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Friday, May 27, 2011 1:43 AM

How to Beat the Market: Follow the Trades of 19 Senators on the Senate Armed Services Committee Who Own Stocks on Prohibited List

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Want to beat the market? Here's how: Take the investment picks of Congress.

A reader sent me an email from Stansberry & Associates, that purports to do just that:

In a new academic study, four university professors examined investment results on more than 16,000 stock transactions made by 300 House delegates from 1985 to 2001. The result was clear: They beat the market by an average of 0.55% per month, around 6.6% a year. The professors note a previous study showed members of the U.S. Senate did so well they outperformed hedge funds.

In fact, if members of Congress didn't beat the market, they'd be bigger morons than you already think they are. Why? Because insider trading laws don't apply to members of Congress…

You heard that correctly. The Securities and Exchange Act does not apply to members of the U.S. Senate or House of Representatives. Congressional ethics rules say Congressional members aren't allowed to use privileged information for personal gain. But it's just a rule, not a law. It's not legally enforceable. And it's obvious they're taking excess profits out of the stock market…

This must be one of the most underreported financial stories of the century. Take one example: The Senate Armed Services Committee forbids staff and presidential appointees requiring Senate confirmation from owning securities in more than 48,000 companies that contract with the Defense Department.

But 19 of the 28 senators on that same committee held assets worth between $3.8 million to $10.2 million in companies on the prohibited list between 2004 and 2009.
19 Senators Own Stocks on Prohibited List

The "new" academic study referenced by Stansbury and Associates is Abnormal Returns From the Common Stock Investments of Members of the U.S. House of Representatives. The data isn't new. The data is from 2001, as the email even states.

The email goes on to say that "19 of the 28 senators on that same committee held assets worth between $3.8 million to $10.2 million in companies on the prohibited list between 2004 and 2009".

That is new, at least to me, but is it really new news? I will return to that question in a moment. First consider this question ...

Should Insider Trading Laws Even Exist?

My answer: It is debatable whether there should even be insider trading laws, but if such laws should exist at all, the one place they should be just happens to be the one and only place they are not: Congress.

For a nice discussion on my answer above, please consider Robert Murphy's article Is Insider Trading Really a Crime?

Where's the Beef?

Returning to the forwarded email, please note that the allegations regarding "19 of 28 senators".

Who are those senators? You may prefer that phrased as a question we have not heard for a while, "Where's the Beef?"

While pondering "Where's the Beef?", I point you to The Daily Crux article Disgusting rules allow Congress to profit from insider trading
... I also told you on Tuesday how famous investors like Bruce Berkowitz and John Paulson were taking advantage of the government's heavy-handed regulation and backstopping of the financial system.

Well, Berkowitz and Paulson are late to the party. They've got nothing on Amy Friend, the chief counsel to Senate Banking Committee Chairman Christopher Dodd. At the height of the crisis, when the government was making plans to bail out AIG and other large financial institutions, Friend bought $1,000 to $15,000 stakes in Morgan Stanley, Wells Fargo, AIG, Fannie Mae, Freddie Mac, Federal Home Loan Bank bonds, and Fannie Mae debt.

Friend bought FHLB and Fannie Mae debt in June and July 2008, just days before President Bush signed a bill that gave the government housing finance agencies big cash injections from the Treasury. Friend is still in the game today, helping to draft Dodd's sweeping overhaul of the financial regulatory system.

If you or I did what Friend is doing, we'd wind up like Martha Stewart. But for her, Senate rules say it's perfectly legal. No SEC investigation. No insider trading violation.
Martha Stewart went to jail. Senatorial insider trading is ignored.

Search for the Beef

In a "search for the beef" I found a Washington Post article written December 19, 2010 entitled Senate panel ban seen as double standard
The Senate Armed Services Committee prohibits its staff and presidential appointees requiring Senate confirmation from owning stocks or bonds in 48,096 companies that have Defense Department contracts. But the senators who sit on the influential panel are allowed to own any assets they want.

And they have owned millions in interests in these firms.

The committee's prohibition is designed to prevent high-ranking Pentagon officials from using inside information to enrich themselves or members of their immediate family.

But panel members have access to much of the same inside information, because they receive classified briefings from high-ranking defense officials about policy, contracts and plans for combat strategies and weapons systems.

The prohibition is representative of how members of Congress set strict rules on investing for others in sensitive posts in the corporate world and government while allowing themselves to manage their finances however they please.

Nineteen of the 28 senators on the Senate Armed Services Committee held assets in companies that do business with the Pentagon between 2004 and last year, according to an analysis of financial disclosure forms by The Washington Post. Those holdings were worth a total of $3.8 million to $10.2 million.

Ethics laws allow senators to hold stocks in industries they oversee. They also may push and vote for programs that could improve the bottom lines of companies in which they own stock. They are precluded, however, from taking official actions that could boost their personal wealth if they are the sole beneficiaries.

The Senate ethics manual maintains that the financial-disclosure process is a sufficient safeguard against conflicts of interest and that requiring senators to divest is not needed. "Members should not be expected to fully strip themselves of worldly goods," the manual says. Some defense industry analysts said that leeway sends a mixed message.

"The message is: 'It's okay to be fuzzy on the edges,' " said Winslow T. Wheeler, a former national security analyst for several U.S. senators who runs a military reform project at the Center for Defense Information.

Gordon Adams, who oversaw military spending as a top official at the Office of Management and Budget in the 1990s, said committee members and staffers have virtually unfettered access to the highest-ranking officials at the Pentagon, which, with an annual budget of nearly $700 billion, is the largest part of the government.

"You get a great deal of information about the Pentagon's intentions for the future," said Adams, a foreign policy professor at American University. "As a member, you have vastly more information than the average Wall Street adviser or investor."

Five Pages of Beef

My search for the beef quickly uncovered five pages of beef in a well written, comprehensive Washington Post article.

It appears to me that not only did Stansberry & Associates trump up something from 2001 as "new", they also sloppily lifted research from the Washington Post without accrediting the Washington Post.

I am tired of this kind of semi-plagiaristic horses**t.

I take great pains to credit my sources with links. I do not pawn off something from 2001 as new, and except by accident I credit original articles, when I can, not necessarily references where I originally found them.

I do think there is a story here (in addition to the semi-plagiarism), and I think the Washington post covered it nicely. I also think Robert Murphy's article Is Insider Trading Really a Crime? deserves serious consideration.

Prosecution aside, please note that Martha Stewart went to jail not for insider trading, but for lying about it. Had there been no such laws (laws that Congress is exempt from), she would not have been prosecuted in the first place.

Regardless of how you feel about Martha Stewart, for Congress to be exempt from laws that apply to everyone else is simply unacceptable.

Mike "Mish" Shedlock
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