Banning Lawmakers From Trading Stocks Won't Fix Congress
But it will make the market worse.
After a collection of questionable stock trades by members of Congress at the beginning of the pandemic, and similar trading scandals in the federal judiciary and the Federal Reserve, there is growing momentum to ban members of Congress from trading or even holding individual stocks while in office. Recent polls show wide support from the American public to impose limits on holding individual stocks, and both Republicans and Democrats have introduced bills with different frameworks for limiting lawmakers' financial holdings. Even House Speaker Nancy Pelosi (D–Calif.)—who has historically opposed such a bill—has recently signaled her willingness to advance such legislation.
A leading argument in favor of banning congressional stock ownership is that such a ban is needed to prevent legislators from insider trading. This is wrong because restricting Congressional trading not only has the potential to harm markets, but a focus on insider trading obscures the broader question of how to address lawmakers who may use their positions for personal, financial gain.
Illegal insider trading is when someone trades a stock misusing non-public information that impacts the stock's value. The STOCK Act, passed in 2012, made clear that trading on non-public information derived from a member of Congress's official position is an insider trading violation. The Securities and Exchange Commission considers insider trading to "undermine investor confidence in the fairness and integrity of the securities markets."
Those who support limits on congressional investments point to well-timed trades and research showing that members of Congress outperform normal people in the stock market. That research tends to draw on trading data from before the STOCK Act, and some studies, including this recent one by the National Bureau of Economic Research, have found no particular outsized returns for lawmakers. Although voters look poorly on elected representatives who may be making unfair gains, it's a leap to conclude from the body of research that unlawful insider trading is widespread on Capitol Hill.
Prohibitions on insider trading already harm market efficiency by preventing a stock's price from reflecting all of the information known about the stock. A broad-based ban on stock trading or ownership would add to that market inefficiency by preventing lawmakers from contributing information that allows the markets to engage in price discovery. Because the type of information that members of Congress are privy to relates not just to individual companies, but to entire industries and the whole economy, such information should actually be absorbed quickly into the market—particularly when doing so does not violate existing insider trading law—rather than kept out.
The fact that prosecuting insider trading violations by members of Congress is challenging, and lawmakers from both parties have a poor record in complying with trade reporting requirements, does not mean that a prophylactic ban on holding individual stocks is a good idea or a necessary one.
Justifying a stock-ownership ban based on insider trading rules also makes little sense. The issue is not with maintaining investor confidence in the market—the stated reason for insider trading rules. The issue is with maintaining voter confidence in their elected officials—two very different issues. The more apt question when considering limitations on congressional financial holdings is whether, and to what degree, members of Congress should be permitted to gain personal financial advantage from their positions.
The question, properly framed, focuses on potential conflicts of interest faced by members of Congress. Uniquely positioned members of Congress have information that may impact the value of particular stocks while also having the ability to impact the value of particular stock by legislating, by calling for investigations, or by otherwise exerting their political influence.
That means potential conflicts of interest can exist not only in a member's individual stock ownership, but also in fund investments, crypto holdings, or business interests of lawmakers, their families, or their staff. Managing these potential conflicts of interest is a complex task, asking lawmakers and voters alike to determine the proper balance between lawmakers' personal financial interests, their stake in particular issues, and their ability to represent their constituents. At best, focusing only on stock ownership and trading provides an incomplete picture.
Insider trading law has a reputation for lacking clarity and generating confusion. It would be a mistake to add to that confusion by attempting to justify a ban on congressional stock ownership in the name of preventing illegal insider trading, particularly when the motivation for such restrictions is protecting Congress's integrity, not the market's. Instead, potential solutions should be evaluated against the full range of financial conflicts of interest that members of Congress face.