Can Rep. Bachus and His Money-Crazed Congressional Colleagues Be Stopped from Insider Trading?

Back in the Gilded Age, venality was the rule in Congress. Bribes were as common as tobacco pipes. Lawmakers fattened their bank accounts through insider deals, with the needs of ordinary people an afterthought. Nelson Aldrich, a powerful Republican who served in the Senate from 1881 to 1911, was that corrupt era’s political poster boy, serving on the Finance Committee and using his position to invest in railroads, sugar, rubber and banking deals that made him rich.

Sound familiar? It should. We’re well on our way to repeating that money-crazed chapter in American history as a growing list of legislators use their office to play the game, “Who Wants to Be a Multi-millionaire?”

Last week we learned that Rep. Spencer Bachus, R-Alabama, Chairman of the House Financial Services Committee, is under investigation by the Office of Congressional Ethics – the first such case involving a member of Congress. The probe comes at a time when America’s ethics alarm bells are ringing loudly. In the business world, trading on insider information is a crime punishable with prison time, but Congress operates in a different – and very lucrative — universe. Recently, the House and the Senate have been debating legislation to stiffen rules on insider trading by lawmakers in the wake of a “60 Minutes” report and a book focusing on the topic, Throw Them All Out, by Peter Schweizer of the conservative Hoover Foundation. But the legislation, known as the STOCK Act, appears to be stalling.

For the public, the debate centers on several questions. Should members of Congress get to trade on and make money from inside information that can seriously sway the markets? Are elected representatives serving the interest of their constituents, or are they serving their bank accounts? And just how do we stop them from abusing their office through insider trading?

More Than Just Luck

A big sign that something is rotten in Washington is that members of Congress who play the stock market do much better on average than the individual investor.

Back in 2004, a study* considered by academics to be the baseline work in the field was published by researchers at four universities. These researchers, Alan Ziobrowski of Georgia State among them, found that during the boom years of 1993-'98, a majority of US senators were trading stocks — and they were beating the market by 12 percentage points a year on average. Corporate insiders, on the other hand, only beat the market by 5 percent, and typical households underperformed by 1.4 percent. Interestingly, there were no differences found between Democrats and Republicans. (See Gail Chaddock's report on the study in the Christian Science Monitor.)

12 percent is a statistically shocking number, way beyond luck or just being smart. Nobody does that well. Not George Soros. Not Warren Buffett.

The 2004 study sent chills through Congress as members realized they were under scrutiny. And yet legislators have gone right on lining their pockets using insider information. In the executive branch, you’re expected to divest yourself of assets when you take office or put your investments into what are known as “blind trusts.” But legislators consider inside dealmaking their divine right. They typically go right on playing the stock market and often neglect to bow out when they have a financial interest in an issue they are legislating. Disclosure statements they have to release are pretty much a joke – they’re incomplete, and they are difficult and expensive for the public to obtain. A reporter requesting documents has to disclose his or her information in the request, which is then sent straight to the member, a move which can be intimidating to those asking questions.

Lawmakers Gone Wild

Remember the frightening days of 2008, the year when Wall Street was crashing and Congress was debating a rescue package? Most of us were scared stiff of losing our savings. But not lawmakers. That’s when the trading fever really caught them again. The influential Rep. Bachus was in the room back in September 2008 when the bank bailout was underway. Through briefings from Secretary of the Treasury Hank Paulson and Federal Reserve Bank Chairman Ben Bernanke, he found out ahead of the public that the markets were going to crash big-time, and he decided he would make some money in the deal, betting against the entire market in what’s called a “short option.” He also sold his shares in General Electric (whose stock price subsequently collapsed), getting out at a profit.

“These meetings were so sensitive that they would actually confiscate cell phones and Blackberries,” Schweizer noted on “60 Minutes.” “What we know is that those meetings were held one day and literally the next day Congressman Bachus would engage in buying stock options based on apocalyptic briefings he had the day before from the Fed chairman and treasury secretary. I mean, talk about a stock tip.”

The Alabama legislator’s funny idea of what he’s supposed to be doing in Congress scandalized the public back in 2010 just as he was named chair of the Finance Services Committee, which oversees banks, financial markets, housing and consumer credit. His succinct summary was breathtaking in its open embrace of corruption: “Washington and the regulators are there to serve the banks.” He forgot to mention that he was also there to serve his portfolio.

OCE investigators are currently examining whether Bachus violated Securities and Exchange Commission laws that prohibit individuals from trading stocks and options based on “material, non-public” inside information.

He may be the worst, but Bachus is by no means alone in his shenanigans. The activities of Sen. Dick Durbin (D-Illinois), Sen. John Kerry (D-Massachusetts), Rep. Jim Moran (D-Virginia) have been under scrutiny as examples of legislators making possible insider trades during the financial crisis. Speaker of the House John Boehner (R-Ohio), and former Speaker Nancy Pelosi (D-California) have also been cited for questionable dealings.

The STOCK (Stop Trading on Congressional Knowledge) Act

Over the years, a version of the STOCK Act has been tossed around and never passed. Members of Congress (surprise!) have not been enthused about applying securities laws to their own trading.

But earlier this month, as the public cried foul, both the House and Senate suddenly seemed open to approving versions of the STOCK Act, and President Obama has vowed to sign such legislation as soon as it hits his desk.

Problem solved? Not so fast. Insider trading is quite difficult to prove. When I spoke to Professor Ziobrowski, one of the researchers on the 2004 study, he observed that you’d pretty much have to have a suspicion ahead of time before you could even make a move against someone. He further noted that there are myriad ways of passing on information, from lunches to golf games, that are nearly impossible to trace. Unless conversations are taped, proving insider trading is difficult at either the corporate level or Congressional level. And what, exactly, qualifies as insider information? If a legislator comes out of meeting sensing which way the wind is blowing on new regulations for the banking industry, for example, does that qualify? The potential for gray area is vast and you can bet that legislators will be taking advantage of this when and if they are indicted.

Then there’s the dismal swamp of the political intelligence industry. Before the 1970s, representatives of various industries would hang around Washington hoping to get a heads up on legislation that might affect business. This tip-collecting then became organized into a formal industry, with players often getting a seat in the room when bills are being discussed and shaped. The result is what you might expect – a system of horse trading where political tips and business tips get circulated to the benefit of everyone except the public. A political intelligence operator gets his or her tip, which could come from a member of Congress or, even more likely, a staffer, and then sells it to a big financial firm. The firm may then offer thanks in the form of donations or insider deals on IPOs and such. There are gargantuan amounts of money involved, and that’s why last week, the political-intelligence industry was breathing a sigh of relief when Republicans chucked a provision from a STOCK bill that would have forced these firms to register their activities like lobbyists.

Finally, any laws that bar members of Congress from insider trading that do not include their staff are also likely to be exploited. “The Capitol Hill reality is that staff go into business, too, either for themselves or with the connivance of their bosses,” political economist Thomas Ferguson told AlterNet. “Any rule that doesn't close that loophole shouldn't be taken seriously. We also need disclosure for spouses, since they are also clearly players in many cases.”

Leveling the Playing Field

The most important aspect of the STOCK Act may be the disclosure rules. Various waiting periods for disclosure have been floated in versions of the bill, some calling for disclosure of transactions within 90 days, others stipulating a 30-day period. Such waiting periods are considered by financial experts to be a huge loophole. Professor Ziobrowski thought that members of Congress should be held to the same time-frame as corporate insiders, who must disclose transactions within 48 hours. After two or three days, he pointed out, “The smoke has cleared and the information on the transaction is of little use to the public.”

But what if the public could observe members betting their money in real time? In such a scenario, you, as a market participant, could make a judgment call on the implications of transactions made by lawmakers. If you see all the members of the Health Committee getting rid of their pharmaceutical stocks all at once, you might not know why they’re doing it, but you may suspect that something bad is going to happen for those stocks.

Giving the public a view of what members of Congress are trading would level the playing field. It would, of course, communicate both good and bad financial information to the markets. If traders had seen that Rep. Bachus was shorting the market the day after his meeting with Paulson and Bernanke in 2008, trading activity may have gone quite differently that day.

Some members of Congress, including Senate Majority Leader Harry Reid and Senate Minority Leader Mitch McConnell, have been trying to weaken the STOCK Act. That leaves the possibility of either no law at all or a law that's useless. “What really concerns me is that we’ll get something passed here, but it won’t do much good,” said Professor Ziobrowski. “They can make something illegal, but if you don’t have the proper tools to uncover the crime, what good is it?”

The American public is strongly opposed to insider trading. But if members of Congress are being asked to basically police themselves through the passage of a new law, it will be difficult to get something with real teeth. Still, keeping the topic front and center in the public mind is a good way to give members pause the next time they decide to violate their ethical duty to the public and use their office to enrich themselves.

*The study, “Abnormal Returns from the Common Stock Investments of the U.S. Senate, Alan J. Ziobrowski, Ping Cheng, James W, Boyd, and Brigitte J. Ziobrowski, was published in the Journal of Financial and Quantitative Analysis (Dec. 2004).