February 1, 2012

The Flip Side of the Insider Trading Ban

Hester Peirce

Former Senior Research Fellow
Summary

The most effective way to slow the unseemly quest for political intelligence is to limit the government’s involvement in the markets.

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Much attention has been paid lately to efforts in Congress to ban insider trading by members of Congress and their staff, which, arguably, is already prohibited under existing insider trading laws. When outsiders meet with government officials, the information can flow both ways. In recognition of this possibility, there are also calls for an analysis of so-called “political intelligence” activities. Hedge funds and other investors use political intelligence – advance knowledge about what government is going to do – to make better informed investment decisions. Scouts sniff around the Hill, the Executive branch, and regulatory agencies to get a sneak peek into what government is planning to do.

Why do government plans even matter to investors deciding which company to buy? A company’s prospects of success may turn less on the quality of its products or services than on the degree to which the company enjoys governmental favor. Whether a company is able to compete may depend on its ability to convince regulators to adopt a regulatory structure that is hard for its competitors to comply with. The fact that investors are willing to pay big bucks for this kind of information is not a surprise, but it is a troubling reminder of just how large a role government plays in the markets.

As long as the government moves markets, it is no wonder that private investors are willing to pay to get an early glimpse into the government’s plans. The most effective way to slow the unseemly quest for political intelligence is to limit the government’s involvement in the markets.