In response to my post about insider trading by Congress, I had some follow up questions from readers. As I mentioned, research found that the average person in Congress earns investment returns that are 25 percent above average. And two Congress people are trying to introduce a law banning the practice of Congressional insider trading because there are currently no laws prohibiting it.

So let me explain how it's not illegal for Congress to use inside information it gets about companies and industries to trade at a profit. Since I am not a legal expert, I posed some questions to a former Commissioner of the Securities and Exchange Commission (SEC) who ought to know.

This former SEC Comissioner explained that there is no policy regarding Congressional insider trading for a reason that really surprised me: "there's no legal definition of 'insider trading.'" As a result, the case law pertaining to insider trading requires either of two tests to be passed to constitute insider trading. My source explained these as follows:

  • "Violation of a duty (as in the duty of fidelity of an officer to his corporation and its shareholders); or
  • Misappropriation of information that belongs to a third person (as in the information about what's going to appear in a print journal that is ascertained [found out] because the ascertainor is an employee of that journal or of a printing company contracting with that journal)."

Translated into English, this means that in order to be insider trading a person must have a legal duty -- for example to a corporation or must take information that belongs to someone else and use it to trade.

The example that my source refers to in the second bullet reminds me of a case that came out around six years ago when a few people working in a Business Week printing plant in Wisconsin got a hold of copies of the magazine before it went out to the public and used information about takeovers appearing in those issues' Inside Wall Street columns to buy shares in the target companies before the magazine was distributed to the public.

Anyway, applying those two tests to Congress reveals an important legal truth. According to my source: "Congressfolk fit in neither category. They owe no duty of fidelity to anyone (possibly excepting their constituents) and all the information they ascertain is ascertained in pursuit of their Congressional functions with no strings attached. Voila!! Home free all!!!"

In other words, since people in Congress don't have a duty to a corporation and they are getting their insider information in performing their jobs as Congress people, they can use that information without restriction.

Simply put: There are no laws prohibiting insider trading by Congress, there's a very high chance that it is happening, it ought to be stopped permanently, and there does not appear to be anyone with the power to investigate and end the practice.

Peter Cohan is president of Peter S. Cohan & Associates. He also teaches management at Babson College. His eighth book is You Can't Order Change: Lessons from Jim McNerney's Turnaround at Boeing.


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