Posted by on Apr 13, 2010 in Articles & Advice, Blog, Columns, Featured |

Image Credit: Heath Hinegardner

By Jason Zweig |  Apr. 10, 2010 12:01 a.m. ET

You might not be surprised to hear about an investor who made money betting that the Nasdaq stock index would collapse during the financial crisis—unless you found out that he is a U.S. congressman who is intimately involved in overseeing the capital markets.

As Congress resumes debating how to reform every other aspect of the financial system, it also might consider revisiting its own investing rules.

Consider Rep. Spencer Bachus (R, Ala.), ranking member of the House Financial Services committee. In 2008, as the financial crisis deepened, Rep. Bachus made more than 200 trades in stocks and options, holding his average position for roughly 15 days at a time and often executing several trades in a single day. On Sept. 10, 2008, as Lehman Brothers teetered on the brink, Rep. Bachus made 12 trades in or out of General ElectricBurlington Northern Santa Fe, Sony and an exchange-traded energy fund.

These details come from account statements that Rep. Bachus included with his 2008 financial disclosure to Congress in May 2009. (The filings for 2009 should be released next month.)

Rep. Bachus isn’t alone. The financial disclosures of other key members of Congress, including at least three dozen who sit on the Senate Finance, Senate Banking or House Financial Services committees, also show some trades during 2008, even in financial stocks. Not all of these legislators manage their own money directly, according to their disclosure forms or their offices; Rep. Bachus does. Nor do other members trade options as actively.

In an email response to The Wall Street Journal, Rep. Bachus said that since most of his trades are considerably smaller than $1,000, the mandatory reporting threshold, “I go beyond requirements in the transparency of my disclosure.”

“Never have I traded on non-public information nor do I trade in financial stock,” he added.

Under Congress’s ethics rules, “there’s not anything wrong” if a congressman or senator trades options, so long as no inside information was involved, says Peter Van Hartesveldt, a partner at Nossaman LLP and former counsel to the House ethics committee.

U.S. representatives, senators and staff are prohibited from using their position for personal gain and must disclose their holdings annually. But they are generally free to invest in companies whose business may be affected by congressional votes or hearings. Staff members in the Senate may be required to divest stockholdings that exceed 3% of their net worth, but that restriction applies neither to Senators themselves nor to House members or their staffers.

During 2008, almost all of Rep. Bachus’s trades were in options: bets that a stock would rise above or fall below a particular price by a given date. Between January and September 2008, he executed roughly four dozen trades in stock and options on ProShares UltraShort QQQ, a “leveraged” exchange-traded fund that is designed to go up by twice as much as the Nasdaq 100 index goes down.

Had you invested in the Nasdaq index, you would have lost 23% in the first nine months of 2008. Rep. Bachus, on the other hand, made money from that decline—effectively betting against a market his committee helps oversee. His account statement indicates that trades in the ultrashort fund and its options earned Rep. Bachus roughly $28,000 in gains, a figure he doesn’t dispute.

“In 2007, I felt the markets were overvalued and said this publicly many times.” he said.

Not all of Rep. Bachus’s trades were as profitable. His 2008 financial disclosure shows that he earned a total of $30,473.85 in short-term gains across his entire trading account. Given the high trading volume, that isn’t much, says Gary L. Gastineau, author of The Options Manual, who analyzed the activity for the Journal without knowing who the accountholder was.

“This person traded more [options] contracts in a single year than I’ve traded for my own account in my entire lifetime,” says Mr. Gastineau, who spent 20 years as a Wall Street options strategist.

“It is prudent to protect your investments,” Rep. Bachus said. “My No. 1 goal [in trading] is to profit from my investments, and a secondary goal is an enjoyment of investing and to better understand the markets. More members [of Congress] ought to be invested in the markets.” Rep. Bachus said he normally enters his trades on nights or weekends.

George Loewenstein, a behavioral economist at Carnegie Mellon University, has studied conflicts of interest. “People can be biased by surprisingly small incentives,” he says, “so even if a congressman’s portfolio is small, it could still influence his behavior in votes and hearings.”

Once people disclose a potential conflict, adds Prof. Loewenstein, they often feel morally absolved—which can blind them to the possibility that they may still be biased. “Disclosure alone,” he says, “is a completely ineffective antidote to these kinds of problems.”

Instead, suggests Prof. Loewenstein, members of Congress should consider divesting shares of any companies they oversee—or transferring all their assets into a blind trust, where they would no longer know which companies they own.

“A specific proposal benefiting a specific company … could create a temporary bias,” said Rep. Bachus. “However, index options create no such bias.”

Congressional staffers say that senators and representatives deliberate on so many aspects of the global economy that they can’t possibly divest every holding that might be affected by their deliberations.

But judges must recuse themselves from cases in which they have a significant economic interest. Reporters—at least at the Journal—are not permitted to write about companies whose shares they own. Congress should abide by the same standards; trades by legislators are troubling at best and, at worst, could make a mockery of the public trust.

Source: The Wall Street Journal