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What Congressman Would You Buddy Up With To Help With Your Insider Trading?

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The Wall Street Journal has a totally maddening article today about insider trading by hedge funds who pay expert-network consultants to give them inside information about congressional deliberations. Which you’d think would have prosecutors demanding that they get 20 years in jail without any concern for their delicate constitutions, except no:

Securities laws don't, however, bar most political insiders from sharing nonpublic information about government affairs. On the contrary, part of the job of lawmakers, staffers and lobbyists is to discuss policy options and pending legislation with anyone who might be considered an interested party. "A legislator normally talks to a lobbyist without any expectation that the information will be kept confidential," says Karl Groskaufmanis, a lawyer at Fried, Frank, Harris, Shriver & Jacobson LLP in Washington who focuses on securities regulations.

"The ultimate [investing edge] is insider information, so you want to get as close to the line as possible without crossing the line," says Sanford Bragg, chief executive officer of Integrity Research Associates LLC, which evaluates investment-research firms. "That's why Washington is so interesting—because there is no line."

Though this is not exactly a surprise to anyone interested in insider trading and the workings of government, that particular sequence of paragraphs filled me with an unfamiliar urge to put on a Guy Fawkes mask, Occupy Wall Street, protest the money-politics nexus and throw all the banksters in jail.

But then, like, breathe. Insider trading, which tends to be a victimless crime that helps markets obtain efficient prices, is not the worst thing in the world. The argument for criminalizing it is typically “insider trading undermines ordinary investors’ confidence in the capital markets,” which, THIS. The Journal's report, and the totally blasé “there is no line,” manages to undermine confidence in the markets, in government, in everything. WE ARE THE 99%.

Still. Breathe. You could make the case that trading on this sort of information about pending legislation improves price discovery and allows information to be transmitted efficiently between politicians and markets. That’s a good thing both for the markets – which can anticipate information about who is going to be screwed by the next bad idea / blessed with below-market loans - and for the legislative process. It can serve as a sort of natural experiment: Legislator tells Lobbyist “we are definitely not increasing the debt ceiling, we’ll just default, we think it’ll be awesome,” Lobbyist tells Hedge Fund, Hedge Fund shorts everything in sight, markets tank, and Lobbyist goes back to Legislator and says “so, are you satisfied that this is going to destroy the world yet?” And then maybe Legislator is willing to increase the debt ceiling.

But it’s pretty annoying. Whatever value is being created here is being siphoned off by middlemen who talk to legislators and can sell that access to the highest bidder for private gain. The legislator isn't paid, at least not directly, which means that he's probably getting compensated in some creepy non-transparent way, like the lobbyist is taking him on lavish vacations or finding him pages with loose morals and a thing for grandfatherly types. The government - whose information it is, I guess, if it's anyone's - gets nothing.

Now that’s true of regular old insider trading too – insiders siphon off corporate information for private gain. But for companies, allowing insider trading can be a sensible compensation mechanism. For legislators that is not at all true - the best profit-maximizing opportunity for a legislator might be to get short the US economy and then do his worst to screw up the country.

So what should be done about congress insider trading? Prohibiting congressmen from discussing their deliberations with outsiders seems like a step in the wrong direction. Banning trading based on those conversations is pretty appealing, but it's another expansion of federal criminal law with dubious underpinnings.

Maybe the simple answer is transparency. Let congressmen sell access directly just like expert networks do – publish an hourly rate and let anyone who wants pay them to ask questions about pending legislation, committee processes, whatever. Make it a first-come first-served signup, or an auction, whatever. Limit the hours they can spend on this – so they can occasionally do their day job – and make them turn over, say, 50% of pretax earnings to the Treasury.

The advantage is that you have much more transparency, more information probably gets out more efficiently, and there's no favoritism - just market mechanisms. Oh and the government actually gets paid for this information.

The main disadvantage would seem to be that open selling of access would undermine confidence in markets, democracy, take your pick. It's just hard to see how it could do more so than articles like this.

Hedge Funds Pay Top Dollar for Washington Intelligence [WSJ]


After The STOCK Act It Will Still Be Legal To Trade On Congressional Inside Information*

Here's a sort of touching monologue from David Einhorn's call with Punch: If you’ve done the analysis, and come to the conclusion that on it’s own, the company is not going to make it, it makes all of the sense in the world to raise equity at whatever the price is, so that you can know that the company, you know, is – is going to make it. Now, what that brings to my mind though is, you know, obviously we haven’t done your analysis, we haven’t done -- signed an NDA; I don’t know that we’re going to sign an NDA, because we prefer to just remain investors, but from my perspective, and I’ll be just straight up with you, is that gives a lot of signalling value. And the signalling value that comes from figuring out the company has figured out that it’s not going to make it on it’s own is that we’ve just grossly misassessed the -- you know what’s going on here. And -- and that, that will cause us to have to just reconsider what we’re doing, which is not the end of the world to you. You will continue on even if we don’t continue on with you. You could sort of see why the FSA read that to mean that he was insider trading. Like ... (1) You have told me something with signalling value. Sorry - "a lot of signalling value." (2) I will now act on that signal. (3) Don't be mad. "Signalling value" sure sounds like it means "material nonpublic information," doesn't it? Now as we've discussed before, trading on that information would not be enough to make Einhorn guilty of insider trading in the US, though maybe it wouldn't be exactly a great idea here either. Why? Because in our weird but sort of sensible insider trading laws, it's just not illegal to trade on material nonpublic information. It's only illegal to trade based on material nonpublic information that was obtained in violation of some sort of duty of confidence. Since Einhorn didn't sign an NDA, he had no duty of confidence. And since the Punch CEO and bankers weren't tipping him for nefarious purposes, but were instead sounding him out on the company's behalf as a shareholder and potential investor in a new capital raise, they weren't breaching their duty of confidence. You could quibble with the details of that but it's basically the law here. In England not so much. That also seems to be the law for our friends in Congress, who recently passed a law making it illegal for them to insider trade, which is worrying some people who make their living from trading on Congressional inside information: