and their aides could be required to invest only in index funds or other highly diversified mutual funds. This would allow them to benefit from the growth potential of stocks and tie their personal fortunes to those of the economy, without giving them the opportunity to manipulate their holdings based on industry-specific information. Another solution would be to have legislators and top legislative aides quarantine their investments in blind trusts, beyond their direct control, for the duration of their service.

If those who make our laws are too addicted to the ticker to step back from trading, they ought to find another line of work. And if the intransigence over insider trading in Congress continues, voters ought to think about getting another batch of legislators.

About Larry M. Elkin 525 Articles

Affiliation: Palisades Hudson Financial Group

Larry M. Elkin, CPA, CFP®, has provided personal financial and tax counseling to a sophisticated client base since 1986. After six years with Arthur Andersen, where he was a senior manager for personal financial planning and family wealth planning, he founded his own firm in Hastings on Hudson, New York in 1992. That firm grew steadily and became the Palisades Hudson organization, which moved to Scarsdale, New York in 2002. The firm expanded to Fort Lauderdale, Florida, in 2005, and to Atlanta, Georgia, in 2008.

Larry received his B.A. in journalism from the University of Montana in 1978, and his M.B.A. in accounting from New York University in 1986. Larry was a reporter and editor for The Associated Press from 1978 to 1986. He covered government, business and legal affairs for the wire service, with assignments in Helena, Montana; Albany, New York; Washington, D.C.; and New York City’s federal courts in Brooklyn and Manhattan.

Larry established the organization’s investment advisory business, which now manages more than $800 million, in 1997. As president of Palisades Hudson, Larry maintains individual professional relationships with many of the firm’s clients, who reside in more than 25 states from Maine to California as well as in several foreign countries. He is the author of Financial Self-Defense for Unmarried Couples (Currency Doubleday, 1995), which was the first comprehensive financial planning guide for unmarried couples. He also is the editor and publisher of Sentinel, a quarterly newsletter on personal financial planning.

Larry has written many Sentinel articles, including several that anticipated future events. In “The Economic Case Against Tobacco Stocks” (February 1995), he forecast that litigation losses would eventually undermine cigarette manufacturers’ financial position. He concluded in “Is This the Beginning Of The End?” (May 1998) that there was a better-than-even chance that estate taxes would be repealed by 2010, three years before Congress enacted legislation to repeal the tax in 2010. In “IRS Takes A Shot At Split-Dollar Life” (June 1996), Larry predicted that the IRS would be able to treat split dollar arrangements as below-market loans, which came to pass with new rules issued by the Service in 2001 and 2002.

More recently, Larry has addressed the causes and consequences of the “Panic of 2008″ in his Sentinel articles. In “Have We Learned Our Lending Lesson At Last” (October 2007) and “Mortgage Lending Lessons Remain Unlearned” (October 2008), Larry questioned whether or not America has learned any lessons from the savings and loan crisis of the 1980s. In addition, he offered some practical changes that should have been made to amend the situation. In “Take Advantage Of The Panic Of 2008” (January 2009), Larry offered ways to capitalize on the wealth of opportunity that the panic presented.

Larry served as president of the Estate Planning Council of New York City, Inc., in 2005-2006. In 2009 the Council presented Larry with its first-ever Lifetime Achievement Award, citing his service to the organization and “his tireless efforts in promoting our industry by word and by personal example as a consummate estate planning professional.” He is regularly interviewed by national and regional publications, and has made nearly 100 radio and television appearances.

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