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American politicians are the kings of unethical trading

When it comes to profiting from insider information, studies show the Wall Street crowd simply can't keep up with elected folks in Washington.

The U.S. Capitol Hill (Photo: Bill Clark/Getty)

Calling Mr. Smith. It is time for you to return to Washington, where politicians regularly beat hedge fund managers at investing in the stock market, likely by trading on non-public information gained by performing their public duties, according to a new study of trading by elected officials in America.

Georgia State University professor Alan Ziobrowski, along with other academics, recently examined Congressional stock filings to see if delegates in the House of Representatives achieved abnormal returns. The results were statistically significant. “We find strong evidence that Members of the House have some type of nonpublic information which they use for personal gain,” reported the authors. “The returns outperform the market by 55 basis points per month (over 6% annually). As additional evidence of information advantage, the trade-weighted portfolio of purchased stocks significantly outperforms the equal-weighted portfolio indicating that Representatives invested much larger amounts in those stocks that performed.”

This sad state of affairs unfortunately didn’t come as a surprise to Ziobrowski. In a previous study of trading by U.S. Senators during the 1990s, he found stock picks that beat the market by 12% annually on average, when corporate insiders were only beating the market by about 6% and investors amongst the voting public underperformed the market by 1.4%.

Why isn’t the SEC clamping down? Well, believe it or not, the boys and girls in Washington have no firm rules against trading on non-public information, even when it involves pending legislation that could impact the value of stocks. As ridiculous as it sounds, members of Congress, not to mention junior staffers, have no duty of confidentiality.

As a result, American politicians don’t have to divest themselves of common stocks when they assume federal office. They can trade freely while in office. And they are not required to refrain from voting on legislation that could affect the value of their holdings. The fact that “insider trading in Washington occurs with a greater frequency than at Galleon is no secret,” the Zerohedge blog noted after the latest findings were made public.

True enough. Back in late 2005, Washington traders sent share prices of several companies with asbestos-related liabilities soaring shortly before a Senate leader announced legislation to relieve the companies of the legal disputes in question.

Why is this allowed? Simple. As the Ziobrowski study notes, Congress has basically decided that unethical behavior is best discouraged by the public disclosure of financial investments and the discipline of the electoral process. But even the ethical guidelines are unclear. The Senate code places no restrictions on securities transactions. In the House, the ethics code prohibits members of Congress from using their official positions for personal gain. But then, the ethics manual for members defends unrestricted stock trading, insisting that restrictions might impair representatives of the people from effectively representing their constituencies.

That book, like the folks it is meant to advise, is obviously a real piece of work.