To Stop Insider Trading in D.C., Shrink Government

This article was originally published in The Hill

Widespread outrage over the recently passed STOCK Act, however justified, is misplaced, as it is directed toward a symptom, not the disease. The disease is the ever-growing micromanagement of the economy by the federal government. You can’t cure a cold by blowing your nose, and you can’t “cure” Washington by trying to restrict information flows.

Inside political information is valuable because legislative actions can have huge effects on industries, and there are few industries these days that don’t face political risks or opportunities in Washington. Subsidies, bailouts, taxes, regulations governing how you can do business---these are just a few of the ways in which Washington can make life miserable (or pleasant) for a corporation.

Health care and finance are just two industries in which politically sensitive information is valuable. Consider the Affordable Care Act’s mandate that all Americans buy insurance. This mandate is being reviewed by the U.S. Supreme Court, but when it was passed, it was expected to deliver a new set of customers to the insurance industry, which in turn was expected to boost industry profitability. Advance knowledge of whether there would be a mandate and, perhaps more importantly, how it would be structured, would be of significant value for an investor in the insurance industry. 

Similarly, the Dodd-Frank Act offered many opportunities for members of Congress and others in the know to trade before the rest of the market caught on. The structure of Sen. Dick Durbin’s debit card processing fee price cap, for example, affected prospects of profitability for debit card issuers and large retailers. The specific wording of Dodd-Frank’s highly technical derivatives provisions had the power to determine the future profitability of companies that hoped to serve as trade data repositories, clearinghouses, or exchanges for swaps, as well as the Main Street companies that rely on swaps to hedge their risks. Keep in mind that these are just a few of the provisions in Dodd-Frank, and this was just one piece of legislation.

If laws and regulations were not such crucial determinants of business success or failure, cashing in on inside information about upcoming regulatory changes would not be so lucrative. If government were not so omnipresent, the resources devoted to gaining an edge in political information could be put toward productive use. But the stakes are high. Not only can the costs of regulation affect companies’ bottom lines, but so can government subsidies or grants of regulatory monopolies.  

Advance knowledge that a company or industry will be on either the winning or the losing side of a law or regulation is very valuable to investors. As long as the federal government is actively managing the economy, information about what it is planning to do will be an important factor in the investment decisions of members of Congress, congressional staffers, and hedge funds that have paid people to glean this information from Congress. The STOCK Act won’t affect these incentives.

Those members of Congress who are shocked, just shocked, at stock trading on political information may want to look in the mirror, because they have created the problem. If they really wanted to solve it, they’d rethink the federal government’s micromanagement of the economy. They would eliminate corporate subsidies, stop allowing regulations to pick winners and losers in the economy, and resist the temptation to redesign the structure of entire industries. And if you believe this will happen soon, given the atmosphere in Washington, do we have a great stock tip for you!