By Michael Roytman
Introduction:
On December 16, 2021, when asked by a reporter whether she knew about the 5 month investigation about insider trading violations, Nancy Pelosi was unknowledgeable about the proceedings of the investigation, but adamantly emphasized that, “It’s a free market economy, and everyone deserves to participate.” Unfortunately that is not the objective truth in the United States’ political economy.
The government intervenes in the economy for the purpose of central planning, whether it comes to social security, welfare, or taxes, policies that Pelosi was an ardent supporter of. The government reach extends beyond certain consumer issues, and has well affected the overarching state of the Keynesian economy we are currently in. With the interest rates set to rise to combat the level of inflation, the Consumer Price Index rising to around 7%, and the value of the dollar decreasing, any American who would be worried about their networth would probably invest their M1 into growth or value assets in the stock market.
However, on the counterpart of retail traders, people in congress like Pelosi have access to extremely sensitive material nonpublic information that is collected for the purpose of regulation, but instead is used in an unauthorized manner to reap unfathomable profits. Nancy Pelosi was the most coveted trader of 2021, with a 45.59% return on her stocks and 66.7% return on her options, so much so that she has been compared to Warren Buffett.(Unusual Whales 2021) The fact that the American government has legislation in place to stop people who manipulate its economy from unethical profiteering, hasn’t been a concern of any sorts.
The American public should condemn bureaucrat politicians for inability to yield personal financial dealings for audit, and impose more severe legislative consequences as punishment. Citizens should also potentially explore new limitations to congressional terms, in order to better the conduct of individuals responsible for the function of democracy.
Definition of Insider Trading:
According to Investopedia, insider trading involves trading in a public company’s stock by someone who has non-public, material information about that stock for any reason. Insider trading can be either illegal or legal depending on when the insider makes the trade. No matter how trustworthy congressmen are, their committee’s require access to sensitive business data for effective implementation of its programs, but mishandling of this data may result in disclosure and uncompensable damage.( Smith, 1977, 780) Sometimes congressional access to undisclosed information comes not through clearance, but through corporate friendships and previous private sector positions of power. A great example in this case would be the incumbent senator from Arizona, Mark Kelly.
Mark Kelly, previously an astronaut, failed to disclose a stock option investment on Boom Technology Inc, a company which is in the process of developing a supersonic passenger aircraft. Senator Kelly previously logged 54 days in space as a NASA astronaut, and was part of the independent safety advisory panel of SpaceX, which implies that he was well accustomed with the industry. This is contradictory to what he said a month after, when introducing a Ban Congressional Trading and Stock Act on the Senate Floor on Jan 22. According to Kelly, his own stocks were already in a blind trust, not only making him unable to “make trades, I don’t even know what’s in there.” In the wake of the 2020 congressional insider trading scandal many others were exposed, but this scandal wasn’t the only historical example of politicians leveraging information in making trades.
Historical Background on Insider Trading:
In 1792, the first inside trader assistant secretary William Duer tried to use his connection with Alexander Hamilton to speculate large profits off the newly established government’s operations. When the securities bubble burst, Duer went bankrupt as did the entire city of New York. In the 1800s politicians sought to profit off the railroad expansion by short-selling railroad stocks. That could be exemplified in the Crédit Mobilier Scandal. During the beginning of the 20th century, the Supreme Court ruled the practice of insider trading illicit activity as a result of Strong v. Repide. J.P. Morgan had a fair share of influence on particularly Republican congressmen during the 1920s. However after the Great Depression, new commercial bank legislation prohibited them from engaging in illicit activities, creating regulatory agencies such as the SEC. In the 1960s the Senate and the House established conduct committees to authorize self-discipline within congressman ranks. Since then the SEC tightened regulations on nonpublic information usage.
With the coming of the 21 century, information technology was forever revolutionized and so was the power of congressional access. In 2004, a professor from the Georgia State department of Real Estate, Alan J. Ziobrowski, conducted a study on the annual stock performance of certain demographics compared to the market and U.S. Senators had the largest return of 12.3% in comparison to the rest of the interest groups. (Ziobrowski, Cheng, Boyd and Ziobrowski 2004) The SEC being on the decline with limited resources such as attorneys, lawyers and overall low staff turnout spurred more scandals, Senators Bill First’s ties with the HCA and Senators Diane Fienstein failure to relinquish government contracts to her husband’s company. Around the same time Representative Brian Baird and Representative Louise Slaughter introduced the STOCK Act which was supposed to bar congressmen to profit off nonpublic information. A couple years later, Obama signed the STOCK Act into existence in April of 2012.
Figure 1: Abnormal Returns from the Common Stock Investments of the U.S. Senate Findings(Cluster Groups on the X-axis, Portfolio Return on the Y-axis)
Current Legislation:
The STOCK Act of 2012 wasn’t what hit the nail on the head to end insider trading once and for all. Actually it was more like a culmination of historical efforts to an ethical dilemma that persisted since Wall Street was just a tiny exchange under a buttonwood tree. After the Great Depression, President Roosevelet sought to tighten control over how financial instruments are traded and safeguarded from irresponsible profiteering. The Securities Act of 1933 was the first major piece of federal legislation regarding the sale of securities, with purposes to ensure more transparency in financial statements so investors can make informed decisions about investments, and to establish laws against misrepresentation and fraudulent activities in the securities markets. The Securities Exchange Act of 1934 created the SEC, a regulatory agency designed to make more reliable information and clear rules of honest trading. In 1958, to keep its members accountable, the Congress adopted the General Code of Ethics for Government Service, which was to apply to all federal workers constituting the three branches of the government. Soon both the Senate and House followed up with their specific codes of conduct.
During the 1960s the Securities Act Amendments extended corporate disclosure requirements to OTC stocks, raised requirements for entry into the securities business, and strengthened disciplinary controls of the SEC over brokers and dealers. In the 1970s code of conducts were amended with financial disclosure rules, and the 1978 The Ethics in Government Act signed into law for all senior personnel and 3 branch employees. The Insider Trading Sanctions Act of 1984 (ITSA) increased civil and criminal penalties for trading while in possession of material nonpublic information. The criminal penalty went up to 100 thousand dollars, however without a defined cause of action the only thing amended was the penalty. The Greed Decade brought on massive stock scandals with Dennis Levine, Ivan Boesky and Michael Milken on the covers of major journalistic publications. So, the government sought to expand the SEC authority with a bunch of administrative tools to restrict security trades.
The SEC under Bill Clinton wanted to improve asymmetrical information in markets by making any material information relevant to just shareholders public. However, the Sarbanes-Oxley Act of 2002 also granted government officials up-to-date financial information because companies had to disclose ‘on a rapid and current basis’ any changes in operations or financial condition. Finally the STOCK Act, made it mandatory for congressmen to file a report on all securities traded in value above $1000 with an enforceable time limit for report, limited access to IPOs, and developed a database for all financial fillings from the Congress. The STOCK Act was supposed to be the culmination of efforts on limiting conflict of interest in stock trading, but the legislation rather turned out to be Sisyphean. The legislation was a slap on the wrist for guilty people in Congress by administering an initial fee of $200 dollars for a reporting violation, with no public information available on whether they had paid it or not. The STOCK Act didn’t expedite legal procedures of insider trading disclosure, which is a disappointing state of affairs in ethically-centered legislation.
Analysis and Purpose:
As witnessed through history, it is evident that the private sector and bureaucrats in power tend to have a lot of collusion, whether it has direct purpose in a direct representative democracy or whether it is due to inappropriate interests. The question is though, why should we restrict people in Congress from leveraging publicly undisclosed corporate information, if they are considered ordinary citizens, who would probably seek to do the same if they weren’t in office?
It is in human nature to prescribe intrinsic value to information catalyzing moral hazard because we like to compete and win by any means possible. However, as civilized beings we must understand the morality we use to govern our nature in order to ensure the fairest partition of resources and entitlement of rights. Particularly for the function of Congressional duties, we should consider the original intent for the purpose of Congress. James Madison, the original proprietor of the political institution believed that ideally, the institution’s legislators would disperse power by sharing and be keen to their commitment to the values that got them elected in the first place. Madison wrote in Federalist 48, “a mere demarcation on parchment of the constitutional limits of the several departments, is not a sufficient guard against those encroachments which lead to a tyrannical concentration of all the powers of government in the same hands.”(Madison 1788 48) With the establishment of bicameral legislatures, both the interest of the public and the state government of the public would be represented at the federal level. Historically, that representation was skewed first due to the exclusion of underprivileged minorities, second because Article 1, Section 2 had also excluded certain candidates from getting elected which tarnished the principle of representation. Hence, the legislative branch of the government had a rift with representing public welfare in the past, which is why insider trading would be a gross misuse of political mechanisms in order to take advantage of a historically flawed institution that alienated minority interests in democratic decision making.
Given Madison’s argument for an idealistic congressional duty, it invokes the basis of the original purpose of this country’s government which was founded on the premise of Christian secularism and Enlightenment philosophy, which brought limitations to the political power of religious organization. The founding fathers intended for the moral engrainment of Christianity and Greco-Roman philosophy into our society. A simple biblical parable which could serve as a basecase for congressional behavior would be the parable of the Rich Fool, where Jesus himself says, “Watch out! Be on your guard against all kinds of greed; life does not consist in an abundance of possessions.” Sure, the expectation of all congressmen being holy people and actually upholding religious principles that dictate their lifestyle is erroneous. However, it would be expected for the people in Congress to uphold “Biblical” dignity in their job because the rhetoric of legislation must be based upon the politician’s platform and the political framework their nation was built upon.
Overall, insider trading seems to be in hand with a historically prejudiced institution that has taken advantage of its voters in order to profit from its positions of power and authority. In order to stop further scrutinization of the democratic process, a policy proposal must be enacted.
Solution Propositions:
Solution 1: Expand the power of the Office of Congressional Ethics, in order to prosecute Congressmen for perjury about their trading record.
Both chambers have bodies to monitor adherement to each respective code of ethics. For the House, it is the Office of Congressional Ethics and for the Senate it is the Select Committee on Ethics. Most recently according to the staff director of OCE, Omar Ashmawy, representatives are becoming less transparent in investigations, since there is no requirement to participate.(New York Times, 2021) What would aid the process is a mandatory yield of evidence, including any property found on premises of government buildings. The Office of Congressional Ethics’s power should be expanded to both chambers, since it is non-partisan, while the Select Committee on Ethics is not, hence why it should be dissolved. Having the freedom to investigate with mandatory cooperation, OCE wouldn’t have to present the investigations to more legislative sub-organizations, but instead send the straight to the federal court.
The OCE would have the power to issue contempt of Congress, based on the premise of obstruction of justice. Under the ordinance of Title 18 dealing with criminal procedure, tried private entities may be subjected to penalties for acts such as perjury, impairment of documentation, its elicit use and evading legal process.(Congressional Research Service, 2010) Members of the House or Senate committees who are involved in financial corporate dealings must already file LD-203 Individual Lobbyist Filing Obligations for lobbying buyouts, so they must do the same for insider trading information. Hence it is a must, that congressmen who are entrusted with sensitive material information should be ironically subject to suspicion for inherent contempt. After the Watkins v. United States trial in 1957, the Supreme Court affirmed that , “the power of the Congress to conduct investigations is inherent in the legislative process”.(John T. Watkins, Petitioner, v. United States of America, 1957) The federal district court could issue civil subpoenas based upon the writ from the OCE. Congressmen summoned to the court must testify that they have properly handled corporate information, and if found guilty of misappropriation, must be punished in accordance with due process.
Solution 2: Restrictions on Investment
Politicians as investors could use confidential information for leverage trading, where they could use margin debt to increase profitability, and bypass beta of the equity itself, given that they know which direction the price would swing. To make politicians’ involvement in trading financial instruments more equitable in the sense of justice and uncertainty, the margin limit should be exponentially lowered. The Federal Reserve set the limit at 50%, so setting the limit at a way smaller percentage to decrease the returns of an investment on the speculated company’s equity.
Beyond account restrictions, further limitations apply to moneyness and time. When it comes to actual securities or commodities, short positions should be outlawed. Rather bearish long term sentiment from Congressional traders definitely implies access to sensitive information past financial statements. Long positions would only be allowed if people in Congress had prior investment in them, however a dollar cost investment strategy should be prohibited. Politicians would only be allowed to invest money in blind trust funds composed of random stocks and commodities. When it comes to moneyness, another way to minimize unethical profits as an externality of insider trading, would be to set mandatory limit order on derivatives by a percentage standpoint of its difference from the option’s strike price.
Also, to limit profiteering it should be possible to outright ban trading of high volatility stocks by congressional brokerage accounts. In general, government officials should have private brokerage accounts that have certain restrictions prescribed by their financial services company provider, to avoid kleptocratic exploitation of the financial markets.
Solution 3: Forbid Congressional Trading Entirely
The United States delegates the power to congressmen by the rule of the people, so they could rule for the people. However, if the legislative system is manipulated so accruement of wealth is easier for politicians because they have the privilege of access to information that could aid them in unfair investments, then the intended function of our democratic republic is innate flawed. James Madison might have foreseen this issue because he held disdain for financiers who had gone long on state debt descend on Congress to lobby for their interests, effectively holding the entire funding program hostage until they were guaranteed their speculative returns. A more republican approach to representation was what was intended, since it meant to serve the interest of all Americans, and not a select group of the ones in charge. Illicit use of power, especially when it is visible and acknowledged by the media, is a bad sign for this late stage government.
It seems that the more selfish individuals in Congress are legislating fiscal policy proposals, simply for the purpose of compromise in the political duopoly America has today, instead of actually having a long lasting impact on the American public. Insider trading by politicians is just one great example of how avarice in the government is stipulating the foretold political doctrine of anacyclosis, and according to Polybius’s sequences, the United States is descending from a democracy into an utter kakistocracy. The best and most effective suggestion to limit financial profiteering of congressmen is an absolute ban of congressional trading.
Congresspeople are still humans, so all of their assets aren’t being seized by this legislation, just the ability to exponentially multiply their intrinsic value. Any access to financial instruments must be put on pause while being in the office, in order to completely abstain from the association of engaging in the manipulation of the market liquidity. This denotes that even a blind trust is inefficient in regards to solving asymmetric information. Although the beneficiaries do not know the assets held in trust nor do they have no power to participate in the management or distribution of those assets, they must allow the trustee to convert existing assets into new assets, where the potential for investment isn’t limited to cash or “safe” assets. So a person in Congress would already know what assets are being transferred into the blind trust which is paradoxical to their intended purpose. Since we are not totally a free market economy, this imposition is only to invoke patriotic subservience in the public stewards’ behavior.
Work Cited
Levinthal, Dave. “58 Members of Congress Have Violated a Law Designed to Stop Insider Trading and Prevent Conflicts-of-Interest.” Business Insider. Business Insider, March 19, 2022. https://www.businessinsider.com/congress-stock-act-violations-senate-house-trading-2021-9.
“Unusual Whales.” Unusual Whales. Accessed March 22, 2022. https://unusualwhales.com/i_am_the_senate/pelosi.
Smith, Barbara J. “Congressional Treatment of Confidential Business Information- Digital Repository.” Digital Repository @ Maurer Law. Indiana University School of Law, 1977. https://www.repository.law.indiana.edu/cgi/viewcontent.cgi?article=3291&context=ilj.
“How Do Congressional Representatives’ Stocks Perform in Relation to the General Market?” ProConorg Headlines. Accessed March 22, 2022. https://insidertrading.procon.org/view.answers.php?questionID=001034.
Congressional Research Service. (2010, November 5). Obstruction of Congress: A brief overview of federal law relating to interference with Congressional Activities. EveryCRSReport.com. Retrieved March 22, 2022, from https://www.everycrsreport.com/reports/RL34304.html#_Toc277574787
Legal Information Institute. (n.d.). John T. Watkins, Petitioner, v. United States of America. Legal Information Institute. Retrieved March 22, 2022, from https://www.law.cornell.edu/supremecourt/text/354/178
Staloff, Darren. HAMILTON, MADISON, AND THE POLITICS OF CORRUPTION. Jack Miller Center. Retrieved March 23, 2022, from https://jackmillercenter.org/hamilton-madison-and-the-politics-of-corruption/
MADISON., J. (2021). Federalist Papers. MINT EDITIONS.
Broadwater, L. (2021, December 28). Ethics investigators in Congress increasingly run into walls. The New York Times. Retrieved March 22, 2022, from https://www.nytimes.com/2021/12/28/us/politics/congress-ethics-investigations.html
Ben, Werschkul. “Sen. Kelly: The Insider Trading Happening in Congress Is ‘Not Right’.” Yahoo! Finance. Yahoo! Accessed April 8, 2022. https://finance.yahoo.com/news/sen-kelly-the-insider-trading-happening-in-congress-is-not-right-152331646.html.