Update: Former Powerful Lobbyist and Businessman Reveals How Some in Congress Do So Well Investing

Update November 11, 2011: In recent years, I've highlighted concerns about members of Congress trading on "inside" information that would land others in trouble with the SEC. Now, former lobbyist and businessman Jack Abramoff has told CNBC in an interview (video below) what I warned folks about nearly three years ago. Abramoff spent several years recently in prison for mail fraud and conspriacy and was released in 2010.

How Did Members of Congress Invest When Briefed On Financial Problems in 2008?

It has been well discussed and reported that during the height of the financial crisis in 2008, Congressional leaders were briefed on what was going on behind the scenes. Furthermore, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke made it clear to these same Congressional leaders how much worse it could get if certain actions were not taken and supported. (Paulson tells the whole story, from his perspective in his recent book, On the Brink: Inside the Race to Stop the Collapse of the Global Financial System)

In late December of 2008, I wrote an article entitled, Do Congressional Leaders Care How the Stock Market Performs? I investigated whether key Congressional leaders had a meaningful stake in the success of the American economy. While there some exceptions (like Barney Frank), most of them did which is heartening to see.

I wondered what members of Congress were doing with their own money during the height of the 2008 crisis as they were hearing the inside details about the extent of the financial crisis.

Now, thanks to a Wall Street Journal analysis of recently filed Congressional reports we know: 

"Some members of Congress made risky bets with their own money that U.S. stocks or bonds would fall during the financial crisis, a Wall Street Journal analysis of congressional disclosures shows...According to The Journal's analysis of congressional disclosures, investment accounts of 13 members of Congress or their spouses show bearish bets made in 2008 via exchange-traded funds-portfolios that trade like stocks and mirror an index. These funds were leveraged; they used derivatives and other techniques to magnify the daily moves of the index they track."

As the chart below from the WSJ shows, many of these leveraged bets on a stock market decline made by four members of Congress from both parties occurred relatively early in the crisis as Congress was just learning about the extent of the problems.





Members of Congress have lambasted Goldman Sachs and other Wall Street firms for profiting from the housing and financial market problems and profiting from short selling and using leverage to increase their returns. Yet, as the WSJ correctly points, there is an apparent hypocrisy in this Congressional criticism although I don't think that's the biggest part of the story.

Insider Trading, Lack of Ethics, or Both?

Business executives and others may not trade on inside (non-public) information. For example, suppose a law firm is helping Apple Computer with an anticipated acquisition of a smaller firm.  Once such a deal is publicly announced, the stock of the smaller company getting bought out generally rises sharply in price because the acquiring company must pay a premium to make the deal attractive to the shareholders of the company to be bought out.

If a lawyer at the firm doing the work for Apple invested in the smaller company stock before the public announcement, he could make a lot of money but he would be doing so illegally using inside information. The U.S. Securities and Exchange Commission (SEC) would fine him and impose jail time if such illegal trading were identified.

In my view, members of Congress trading on some of the financial crisis information that was shared with them in private meetings in 2008 by high ranking government are also engaging in insider trading. However, insider trading rules don't make that clear.

Now, the WSJ analysis states, "There's no evidence the legislators and their spouses used privileged information or failed to follow rules on disclosure. Congressional rules permit lawmakers and their families to invest in-or bet against-publicly held companies they oversee through committee assignments, as well as broader markets or indices."

Well, the rules should be changed. This is a double-standard. What's good for corporate America is also good for members of Congress.

The WSJ points out, "While some lawmakers trade for their own accounts, others delegate trading to a spouse, stockbroker or financial adviser. A few legislators keep their money in blind trusts and don't know how it's invested." Usage of a blind trust, which Presidents use to invest their money while in office, makes a lot of sense.

The financial interests of the members of Congress should be aligned with the rest of us. They should not be able to trade on inside information and if they do, they should pay fines and do jail time as happens to others who violate the SEC's insider trading rules.