"It profits me but little that a vigilant authority always protects the tranquillity of my pleasures and constantly averts all dangers from my path, without my care or concern, if this same authority is the absolute master of my liberty and my life."

--Alexis de Tocqueville, Democracy in America

Monday, November 14, 2011

And Why Exactly Isn't This a Major Scandal? - Revisited


The post below was from September 28, about seven weeks ago.   I asked why it wasn't a major scandal that the laws of insider trading don't apply to Congress.   Well, now it is a major scandal, or at least I hope it is, since it has now ensnared one of the biggest names in Congress on the Democratic side, former Speaker of the House Nancy Pelosi:

Last night, 60 Minutes aired its report on possible insider trading by Members of Congress. A principal focus of the report was House Minority Leader Nancy Pelosi and her participation in an IPO of Visa, one of the hottest IPOs in recent years. Reporter Steve Kroft questioned Leader Pelosi recently at a press conference about her investment and its possible impact on credit card legislation before the House during her term as Speaker.

Participation in a stocks IPO, i.e. Initial Public Offering, is one of the more sought after trades on Wall Street. Often, an IPO investor is able to get into a stock at a relatively low price and realize an almost immediate gain once trading commences, especially if the IPO is “hot” or, rather oversubscribed, meaning more investors wanted shares than were available. Visa’s IPO was blockbuster-level “hot.” As reported by The New York Times:
Visa‘s blockbuster initial public offering is currently oversubscribed for its expected trading start on March 20, Scott Sweet of the research firm IPO Boutique told MarketWatch.
Mr. Sweet told the publication that the I.P.O. is drawing “extreme demand.”
It is very difficult for any individual investors to participate in an IPO, as most of the shares are reserved for major brokerage clients, institutional investors and pension funds. It is so difficult, in fact, the SEC has published an “FAQ” on why it is so difficult for individual investors to participate in IPOs:

The underwriters and the company that issues the shares control the IPO process. They have wide latitude in allocating IPO shares. The SEC does not regulate the business decision of how IPO shares are allocated.
Somebody, somewhere decided to allow Nancy Pelosi-or her husband-participate in what was the most anticipated IPO that year. It could have been one of the underwriters selected by Visa to manage its IPO or it could have been Visa itself that awarded the Pelosis the coveted shares. Who was it? And, did they approach Pelosi or did Pelosi approach them?

My strong suspicion is that this kind of scandal will likely hit both Republicans and Democrats.   As far as I'm concerned, that's fine.   This sort of thing is pure corruption... it's a flat-out bribe, particularly if we learn, as I'm sure we will, that Pelosi and her husband flipped the stock soon after obtaining it in the IPO, once the price went up dramatically.


Original post (9/28/11):
Ace of Spades is highlighting the fact, unknown to most, that the laws against securities fraud, and specifically the laws against insider trading do not apply to Congress.    With predictable results, I might add:

A pair of recent academic studies found that House members beat the market in their personal stock trading by about 6 percent, and Senators beat the market by about 10 percent.

In the 2011 study “Abnormal Returns From the Common Stock Investments of Members of the U.S. House of Representatives,” four university professors found that a portfolio that mimics the purchases of House Members beats the market by 55 basis points per month, or approximately 6 percent annually. That study looked at 16,000 common stock transactions made by approximately 300 House delegates from 1985 to 2001.

“Overall we find that the common stocks purchased by Members of the U.S. House of Representatives earn statistically significant positive abnormal returns. Our results indicate that Representatives, like Senators, also trade with a substantial information advantage,” wrote the study’s authors, Alan J. Ziobrowski of Georgia State University, James W. Boyd, of Lindenwood University, Ping Cheng of Florida Atlantic University and Brigitte J. Ziobrowski of Augusta State University.

The group also noted that stocks purchased by Democrats outperform stocks purchased by Republicans.

This ought to be a major, major scandal, if the media were doing it's job.   And, from a legal perspective, while this may not be securities fraud, I have a hard time believing that trading on insider information you obtain as a Congressman isn't a crime.   Information is valuable, and obtaining something of value in relation to issues you vote on is corruption by definition.  

Moreover, trading on such information (and doing better than the general public) is akin to a trustee self-dealing in matters affecting a trust.   It's a breach of fiduciary duty.   After all, consider that every time a Congressman buys a stock, someone else sells it; every time a Congressman sells, someone else buys.   If Congressman are doing better than the norm on their trades, that means that the people they are trading with (let's call them "citizens") are doing worse.  

In short, the Congressman who trades on insider information is willfully screwing the public he has sworn an oath to serve.   

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