Why Congress is warming up to ban on insider trading

Legislation to bar members of Congress and staff from trading on insider information, sidelined in Congress since 2005, is suddenly on a fast, bipartisan track.

A new book by conservative author Peter Schweizer and a CBS “60 Minutes” exposé on Nov. 13 have given the issue a sharper profile – featuring examples of lawmakers who appeared to use insider information to score unusually high profits on Wall Street in ways illegal to other traders.

On Tuesday, the House Financial Services Committee launched a hearing on proposed legislation known as the Stop Trading on Congressional Knowledge Act (STOCK). By next week, the Senate Homeland Security and Governmental Affairs Committee expects to mark up legislation to strengthen a ban on insider information.

For the past half decade, Rep. Louise Slaughter (D) of New York never attracted more than a handful of sponsors willing to endorse her bill to explicitly ban members of Congress from insider trading. Now, the STOCK bill has more than 170 sponsors and counting.

Sens. Kristen Gillibrand (D) of New York and Scott Brown (R) of Massachusetts, both up for reelection in 2012, are also sponsoring bills to outlaw the practice.

Moreover, Rep. Spencer Bachus (R) of Alabama, a target of insider-trading charges, is proposing legislation that requires all members to place their stocks, bonds, commodities, futures, and other forms of securities in blind trusts run by independent managers.

Representative Bachus, chairman of the Financial Services Committee, disputes claims that his profits during the financial downturn were due to insider information. In a letter citing factual errors in “Throw Them All Out,” Mr. Schweizer’s book, Bachus he says that he does not trade in companies related to the jurisdiction of his committee, and that claims in the book to the contrary are “unfair and untrue.”

“While laws that prohibit insider trading already apply to Congress, this bill [proposing blind trusts] sets a higher standard of public service,” Bachus said in a statement. “It is an extra step that will strengthen accountability and, hopefully, the public’s trust that no Representative or Senator benefits financially from non-public information.”

Some witnesses at Tuesday’s hearing pointed out that members of Congress are already subject to insider-trading laws.

“Congressional insider trading in securities violates the broad anti-fraud provisions in federal securities law as well as the federal mail and wire fraud statutes,” says Indiana University law professor Donna Nagy, in testimony prepared for the hearing. “Thus, congressional insider trading is already illegal under existing law.”

Adds Larry Lavender, GOP staff director of the Financial Services Committee: “There’s a claim widely disseminated that members of Congress are not subject to insider-trading laws. That will be roundly disproven.”

The aim of the Bachus legislation is to avoid even the appearance of profiting on inside information.

After the CBS exposé, the House ethics panel on Nov. 29 released a memo reminding lawmakers that they are subject to insider-trading laws.

But critics say there is evidence that members of Congress have advantages over other investors that produce outsize profits. In a 2004 academic paper widely ignored at the time, economist Alan Ziobrowski detailed how US senators who actively traded stocks outperformed the market by nearly 12 percent in the mid-1990s. A more recent study of House member portfolios from 1985 through 2001 shows similar but less-dramatic gains.

“When I first testified before Congress, only a handful of people were there,” says Mr. Ziobrowski, a business professor at Georgia State University in Atlanta. “Then, there was ‘60 Minutes.’ They broadcast before millions.”

In fact, most members of Congress don’t actively trade stocks, he notes. “But the basic issue is appearance. The public needs to have some confidence that when members vote on an issue, they do so because they think it’s good for the American people,” he adds.

While approving the direction of proposed legislation, ethics watchdog groups say that any resulting law needs to be even tighter. The STOCK legislation requires members of Congress to disclose their trades within 60 days. That’s not prompt enough, says Melanie Sloan, executive director of Citizens for Responsibility and Ethics in Washington.

“Corporate executives are required to report trades in 48 hours,” she says. “A week to 10 days would be reasonable for members of Congress.”

The new public focus on the issue is giving it unprecedented momentum, she adds. “Members who vote against it,” she says, “have a potential election ad against them that’s pretty easy to write – that members want to protect their privilege to trade on inside information.”