Senators who sit together, trade together

As Congress continues to debate whether lawmakers should be allowed to trade individual stocks, new research from Northwestern University, Texas A&M University, and the University of Oregon suggests that information may spread through social networks inside the Senate in ways that influence investment decisions.

The study, co-authored by Beverly R. Walther, Eric L. Kohler Professor of Accounting at Kellogg School of Management, finds that U.S. senators who sit closer together on the Senate floor are more likely to trade stocks in the same industries and earn higher returns on those trades. The findings are consistent with senators sharing investment-relevant information through interpersonal interactions with colleagues.

“The evidence is consistent with information flowing through interpersonal relationships inside the Senate,” Walther said. “If the information being shared is not public, our research has potential implications for policies and the functioning of free and fair markets.”

Researchers examined more than 5,000 stock trades by U.S. senators between 2012 and 2018 and compared trading activity with detailed Senate seating arrangements. When senators changed desks and moved closer together, they were more likely to make similar industry-level trades within days of one another. The relation was strongest among senators from the same political party and largely absent among senators from opposing parties.

The association weakened when senators spend less time in Washington D.C. because they are away campaigning for reelection and disappears when Congress is not in session, Walther said. The researchers also found that the effect is stronger when one senator has committee oversight responsibility for the affected industry and after committee hearings involving those industries.

While the researchers cannot determine whether any particular trade violated securities laws, they conclude that the patterns they document are difficult to reconcile with the sharing of purely public information. Although the co-trading was not pervasive, the study provides new evidence about how information may travel through social networks within Congress.

“We cannot prove that the findings we document are a result of insider trading because we cannot observe any private communications that might have occurred, much less what was communicated,” Walther said. “One possible explanation is that the trading patterns are merely a coincidence and are not based on private political information. Another possibility is that that the patterns we document are not widespread, and it is difficult to identify and prove insider trading occurred without other corroborating evidence.”

The trades associated with these interactions also appear to be more profitable. When senators who sit near one another make similar trades, those trades generate average market-adjusted returns of approximately 1.1% over the following six months, with profitability increasing as senators sit closer together.

“Interestingly, the trades most likely associated with interpersonal interactions also appear to be the most profitable,” Walther said. “That finding raises important questions about the economic value of information shared within political networks.”

Walther said the findings may also have implications for Congressional trading reform. While many recent proposals would prohibit lawmakers from trading individual stocks, the study’s findings correspond to politically valuable information about industries, rather than individual companies. On July 22, the U.S. House passed the Stop Insider Trading Act, a bill that would limit lawmakers, their spouses and dependents from buying individual stocks while in office. It would not affect stocks they already own, but require public notice before selling them. The bill now awaits the Senate.

“The efforts in Congress to restrict trading in individual stocks has been ongoing,” Walther said. “Congress passed the STOCK Act in April 2012 to make members of Congress explicitly subject to insider trading regulations. Critics argued that that act did not go far enough, and there have been ongoing concerns about politicians profiting from their access to privileged political information. Bills to restrict trading in individual stocks have been introduced in the House and Senate for the past five years.”

Walther said that most legislation considered by Congress concern entire industries, rather than specific firms.

“If policymakers are concerned about lawmakers benefiting from politically valuable information, it’s important to recognize that the information itself is often industry-wide in nature,” she said. “Restrictions focused exclusively on individual stocks may not fully address the issue if lawmakers remain free to invest in industry-specific funds or sector-focused investment vehicles.”

Notes

The study was published in the Journal of Financial and Quantitative and Analysis. Including Walther, co-authors include Dane M. Christensen and Laura A. Wellman of Lundquist College of Business at University of Oregon, and Hengda Jin of Mays Business School at Texas A&M University.