Financial Reform

By Robin Hanson · July 9, 2010 4:30 pm · Comments (40) · ·

Hollywood Stock Exchange (HSX.com) laid off the majority of its staff [last] Thursday. … The move comes as HSX’s parent company Cantor Fitzgerald’s long-gestating plans to sell shares of box-office earnings hit a legislative roadblock last week. Bowing to pressure from big studios, the House of Representatives and Senate have included a ban on movie box-office futures trading in their proposed financial reform legislation. (more)

While the US Congress has found time to “reform” finance by preventing movie futures, they have not found time to regulate insider trading by Congress.

Ordinary folks are banned from “insider trading.” For example, someone who noticed a factory fire via an airplane window was convicted of insider trading for trading on this info before it was publicly announced.  But Garrett Jones tells me that US Congressional representatives, and all their staffers, have long been explicitly exempt from these rules – the SEC is not authorized to regulate Congress, and Congress has not chosen to regulate itself.   So Congress-folk regularly profit by trading on inside info they gain from interactions with industry representatives.  So much so that their average return on investment (ROI) is far larger than the public’s.

The logic under which ordinary insider trading is harmful while this is not escapes me.  Alas, Congress is just too busy banning movie futures to deal with this “problem.” Sigh.

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  1. [...] This post was mentioned on Twitter by Ryan Singer and bhewes, Cole Tucker. Cole Tucker said: US Congress and staff legally participate in insider trading and have a far larger average ROI than other investors – http://ow.ly/29srN [...]

    By Tweets that mention Overcoming Bias : Financial Reform -- Topsy.com July 10, 2010 at 12:33 am

  2. [...] a hat tip to Pejman Yousefzadeh at The New Ledger for this little gem from Overcoming Bias: Ordinary folks are banned from “insider trading.” For example, someone who noticed a factory [...]

    By Remember when, in 1994, Congress exempting themselves from laws… | RedState July 10, 2010 at 8:02 pm

38 Comments

  1. Ted
    July 9, 2010 at 4:52 pm | Reply

    What is Congress’s average ROI?

  2. Brian Hewes
    July 9, 2010 at 5:42 pm | Reply

    Can you file a Freedom of Information Act request for Congressional staffer’s trading records?

  3. Thomas McCabe
    July 9, 2010 at 5:46 pm | Reply

    Do you have a cite on that insider trading incident? From what I know of securities laws, doing what you describe wouldn’t be illegal, unless the person in question is either an insider or has a substantial personal relationship with an insider (“insider” = executive, board member, major stockholder, etc.). Wikipedia says:

    “Not all trading on information is illegal inside trading, however. For example, while dining at a restaurant, you hear the CEO of Company A at the next table telling the CFO that the company’s profits will be higher than expected, and then you buy the stock, you are not guilty of insider trading unless there was some closer connection between you, the company, or the company officers. However, information about a tender offer (usually regarding a merger or acquisition) is held to a higher standard. If this type of information is obtained (directly or indirectly) and there is reason to believe it is non-public, there is a duty to disclose it or abstain from trading.”

  4. Thomas McCabe
    July 9, 2010 at 5:55 pm | Reply

    What appears to actually be going on isn’t that congressmen can ignore existing insider trading laws through some kind of magical loophole, but that information about legislation isn’t considered inside information. For example, if I, the CEO of company X, trade on secret information about company X’s profits, I can go to jail. If congressman A, who is on the board of company X, trades on secret information about company X’s profits, he can also go to jail. But if congressman A is writing a new legislative proposal with congressmen B and C that will give company X a new tax break, he can trade on that information, because it’s considered information about Congress rather than information about the company.

  5. A dude
    July 9, 2010 at 5:57 pm | Reply

    The main problem with HSX is that its trading would become self-fulfilling. Best performing movies would attract viewers and vice versa. This systemic resonance would lead to even greater concentration of blockbusters.

    • kevin
      July 9, 2010 at 11:38 pm | Reply

      The precautionary principle at its finest. Someone speculates (based on no evidence) that something may have some kind of negative effect. Therefore it must be preemptively banned.

      Better to stop all innovation than allow innovations that might possibly have some downside.

    • Robert Wiblin
      July 10, 2010 at 1:04 am | Reply

      You are also against preview screenings of movies then?

    • John Maxwell IV
      July 11, 2010 at 2:16 am | Reply

      Just because a hyped movie attracts viewers initially does not mean that it will be financially successful in the long run…

  6. Hopefully Anonymous
    July 9, 2010 at 6:02 pm | Reply

    a ban on movie box office futures seems corrupt to me, and not in the public interest.

  7. Daniel Burfoot
    July 9, 2010 at 11:17 pm | Reply

    Why not team up with a lawyer and argue that securities trading is just another medium for communication, and therefore should be protected in the same way that free speech is protected?

    The analogy fits quite well. Speech and trading are both tools we use to express beliefs about the world. Speech involves reputational risk, trading involves financial risk. Both acts involve two roles, which are willingly entered into – free speech means you have the right to speak, not that anyone is required to listen. Trading means you have the right to make an offer, not that anyone is required to take it.

    • Mike
      July 15, 2010 at 1:55 pm | Reply

      Sure. And the response will be “OK, then you can legally do a futures market for monopoly money or reputational points, just not for anything that can be used to buy stuff.”

  8. Eric Yu
    July 9, 2010 at 11:53 pm | Reply

    “The logic under which ordinary insider trading is harmful while this is not escapes me.”

    Well, there are less Congressmen than ordinary insider traders, so if they each did the same amount of harm (a questionable assumption) they would do less overall and it would not be a significant problem.

  9. Mike
    July 10, 2010 at 1:11 am | Reply

    Do you have a cite on that insider trading incident? From what I know of securities laws, doing what you describe wouldn’t be illegal

    Then you are mistaken.

    This is black-letter law. A couple of minutes of Googling would give you the source you desire. Why not just Google it yourself?

    • Doug S.
      July 10, 2010 at 2:10 am | Reply

      I just went and Googled, and didn’t find another source for this story.

    • Robert Bloomfield
      July 10, 2010 at 9:10 am | Reply

      I couldn’t find any support for this story either. I am guessing Robin left out the part about this ‘ordinary folk’ actually being an insider. It isn’t just the information that makes insider trading illegal, it is also the person’s status as an insider.

    • Mike
      July 15, 2010 at 1:57 pm | Reply

      Dang, I need to change my user name. I looked to see who this was from and it was me! (Not really. I’ll be mwengler in future posts.)

      Hey Mike, what hits do you get when you google it, because I get nothing.

  10. mjgeddes
    July 10, 2010 at 2:47 am | Reply

    In Europe there’s no such stupid restrictions. On Betfair there are markets on everything, I’m sure you can bet on movie futures there. Now I’m not suggesting American readers break the law. Many Americans are definitely NOT using a VPS (Virtual Private Server) with trading software (e.g BetAngel) installed to access Betfair.

    Look at the liquidity on the Betfair sports market for the world cup final as an example:

    http://sports.betfair.com/Index.do?mi=20692870&ex=1&origin=MRL

    Top right: Matched $ (tens of millions)

  11. Douglas Knight
    July 10, 2010 at 12:50 pm | Reply

    What is the evidence that congress actually makes the stock trades that do so well? Another explanation is that they are fabricated as a means of disguising bribes, which is certainly the simplest explanation of Hillary’s commodities trading.

    Another possibility is that legislators treat better companies they already own, but I think the data is about their trades, so this doesn’t explain it.

    Tom McCabe: why do you think wikipedia, the written law, etc, are relevant? Have you looked how insider trading cases play out in reality? eg, the civil action against Martha Stewart for trading on the knonwlege that an insider had traded?

    • RJB
      July 10, 2010 at 5:35 pm | Reply

      @Douglas,

      Here       is the academic evidence of senators’ impressive stock trading skills. They earn .85% higher-than-market returns a month, and it is due to timing–mimicking their portfolio with a 1-month delay does .12% worse than the market each month.

  12. Bill
    July 10, 2010 at 3:18 pm | Reply

    Robin,

    I challenge you to point me to the source for your comment:

    “For example, someone who noticed a factory fire via an airplane window was convicted of insider trading for trading on this info before it was publicly announced.”

    That is not the law.

    Point me to the source of your comment.

  13. Robin Hanson
    July 10, 2010 at 3:36 pm | Reply

    Bill, in a real “challenge” I’d have something concrete to gain from being right, and something concrete to lose by being wrong. You offer neither.

    • Bill
      July 10, 2010 at 9:27 pm | Reply

      Robin, I am a lawyer and what you said was untrue. A person flying over burning plant and acting on this public non- insider information is not violating securities law.
      What you lost for making up this story is your reputation.

      • NotBraveEnoughToUseMyRealName
        July 10, 2010 at 11:04 pm |

        Indeed.

      • retired urologist
        July 11, 2010 at 11:24 am |

        Hanson considers anecdotes to be actionable evidence when it suits him, as discussed here. It is an example of “intellectual attribution bias”, by which smart people are about nine times more likely to attribute their own position on a given subject to rational reasons than they are other people’s position, which they will attribute to emotional reasons, even if that position is the same as theirs (Shermer).

  14. TGGP
    July 11, 2010 at 12:14 am | Reply

    The possible origin of the airplane-insider meme. Robin previously referenced it here.

    • Bill
      July 11, 2010 at 3:17 pm | Reply

      This National Review editor attributes this to a story he once heard from a finiancial industry rep. What a joke. Urban legend in the making, but it also tells me that the listener doesn’t have any knowledge to uncritically believe or repeat it. Talk about revealing biases.

    • lemmy caution
      July 12, 2010 at 9:11 pm | Reply

      Thanks for tracking this down. My Google skills were failing me. That financial adviser and Robin are wrong.

  15. Rudd-O
    July 11, 2010 at 8:22 am | Reply

    The logic is very simple: the rules apply for everybody, **EXCEPT** for the corrupt individuals who invented them.

  16. Douglas Knight
    July 11, 2010 at 10:20 pm | Reply

    If the disclosure forms are true and the congressmen are trading on their knowledge of legislation, then their staff should be privy to much of the same information and be able to trade as well. I doubt that they disclose their trades, though. But if the forms are frauds, rewritten by the brokers to bribe the congressmen, then the staff should be much poorer.

    Also, it should be possible to connect the trades to relevant bills. Do many congressmen trade the same stocks? Are the gains concentrated there?

  17. Mark Astarita
    July 12, 2010 at 8:31 am | Reply

    As a securities attorney who has defended many insider trading cases and investigations I too was curious as to the source of the “factory fire” story. While the insider trading laws have been expanded beyond all bounds of common sense, the “factory fire” story is not insider trading by any stretch of the imagination. Google didn’t help, but a comment here led to the John O’Sullivan article.

    In the article Mr. O’Sullivan, complaining about the broad expanse of insider trading regulation said “One financial expert told me not long ago that I would be guilty of it if I saw a factory on fire from my plane as it landed in Des Moines, inquired about it, learned that the factory was owned by a company in which I had stock, and promptly telephoned my broker to sell before the news reached Wall Street.”

    It’s not a case, it’s not even an actual fact pattern – it is a hypothetical told by an unknown “financial expert” to a reporter.

    And an incorrect conclusion as well.

    • CBrinton
      July 12, 2010 at 10:13 pm | Reply

      I suspect a hypothetical illustration may have been garbled in transmission to give O’Sullivan’s story (which Hanson then further embroidered by rendering as an actual case).

      I’m no securities lawyer, but it’s my understanding that corporate insiders can be prohibited from trading on information that has not been broadly publicized regarding the companies in which they are insiders _even if they obtain the information in ways completely unrelated to their insider status_ (e.g. by witnessing a fire from a plane).

      So if an officer or major stockholder of the tire company saw the fire, that person might have an obligation to make sure the information had been publicized before trading on it.

      But no such obligation could arise for an ordinary citizen who owned some shares in the company.

      Missing out on the bit about the importance of insider status could give both O’Sullivan’s and Hanson’s anecdotes.

      I could also be mistaken about the relevant law myself, in which case I welcome correction.

      • Mark Astarita
        July 13, 2010 at 8:32 am |

        Making the guy in the plane a corporate insider does make for an interesting change in the hypothetical, and perhaps closer to insider trading. I suppose the theory would be that the corporate insider would understand how significant the impact of the fire was to the bottom line of his company, whereas an outsider would not.

        Then there is the concept of public disclosure. The fact that a couple of hundred people on the plane saw the fire, plus those on the ground, puts another twist on the facts – was the information public at the time of the purchase?

        Here is another one. Suppose Lebron James had decided to go to the Knicks, and the day before his announcement, he buys up shares of MSG, the public company that owns the Knicks. Insider trading? I say no since he is an outsider, not a corporate insider.

        Same concept with Congress. They are not exempt from the insider trading laws. Insider trading law does NOT ban trading on information that comes from outside the company – like pending legislation. I’m not saying it’s right, and perhaps we should force Congress to use blind trusts for their investments, but it is not insider trading.

        Mark (www.seclaw.com)

  18. Floccina
    July 12, 2010 at 5:06 pm | Reply

    Garrett Jones should be Garett Jones. Odd spelling. Your spelling made me search not work.

  19. perde
    May 28, 2011 at 5:42 am | Reply

    The logic is very simple: the rules apply for everybody, **EXCEPT** for the corrupt individuals who invented them.

  20. motorlu panjur
    May 28, 2011 at 5:43 am | Reply

    I challenge you to point me to the source for your comment:

    “For example, someone who noticed a factory fire via an airplane window was convicted of insider trading for trading on this info before it was publicly announced.”

    That is not the law.

    Point me to the source of your comment.

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