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Tuesday, March 28, 2006

Insider Trading By Lawmakers (via WSJ)

Lawmakers are once again considering strengthening insider trading laws. However, in a twist, this time the laws wouldn't apply to corporate executives or securities brokers, but to the legislators themselves! According to Tuesday's Wall Street Journal:
Amid broad congressional concern about ethics scandals, some lawmakers are poised to expand the battle for reform: They want to enact legislation that would prohibit members of Congress and their aides from trading stocks based on non-public information gathered on Capitol Hill.

Two Democrat lawmakers plan to introduce today a bill that would block trading on such inside information. Current securities law and congressional ethics rules don't prohibit lawmakers or their staff members from buying and selling securities based on information learned in the halls of Congress.

It isn't clear yet what kind of support the bill will garner from Republicans. But its prospects are enhanced by the current charged environment in Congress; lawmakers from both parties in both houses have placed a high priority on passing ethics and lobbying-reform legislation. Such legislation would provide a vehicle to which proponents could attach a measure on stock trades. In addition to banning trading on inside information, the proposal would require that lawmakers and their top aides disclose within 30 days any stock trades. Congressional rules now require lawmakers to disclose their trades once a year.
Read the whole thing here (online subscription required).

This is one of the few cases where I'd be more in favor of additional regulation than not, but I don't think it goes far enough. I don't have a problem with legislative "insiders" trading on inside information. But, I think they should be held to the same standard as corporate insiders - make them report their trades within a couple of days. In addition, I think they should make the reports of trading available online so that they become public much sooner. After all, it would provide valuable information that would make markets more efficient.

There is some evidence that legislators benefit from inside information, and I'm surprised the Journal didn't mention it (they're usually pretty good at these things). Cheng, Boyd and Ziobrowski in their 2004 Journal of Financial and Quantitative Analysis article "Abnormal Returns From the Common Stock Investments of the U.S. Senate" found that
...a portfolio that mimics the purchases of U.S. Senators beats the market by 85 basis points per month, while a portfolio that mimics the sales of Senators lags the market by 12 basis points per month. The large difference in the returns of stocks bought and sold (nearly one percentage point per month) is economically large and reliably positive.
While this is merely suggestive, it is as Arnie Johnson would have said (in a German accent), "Verrrrrry interesting".

Update: Larry Ribstein has some good analysis on the matter here.

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