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Here in Nevada, there is a popular urban legend. The American Physical Society (APS), which is one of the largest organizations of physicists (~50,000 members) hosted its annual conference in Las Vegas in 1986. In case you didn’t know, hosting conferences is a win-win scenario for everyone. The attendees get to experience the delights of a different city, meet people, and have fun - while the city gets increased footfall from visitors who spend their vacation money on local businesses.
So, when the MGM Grand Hotel hosted nearly 4,000 physicists in April 1986, they thought they would be in for a burst of increased revenue from the gambling tables and slot machines. Often in casinos, the hotel rooms, drinks, and food are sold at a loss with the hope of getting folks to spend more. However, at the APS meeting, something different happened.
Distraught casino owners watched helplessly as scientist after scientist avoided gambling. The next day, a local newspaper went with the headline ‘Physicists in town, lowest casino take ever’. The legend goes that the revenue from the conference was so bad that APS was asked to never return to the hotel for another conference
What happened here is that the physicists were very good at probability (duh) and looked at gambling odds differently. They understood quite clearly that in a casino, the house always wins: i.e. the games are designed in such a way that barring a lucky few, most of the patrons will end up losing money. The only way to win in such a ‘rigged game’ is by refusing to play.
A rigged game: that is all I could think of when I read the jaw-dropping New York Times report about potential conflicts of interest in stock trades by lawmakers. The rigged game here is the stock market and the house in this case is quite literally the US House of Representatives (and the Senate, but play along).
The reports and other analyses show that several trades were made by members of Congress when they were sitting on committees that could have given them insight that was inaccessible to the average person using publicly available information. To make things worse, most of the trades were very successful and many of the members have outperformed benchmark indices by a large margin! To borrow GenZ lingo, things look a bit sus.
Equality is a foundational American principle. For a group of people who are divided on just about every political issue, we are remarkably unified in the demand that everyone should have an equal chance to succeed. Across several surveys, ~90% of Americans agreed that ‘Our society should do what is necessary to ensure that everyone has an equal opportunity to succeed.’
How do we then reconcile with the incredible performance of several lawmakers in the stock market? Are regular investors playing a rigged game? Are elected officials taking advantage of public trust to make financial gains?
This week, let’s do a deep dive into the alleged irregularities, the intricacies of insider trading, and whether you should adjust your portfolio according to what the lawmakers are doing.
All are equal, but some are more equal than others - George Orwell
Lawmakers’ profiting off individual stock trades has been flagged as a potential conflict of interest for quite some time now. However, most of the recent interest in this topic came from a New York Times investigative article, which analyzed trades by 183 representatives/senators (or their immediate family members) between 2019 and 2021.
The Times’s analysis found that out of the 183, 53% of the senators reported trades that overlapped with the work of the committees they were a part of. Overall, more than 3,700 trades (10% of the total) potentially caused a conflict between their public responsibilities and private finances.
There are some particularly striking cases of successful trades. For example, the wife of a Democrat congressman from California sold Boeing shares one day before the house committee he sits on released a report on the companies mishandling of the 737 Max crashes, which caused Boeing’s stock to tank. In another case, a Republican senator bought and sold cattle contracts even when he was part of an agriculture committee that was discussing the cattle market.
Several analysts have now detailed the trades by members of congress and benchmarked them with the S&P 500. For example, in 2021, Market Sentiment analyzed the stock trades over $15,000 made by members of Congress and found that they beat the S&P500 benchmark over several timelines. Another analyst found that on a similar timeline where the S&P500 returned 13.6%, House Democrats and Republicans had a return of +14.7%, and Senate Democrats had a return of around 15.4%. Overall, 16 Republicans and 19 Democrats did better than the benchmark index.
The success of members of Congress in the stock market has led to many analysts wondering whether they can beat the market following the trades of members of Congress.
I think we can all agree that lawmakers profiting from trading stocks in companies over which they have oversight is at the least, not a good look. The primary reason this happens is because of the inadequate regulations around trading stocks on members of Congress.
Slap on the wrist
As of now, the primary tool that allows members of Congress to trade stocks is the 2012 Stocks act. Essentially, if a lawmaker (or their senior staff) makes any stock trade of more than $1,000, they must report it within 30 days of the transaction or 45 days if the trade was made by a third party or spouse.
Punishable by a fine means legal for a price - Unknown
Now, here is where it gets interesting: most members had a median 28-day delay before they reported their trades and the average delay was 52 days. But aren’t they supposed to report it within 45 days? Well, if they don’t comply with that, they have to pay a whopping fine of $200 - which was even waived in many cases!
Although there have been cases where lawmakers were convicted of insider trading, the ethics and legalities regarding insider trading are often complex and difficult to ascertain. For example, if someone was standing in line at a Starbucks, and overheard the founders of a public company discussing a potential data breach, it might not be considered insider trading if you load up on short positions on that company.
However, the ethical dilemma becomes a lot murkier when you are a member of Congress sitting on a committee that is tasked with determining whether a company was breaking regulations or defrauding its customers. Rightfully, there are now calls that seek to regulate how lawmakers trade stocks.
Left at the Altar
If enacted, the Bipartisan Ban on Congressional Stock Ownership Act would be a step towards bringing more accountability from elected officials. Specifically, it would ban elected officials and their spouses from trading stocks, bonds, commodities, and cryptocurrency while allowing them to invest in diversified mutual funds and ETFs. Further, it would allow a transition period for lawmakers to sell their holdings before being sworn into office.
However, this is likely to be met with resistance and Congress is already stalling the vote and delaying it till after the midterm elections. House Speaker Nancy Pelosi informed reporters that she did not think the measure had enough votes to pass because of widespread concerns from other members. There are widespread concerns that this bill, after so much deliberation, might end up being left at the altar.
Play the hand you’re dealt
You play the hand you’re dealt. I think the game’s worthwhile. - Christopher Reeve
Now, as to what the average investor can do in this scenario, it’s tricky. When we constantly come across suspicious trades by lawmakers that would make Warren Buffett envious, it’s certainly reasonable to feel that the game is rigged.
Unfortunately, unlike the physicists at the casino, refusing to play is not a choice we have. Investing in the stock market is one of the few methods by which the average investor can generate inflation-beating returns and build wealth. Also, unlike the casino where most folks lose money, people who stay invested in the markets for long periods will almost always end up making money.
Personally, I plan to stay invested in the market and continue Dollar Cost Averaging into the current dip. As a rule, I generally do not trade individual stocks, but if you do, make sure you keep an eye out on the trades made by members of Congress. After all, it’s not a good idea to bet against the ‘house’. Not unless you are George Clooney leading a ragtag team of misfits to get back at a casino owner (Don’t tell me you haven’t watched Ocean’s 11).
A lot of effort and research went into making this article, so if you found it insightful, please help me out by clicking the like button and sharing this article. I want to know your thoughts on the report about Congressional stock trading. Do you think a complete ban would work? Is there a better way to enforce transparency? Let me know in the comments!
See you guys next week with another deep dive!
Another great article! Why the “concerns” from lawmakers? They are the only ones who stand to benefit from a law they are deciding upon. The proposed changes would level the playing field appropriately, given the asymmetric information.