Congressional Insider Trading and American Hypocrisy

Posted on December 23, 2011 at 12:45 PM PDT by

Have American politics finally become as debauched as the late Roman Empire?

A recent exposé by 60 Minutes on Nancy Pelosi’s insider trading activity and the resulting media storm have left much of America agape. Can it really be that the same congressional leaders that have established laws to firmly punish insider traders such as Martha Stewart, the insider king Raj Rajaratnam, and just this past week Diamond Back Capital and Level Global, are themselves exempt from the rules? Sadly, under the status quo, they are.

According to reports, former House Speaker Nancy Pelosi bought stock in an initial public offering that earned hefty returns while she had access to insider information about pending legislation likely to impact those values. Additionally, just days after a private committee briefing during the 2008 financial crisis, Spencer Bachus purchased stock options that proved quite profitable through the downturn. The irony that Mr. Bachus is currently the chairman of the House Financial Services Committee is palpable.

And if you have doubt that this problem is widespread, all you have to do it look at the results of a recent study that reveals the average portfolio returns of congressmen and senators. As reported in the Wall Street Journal, these leaders consistently outperformed stock indices like the Dow and the S&P 500 and the returns of professional money managers.

In academic studies from the Journal of Financial and Qualitative Analysis, statistically significant results demonstrate that both Republican and Democratic politicians are outperforming the market, with the Democrats enjoying a whopping 9 percent annual outperformance. Senators were the biggest winners, displaying Houdini-like magic and beating the S&P by 12 percent annually. These results are not due to luck or financial acumen, but are rather the result of trades based on non-public information that these politicians are privy to in closed-door sessions. For the rest of us hard-working and investing Americans, this type of advantage is called insider trading.

Obviously, behavior that is criminal for everyday Americans should not be okay for lawmakers who have the power to gin up laws that affect companies while simultaneously keeping an eye on their own spreadsheets and brokerage accounts. Sadly, however, this is in fact the case.

Congressional immorality seems to extend beyond this insider debacle. Recent reports have revealed that Countrywide provided special VIP loans with publically unavailable discounted interest rates to representatives. There was even a rumor this past month concerning student loans given to congressional family members that are later forgiven. Further research by and others revealed that these forgiven student loans are just for a limited group of staff members who work for our elected officials. Well, there you go; finally some moral fiber. It leaves those of us struggling to get our retirement portfolios on track to wonder if there is a way to pick up one of these staff member positions, or better yet become a lawmaker to get to the real juice.

Some may be old enough to recall Newt Gingrich and Dick Armey’s Contract With America. Amongst such common sense things as a balanced budget amendment, congressional term limits, and “loser pays” tort reform was a cornerstone section that stated: “All laws that apply to the rest of the country also apply equally to Congress.” Here is something that should unite Tea Party members right through Occupy Wall Street protestors: legislation that requires lawmakers to play by the same rules as the rest of us.

Now, due to this dust-up, Congress is pursuing legislation to address the insider trading problem. The STOCK Act seeks to require lawmakers to publicly report all trades within 90 days. Those in the know say this law does not go far enough and that immediate and transparent reporting is necessary on all trading. Unfortunately, the real answer should be moral rectitude in the form of public servants constrained by an internal sense of conviction that they must serve the country and not themselves. This conviction should second nature, but it is no longer clearly evident in congressional behavior. The fact that we have to codify this ethic in writing shows just how bad Washington has sadly become.

On the one hand, lawmakers have been passionate about confronting corruption on Wall Street. From Sarbanes-Oxley to Dodd-Frank, politicians have sought to weed out the next Enron, stop the next Madoff, and avoid the next Lehman collapse and MF Global bankruptcy. All the while, as they slap the hands of others, they too are burying their hands up to their wrists as they riffle through the cookie jar.

While index investing cannot hold a candle to the results these insiders enjoy, this mess underscores why a passive approach to your portfolio is the smartest way forward in this unfair world. While it is hard enough to build a smart and globally diversified portfolio, it is virtually impossible to compete with those who enjoy their insider advantage. By keeping your investment costs down and your bets widely spread across many markets, you will enjoy the rewards of long-term and tax-efficient market growth. If you want to jump into the ring, one hand tied behind your back, and fight the pros with insider insight, then good luck.