SEC Employees See Insider Trading-Level Returns

USA

Hold onto your armrests, ladies and gentlemen. If you are standing, sit down and take a deep breath. I have some shocking news: it appears that governmental bodies in charge of ‘regulating’ the financial industry may routinely engage in the very same practices that they are charged with prosecuting.

The systematic abuse of power for personal gain within the American political system? How could it be? You mean to tell me that the cogs in the ever-sprawling, secretive, omnipotent agencies which manifest governmental benevolence would use their unmatched trove of information to further their own self interests?

But…but…but…this is America. Such hypocrisy doesn’t happen here! Especially not from the federal government, who wants nothing more than to protect and better the lives of its beloved citizens, an even playing field for all. To believe otherwise is to assert that water is not wet or that climate change is far from settled science. It’s blasphemy.

Heretical as it may seem, it’s true. The ills of human nature have pervaded our incorruptible democratic system. I have proof, too. But I’ll allow you a moment to let the shock wear off, to re-orient your worldview before we delve further into the facts.

Ready? Ok, here we go.

Here’s the essential thesis, backed up by the joint findings of professors from Columbia and Arizona State Universities: during a three-year span, employees of the Securities and Exchange Commission earned ‘abnormal trading profits’. These abnormal profits were ‘similar’ to those earned by ‘corporate insiders’ who are often indicted on charges of insider trading. The primary tactic by which SEC employees maintained abnormal investment returns was divestment in companies who would soon be under public investigation by none other than the SEC.

The insider-trading police, aka the Securities and Exchange Commission employee pool, engaging in what can only be seen as insider-trading practices? Hypocritical? Yes. Ironic? Absolutely. Surprising? Not in the least.

SEC employees who sell off shares in companies they know will soon see a dip in their share price are driven by the same human motivations as non-SEC employees with non-public knowledge who do the same: self-interest, wealth preservation, and common sense. Why would you take a financial hit if you had the information available which allowed you to avoid it?

I’m not going to villainize these unnamed SEC employees for protecting their portfolios if in fact they only happened across information about forthcoming investigations. It’s the same predicament I find with insider trading charges: in their shoes, what would you do? Willingly take a hit despite knowing better? It’s a tough scenario to grapple with. Plus, most SEC employees – at least the ones selling shares in companies they are personally investigating – don’t have a choice.

‘Rajgopal and White said the excess returns seemed to be primarily due to employees selling stocks ahead of bad news revelations. SEC employees, they explained, are required to divest their holdings in companies they are assigned to investigate.’

Apparently, it’s the SEC’s policy to ‘force’ the sale of those stocks by employees, which seems to be somewhat of an institution-wide CYA from charges of insider trading. This is what the SEC can be villainized for: the zealousness and now-exposed hypocrisy with which they denounce and prosecute inside traders, sentencing many to prison terms, while employing policies that mandate and insulate their employees from similar activity. The agency employees are engaging in behavior which the SEC has deemed unethical to the extent of criminal prosecution, per SEC guidelines! The implications of it all potentially reach further. The SEC also has the power to engage in even more malevolent activity, should they decide to.

The Securities and Exchange Commission could theoretically open an investigation into a company for the sake of shorting their stock, whether an investigation was warranted or not. This would not mean merely uncovering investigation-worthy information which would then allow SEC employees to protect their own portfolios through divestment. It could mean creating a scenario under which the SEC employees could profit, even if that company had no legitimate reason for being put under investigation. This is mere speculation, but any evidence of ethical fallibility leads to such lines of thought down the most slippery slopes.

What we do know as fact about the investment patterns of many SEC employees between 2009-2011, a period during which ‘the SEC pledged to dedicate substantial resources to restrict opportunistic employee trading’ is damning enough to the Commission’s credibility.

‘A portfolio mimicking trades made by SEC employees between 2009 and 2011 earned excess risk-adjusted returns of about 4 percent a year for all securities, with abnormal gains jumping to 8.5 percent when only stocks of firms based and registered in the U.S. were tracked.’ (Institutional Investor via the joint report)

In other words, the portfolio which mimicked SEC employee investment patterns was substantially more profitable when adjusted for returns on stocks for U.S.-tracked and registered firms; the stocks which would fall under the jurisdiction of SEC investigation.

The authors of the study, which was based on the investment records of 3,500 SEC employees, suggested that those in the SEC were no better at picking stocks than the average investor. They merely knew when to get out of them. Which, of course, aligns with the notion that they can see the storm coming before it hits, and act upon their well-founded premonitions to avoid taking losses.

‘Rajgopal and White said they “seem no different from naïve individual investors in terms of the securities they pick to buy” — suggesting excess returns were not the result of investment skill.

“If SEC employees are simply good stock pickers, given their background and experience, we would expect to observe abnormal returns on their buys as well,” they wrote in the paper.’

It looks like it pays more than just a salary to be an SEC investigator.

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