The incredible stock-picking ability of SEC employees

http://www.washingtonpost.com/blogs/wonkblog/wp/2014/02/27/the-incredible-stock-picking-ability-of-sec-employees/

206 97 12 years ago

mkempe3• 12 years ago

Quis custodiet ipsos custodes?

The wealthier our societies, the more numerous and lucrative the government positions, relative to the population median. At some point, the social fabric is likely to rip in awful ways.

dragonwriter2• 12 years ago

The wealthier our societies, the more numerous and lucrative the government positions, relative to the population median.

Evidence?

mkempe3• 12 years ago

The abusive stock-profits of these SEC employees is not an isolated event. The enormous difference in salary levels and wealth accumulation around DC vs the rest of the country over the last few years should be a clue.

Similar disparities in economic fate --between government employees and those they perceive as subjects-- are visible in most Western European countries I know well.

As our societies have gotten wealthier, governments have grown in disproportion -- and opportunities for steady income (including very early retirement) and indirect graft have increased.

steverit• 12 years ago

The SEC's response: "Nester explained that before staff can work on an issue that involves a company, they have to sell any holdings of stock in that firm. As a result, he said, there shouldn't be any surprise that a sale would precede the announcement of an enforcement action."

I don't know about anybody else, but this seems pretty plausible to me.

JumpCrisscross5• 12 years ago

This story is more instructive in the perils of jumping to conclusions than anything else.

jey• 12 years ago

That's extremely amusing, since the probability of a enforcement action conditional on an investigation being started is much higher than the prior probability of an enforcement action. And if an enforcement action occurs, the price is only going to go down. So this is practically an institutionalized version of the insider trading the article is talking about!

letstryagain• 12 years ago

The fair way to handle this is to disallow any buying OR selling of related stocks until the public announcement of the results of the investigation.

nostrademons4• 12 years ago

Yeah, when I looked at the data in the article, the pattern wasn't that SEC employees were systematically selling stocks they were investigating. Rather, it was that they were always selling, and refused to buy stocks under investigation. This is consistent with the SEC's policies, and also makes a lot of sense.

I would chalk this up to a quirk of statistics rather than any deliberate malfeasance. (Although, I'd note that the SEC policy that employees sell any stocks of a company that they will be investigating is good for the employees, because those companies are disproportionately likely to suffer a stock price penalty in the near future. Basically, the policy is a way of turning material non-public information into a market advantage without requiring that any individual employee act on that. But this situation exists in a lot of other cases, eg. stock option grants should systematically beat the market because companies that are financially healthy are more likely to hire people, and that financial health usually translates into hiring before it translates into profits.)

judk2• 12 years ago

Hiring is basically public information.

smutticus2• 12 years ago

Do you see any conflict of interest in an employee at the SEC and buying stock in every SP500 company matching their market cap, then selling them right before the SEC investigates them? If someone did that with the SP500 they could easily beat the index. I think this is the definition of malfeasance.

phoney• 12 years ago

So this is a job perk? Not only can you sell ahead of bad news based on inside info, as an employer, the SEC forces you to!

tlrobinson2• 12 years ago

If you change "sell any holdings of" to "short" that statement sounds absurd, but they're roughly equivalent.

How about not allowing staff to hold stock in companies they might have to deal with?

pseut• 12 years ago

That would be "all companies."

jashkenas• 12 years ago

For what it's worth, that's exactly what the rule is for journalists at The New York Times. To quote the relevant section from the handbook:

"No staff member may own stock or have any other financial interest in a company, enterprise or industry that figures or is likely to figure in coverage that he or she provides, edits, packages or supervises regularly. A book editor, for example, may not invest in a publishing house, a health writer in a pharmaceutical company or a Pentagon reporter in a mutual fund specializing in defense stocks. For this purpose an industry is defined broadly; for example, a reporter responsible for any segment of media coverage may not own any media stock. “Stock” should be read to include futures, options, rights, and speculative debt, as well as “sector” mutual funds (those focused on one industry)."

pyre• 12 years ago

Doesn't that effectively translate into "not allowing staff to hold stock at all?"

samstave• 12 years ago

So.... if you can monitor the sales of all SEC employees; then you could copy-sell, or buy up their shares en-mass and very rapidly sell them for a profit?

mherdeg• 12 years ago

Cool, so can you trade on this?

Specifically, is the SEC's turnaround time to Freedom of Information Act requests fast enough that you could make a viable trading strategy out of "ask for the last week's worth of trades and rebalance appropriately"?

sixQuarks• 12 years ago

SEC employees should not be allowed to trade stocks, period! Fed chairman abides by these rules, it's ridiculous that employees of SEC do not.

JumpCrisscross5• 12 years ago

In an ideal world. In practice the most qualified people for SEC roles have a background in industry, and prefer to have a say on their portfolios. Prohibiting discretionary trading (or worse, stock ownership) would likely catastrophically restrict the pool of applicants to the clueless and unqualified.

dmckeon• 12 years ago

So, create a mutual fund that operates as a blind trust, and allow transfers free of capital gains tax into the fund when an employee is hired.

For extra points, require everyone who gets a Federal salary to participate, including Congress-folk and their staff.

Operate the fund so that when the US economy is doing well, and unemployment is low, and other reasonable and measurable national economic goals are met, all the participants benefit.

An incentive like that might attract to Washington more cluefull and qualified people who are willing to cooperate so that the people of the country benefit.

001sky2• 12 years ago

"catastrophically restrict the pool of applicants"

This is amusing, but false. This is similar reasoning to why CEO's should make 10-20million dollars a year, rather than say...$10MM/yr. There is actually no shortage of people to be the CEO of any company (or the top rank in any hierarchy) and truth be told, Boards of Directors could not tell the difference for 9/10 candidates. As the saying goes, "graveyards are filled with the people thought previously indispensible". And empirical examples abound. Just imagine Apple without Steve Jobs, or Yahoo without whoever the guy was before Marissa Mayer. The only thing keeping quality applicants out of the SEC is power, presitige, and respect. There are many jobs that people work for low pay (eg Academia) provided that their social status is secure.

rayiner2• 12 years ago

At least on the enforcement side, most potential employees will be private practice attorneys whose ability to trade is already restricted by conflict of interest rules. Many therefore prefer to use passively managed investments anyway. I doubt it would be a big deal.

TheCondor• 12 years ago

The SEC already has this problem. Those with sophisticated enough financial knowledge to regulate the best are already hired up by the big financials where they can make more money. Anyone at SEC is likely to be a better than average stock picker. This study might be flawed. They need to measure the SEC against the hedge funds and mutual fund pros. If they beat those guys, who already beat the market then maybe there is something fishy going on.

JumpCrisscross5• 12 years ago

The paper [1] finds "at least some of these SEC employee trading profits are information based, as they tend to divest (i) in the run-up to SEC enforcement actions; and (ii) in the interim period between a corporate insider’s paper-based filing of the sale of restricted stock with the SEC and the appearance of the electronic record of such sale online on EDGAR."

On (i): SEC employees are required to divest of their holdings in a company before working on an issue relating to it. The findings thus demonstrates an alignment of ethics and private interests.

On (ii): there is potential for abuse. When an insider sells stock, the sale must be reported electronically to the SEC via Forms 3, 4, and 5. When an insider sells restricted stock it is reported via Form 144. Form 144, unlike Forms 3, 4, or 5, may be filed electronically or by paper - over 90% of Form 144s are filed by paper. These paper filings are only available through third-party data providers, e.g. Bloomberg, and even then at a delay from filing.

[1] http://www.darden.virginia.edu/web/uploadedFiles/RajgopalSEC...

jellicle• 12 years ago

Just think about how good Mt. Gox employees must be in bitcoin speculation.

loumf• 12 years ago

Seems like a pretty small sample size. Shouldn't we expect it to be less like the overall market?

Oculus5• 12 years ago

This is absurd. Why would we ever let regulators of the market be active participants in it. Certain jobs in the government require for one's assets to be in a blind trust for there to be no conflicts of interest. If anyone in the government is doing it, it should be the SEC.

devindotcom• 12 years ago

If you read the article, the SEC states that the reason they sold is because they were forced to by law, as they were soon going to being regulators of the securities they were going to regulate.

However it does appear to be a good indication that something is coming down the line if SEC people sell...

nostromo• 12 years ago

They should be barred from changing any position they have the moment there is a whisper of some sort of regulatory action against a company.

This policy is forcing them to act on non-public information, which is very illegal for everyone outside of the SEC.

tosseraccount3• 12 years ago

How about let them dump it all in a broad market ETF ?

morganherlocker• 12 years ago

It seems like this should extend to many other roles as well. If someone in the EPA has investments in energy or manufacturing, for example. If someone in the FCC has investments in tech or media conglomerates. Pretty much anyone who has access to information about changing regulations, enforcement, etc. before the public.

Congress has been known to have above average returns on stock investments, making the congressional salary increases we quibble over look like chump change, if they are using their unique knowledge of policy direction to the fullest.

TheBiv3• 12 years ago

I believe it is a zero sum game to try and have "no conflicts of interest" in anything. At least the SEC is now forcing a system that A) Allows their regulators to be transparent about an activity that they have done their whole life (picking stocks) B) A system that forces them to opt out of explicit conflicts of interests.

Oculus5• 12 years ago

I fail to understand your point. Why would eliminating conflicts of interest be a zero sum game? If somebody's job is to police the players, how could they do it effectively if they have a bias towards certain players? Allowing a conflict of interest destroys the purpose of their job in the first place!

3327• 12 years ago

Hey the SEC only hires the best of the best .

nazgulnarsil• 12 years ago

6 out of 56 doesn't seem "incredible" to me.

Rangi42• 12 years ago

Aren't the employees' sales a useful contribution to the stock market? They're turning private knowledge about upcoming SEC actions into public information, assuming that the public bothers to correlate stock sales with SEC employee lists. (If either of those pieces of information isn't publically known, then an SEC employee selling stock doesn't contribute any more information than any random shareholder's sale.)

boon• 12 years ago

What do you expect in a perfect libertarian free market system??? Oh. Wait.

Sorry, I had to after reading all the bitcoin hate in other threads.

tosseraccount3• 12 years ago

The TSP (fed retirement) plan has 5 basic funds: Large , Small, international equities and corporate and government bond funds. Perhaps allowing a similar mechanism to invest a private portfolio in these funds and allowing re balancing once a year would be a good policy. Investments and withdrawals will be weighted based on selected allocation.

TheBiv3• 12 years ago

Very good idea, and one that I hope they had brought to the table (I wasn't at the table and I would love to know if you were). I have to imagine that something like this was brought up as an option, and it was struck down due to a counter argument that these are former stock traders and to disallow the stock traders to do what they love to do, would not allow the SEC to get the best talent.

erikpukinskis• 12 years ago

Is it really that hard to do a t-test comparing the buys and the sells to find out if the difference is statistically significant at this sample size? I'm sure there are better tests, but that one is literally the first test you learn in a statistics course. Are there no journalists at the Post who have taken a basic stats course?

They could literally just punch in the 10 numbers (buys and sells for each of the five events) into http://studentsttest.com/ and get a result.

We should really figure out some way to enable more science students to pursue journalism. What's the point of having thousands of brilliant scientists doing research if journalists are just going to mangle it every time? Distribution is just as important as production.

mikeyouse• 12 years ago

Are we just going to ignore that this data only began to be collected in 2009, at a stock market bottom? All stocks have done well since then..

jcrites• 12 years ago

Nester explained that before staff can work on an issue that involves a company, they have to sell any holdings of stock in that firm. As a result, he said, there shouldn't be any surprise that a sale would precede the announcement of an enforcement action.

Can I use this fact to detect upcoming potential investigations or enforcement actions which may not be public knowledge, and use that to my advantage?

[Edit:] This also seems to have the unfair effect that SEC employees get an "out" from previous investments in companies that the SEC is about to investigate. Isn't that ultimately another form of trading on insider knowledge, even if it's mandatory?

On the other hand, if SEC employees are not forced to sell, then their holdings may diminish their impartiality. It seems like the only fair and neutral approach is to require SEC employees to hold no individual stocks at all during their employment - or any type of financial instrument issued by organizations they might potentially investigate.

(Is this perhaps what the SEC means, that employees are forced to sell because they've just joined the SEC? If they're forced to sell an individual instrument only at the beginning of a specific investigation into a single organization who issued the instrument, then that seems like a loophole.)

toomuchtodo3• 12 years ago

On the other hand, if SEC employees are not forced to sell, then their holdings may diminish their impartiality. It seems like the only fair and neutral approach is to require SEC employees to hold no individual stocks at all during their employment - or any type of financial instrument issued by organizations they might potentially investigate.

The solution is blind trusts, with the additional cost picked up as part of their compensation package. The way to guarantee impartiality is to remove any chance of impropriety.

I would also settle for extremely common ETFs like the SPDR S&P 500.

JumpCrisscross5• 12 years ago

SEC employment is often preceded by time in the industry. This means a large fraction of high-value employees are likely entering their roles with existing holdings. Requiring immediate divestment for all SEC roles sounds extreme.

It makes sense that any new investments made during one's time at the SEC should be made into index funds or accounts managed at the independent discretion of a non-SEC manager. But banning all SEC employees from holding any individual stocks during their employment is a deterrent to recruiting.

camillomiller• 12 years ago

Well, first and foremost: why is it possible for SEC employees to trade stocks at all? I supposed some sort of ethic barrier was in place, at least for those exposed to sensible informations...

interstitial• 12 years ago

Because Wall Street is the intelligence tax on all Americans. Every task, even a wink, requires up front fees and a percentage off the top. The social contract states, give us your money, and we will share our tax on the stupid with you.

Houshalter• 12 years ago

It is unfair, but does it actually do any damage to the market? The same amount of people would lose the same amount of money regardless. The problem with insider trading is that it can create bad incentives (like the SEC employees choosing not to investigate companies they are invested in.) Just forcing them to sell before hand doesn't seem to bad.

spikels2• 12 years ago

My two favorite government investing scams:

(1) Congress's insider trading exemption - Until recently legislators and their staff were completely exempt from insider trading laws while they were often privy to insider information[1]. It's no wonder they do so well in the market. Too bad some minor restrictions recently were enacted - but no worries they just got rid of them as soon as the noise died down[2].

(2) Tax-free portfolio rebalancing - Big shots like the Secretary of Treasury often sell billions in stock without paying any capital gains tax. This allows them to fully take advantage of the free step up in basis when they die. So they can never pay anything on the fortune they made at Goldman Sachs[3].

Fuck these assholes!

[1] http://www.thewire.com/politics/2011/11/hustle-defuse-60-min...

[2] http://www.techdirt.com/articles/20130416/08344222725/congre...

[3] http://www.celebritynetworth.com/articles/entertainment-arti...

tosseraccount3• 12 years ago

Tax free re-balance? Wow! Paulsen took got 500 million with no tax.

AjithAntony• 12 years ago

As to the tax-free sale, unless I misunderstand, this is extremely limited and far from "often". Few people will ever have the opportunity, it occurs once in a lifetime, and it is offered as compensation for the forced liquidation of one's entire stock portfolio to become a public servant.

spikels2• 12 years ago

Yes you get to sell all your stock in one company and buy a diversified portfolio. Maybe you haven't heard but diversification is good. And NOT FREE for everyone else. Do you understand the value of this?

In my view everyone should be able to do this under the ancient English law principle of like-kind exchange. But in the US today it is "special people" only.

To recap: Why are you taxed for something? Because they can tax you. There are no principals just opportunity. Much like why did your car get broken in to. Because they can.

jvm• 12 years ago

Insider trading seems unfair. But after a lot of thinking and listening to arguments on both sides, I now actually find the argument in favor of legalizing insider trading fairly compelling. I'd suggest that anybody with strong feelings against it take a little time to consider the arguments for.

The argument for has two levels:

1) The trade is a victimless crime. Given the way markets worse, the naïve party would have bought or sold the asset anyway from someone else. Think about how you buy stocks: you just call your broker and ask to buy at the market price. If you do that and end up buying from an insider, you are no worse off.

2) Insiders actually move the price in favor of the naïve party they trade with. If a stock is being sold on the market $29 and the insider knows its true value is $20, they must sell below the other offers (e.g., $28.99) to make the trade. This is in favor of the buying party relative to the outcome without the insider: the buyer will lose $.01 less per share. At large trading volumes, insiders will actually move the market strongly in the direction of the fair price, making all trades of that asset more fair.

Unfair though it may be, society at large does not benefit banning insider trading, and allowing it would make stock market prices more accurate which is actually probably a fairly strong benefit to society.

nostrademons4• 12 years ago

The victim is trust in the market. If you know that someone else may have better information than you do, you get a "market for lemmings" situation where everybody assumes that the only reason someone would sell a stock is that they know it's going to tank, and so nobody buys. Liquidity collapses, and with it, the market.

The SEC isn't intended to protect individual investors, it's intended to protect the market as a whole. That's why they don't care when individual people get screwed, only when people get screwed to an extent that they won't invest in the market. People change their behavior based on what other people do; without full public information, the result of that tendency is to tend towards zero liquidity.

dnautics• 12 years ago

forgive me if I don't shed any tears for 'trust in the market'. Shouldn't we be more suspicious about the market? People blindly throw their money at the hands of fund managers etc, which means our society is overleveraged on risky propositions.

sehugg• 12 years ago

The trade is a victimless crime.

Like punching someone in the dark!

yetanotherphd• 12 years ago

I have a PhD in economics, and I was initially convinced by these arguments, but the are actually misleading.

If I have inside information, and there is a market with 1000 people, and I make $100 by doing insider trading, that money must come from the pockets of those 1000 people. This follows from the fact that the stock market is (for these purposes) a zero sum game.

The error in your argument is that (1) is false. You say "you just call your broker and ask to buy at the market price". But if every market participant was like that, then the order books wouldn't match and the market would break down. There must be some participants who are price elastic. And these are precisely the people whose decisions are effected on the margin, that is, the people who you cause to buy/sell when you engage in insider trading.

So when I buy shares with inside information (say I know the price will rise), I cause the price to rise by a tiny amount, and induce some people to sell who wouldn't have. Since these people wouldn't otherwise have sold, they lose money from my actions.

It is true that insider trading provides information to the market place, and so it is beneficial in that sense. However, it also creates asymmetric information and so harms liquidity. While there is always asymmetric information (I own stocks through my 401k, but I have no idea what MSFT should be worth), insider information is an especially extreme kind, and therefore especially harmful to liquidity.

notastartup• 12 years ago

Isn't this like telling people to not to break the law but we can because we are the law?

What stops a hedge fund manager from being extra nice to the boys that turn Bud Fox?

alexjfowler• 12 years ago

Members of the sec could be required to register their trades (tested against IRS records yearly to ensure 100% accuracy and eventually automated).

Now, place all holdings in a database table.

When a company is going to be investigated, select only sec employees who are not listed as having holdings in that company.

My solution is obviously incomplete, but maybe it could be the basis for a more robust system.

lutusp• 12 years ago

This problem is trivially solved -- force new SEC hires to buy one or more market index funds and put them in a blind trust for the duration of their employment.

Historically, market index funds do as well as active portfolios (on average), unless brokerage commissions and tax implications are included in the assessment, in which case they do better (a fact proven by the now-famous WSJ dartboard contest). So SEC employees would have a more profitable portfolio than usual for the duration of their employment, and they would avoid even the appearance of impropriety.

How is it that this obvious solution hasn't been put in practice?

The incredible stock-picking ability of SEC employees

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