The longer they live, the bigger babies they are.
—
PROFESSOR WILLIAM GRAHAM SUMNER
of Yale, 1895, on the demands of businessmen and politicians for special privileges
LET'S BE CLEAR: we need to stop coddling these people. Many others have been prosecuted for actions much less serious than those discussed in this book.
These people are not doing us a favor, and they don't deserve special treatment. There is no reason why only one place in the United States should be excluded from ethical standards and laws concerning insider trading, conflict of interest, nepotism, and cronyism. That in that same place, you won't be protected if you report financial corruption. After all, that may be the one place where we most need all these things: Washington, D.C.
The problem with Washington isn't gridlock. It isn't that things aren't getting done. The problem is the corruption of the public spirit. The Permanent Political Class has no sense of urgency to change because, for them, business is good.
We need to break the cycle of crony capitalism, land deals, and insider trading. And we can do it simply by applying the rules that the politicians expect the rest of us to abide by.
As we have seen, disclosure requirements are not sufficient to stop cronyism. What about trusts? Many members of Congress put their assets in so-called blind trusts, and thereby appear to be above suspicion. Yet such trusts don't work either. Despite the name, blind trusts are far too often not, well, blind. And they are not dumb either. Senator Robert Toracelli had a blind trust, and by picking a political acolyte and longtime friend as his trustee, Toracelli made a killing on illegally manipulated stocks.1 Senator Bill Frist had a blind trust where he held, among other things, shares of Hospital Corporation of America, a company started by his father. But that did not prevent the trust from making some well-timed stock sales, which set off an eighteen-month SEC investigation. Frist was cleared of all charges, but the episode highlighted the fact that a blind trust is not always blind. Politicians who have their assets in a blind trust whose trustees seem to show amazing deftness in predicting government actions need for serious scrutiny.
The rules of a blind trust are simple. You must select a trustee (it cannot be a family member) to direct the trust and deal with the investments. You cannot have a conversation with the trustee about the portfolio, and you cannot direct or suggest trades. Of course, what a politician can do is share nonpublic information, the kind that hedge funds pay a lot of money for, and then let the trustee make his own decision about how to react. As law professor Megan Ballard puts it, "The rules for these trusts do not include sufficient incentives to maintain blindness." Indeed, "blind trusts can mislead the public into believing that policymakers are avoiding conflicts, when they may not be doing so." As Ballard points out, the first elected U.S. official to use a blind trust was Lyndon Johnson, who was notorious for using his position to benefit his businesses. LBJ named two business associates and a family friend as his trustees. And he continued on as usual, with his trustees handling specific details.2
The simple fact is that politicians often select close colleagues, friends, and acolytes to run their blind trusts. Furthermore, once you establish a blind trust, according to the rules of the Senate, you are no longer required to disclose your assets annually, so it creates less transparency than before. Things that politicians are allowed to do in the dark are not always good.
Back in 1995, when legislators were arguing over the Congressional Accountability Act, which would subject Congress to federal antidiscrimination and other workforce protection laws, Senator Charles Grassley of Iowa said: "I hold the strong belief that we, in Congress, are merely representatives of the people. We are not better than the people we represent and we are not, by definition and determination, different from the people we represent. We are, as representative government intends, the people themselves."3 It's time for Grassley's argument to be applied to crony capitalism on both Capitol Hill and in the White House.
Insider Trading
Henry Manne recognized in 1966 that "the federal government is the largest producer of information capable of having a substantial effect on stock-market prices."4 The author of the standard text on insider trading knew Congress was a rich source of privileged information. What do our laws say on the matter?
When it comes to current SEC insider trading laws, there is a spirited debate going on among legal scholars as to whether current laws actually apply to Congress. Many contend that they don't, because our legislators are not fiduciaries (that is, client representatives) and are therefore not obligated to keep secret information secret. Other scholars argue that SEC laws on insider trading do apply to members of Congress. They claim it is illegal under Rule 10b-5 of the Securities Exchange Act, which is a general antifraud provision that prohibits deceptive conduct "in connection with" the purchase or sale of securities.5
But even if current laws do apply, the political reality is that the SEC is not going to enforce them against Congress. Remember, the SEC is funded by Congress. And SEC commissioners require Senate confirmation. Congress has oversight over the whole operation. Remember what happened when the FBI raided Congressman Jefferson's office? His colleagues threatened to cut funding for the Justice Department. And recall from the introduction how everything from IRS enforcement rates to listings under the Endangered Species Act are directly influenced by congressional power.
In Great Britain and throughout the European Union, it is already a crime to use insider government information for stock trades. Britain's Financial Services Act of 1986 extended the scope of the so-called Insider Dealing Act to explicitly cover all public servants. This included political or government information received "by all royal and civil servants and by all outside individuals receiving information from these servants." In other words, you better not pass the information and you better not trade on that information. This standard, if applied to the United States, would make clear to hedge funds that if they receive information from government employees and trade on it, they too may be liable.6
In 1989, the European Union deemed that insider trading laws for member states needed to meet a minimum floor. The EU said explicitly that insider trading meant trading on private information obtained "by virtue of the exercise of [one's] employment, profession, or duties." It specifically included "members of the central bank, the press, the parliament, the ministry of economics and of other institutions, committees and bodies who may possess inside information because of their profession or their duties."7
It would be difficult to apply the European standard here because in the United States there is no statutory definition of insider trading; it has been defined by our courts over time. I'm not one to adopt a law simply because some other country has it, but clearly the British and the Europeans are on to something: sensitive insider information means not just advance warning of a corporate announcement. It can also mean a key piece of legislation that will affect the stock price of a company. And if a legislator trades on this information, or shares it with someone else who trades on this information, he should face possible legal sanctions.
Conflict of Interest
The U.S. Supreme Court recognized decades ago "that an impairment of impartial judgment can occur in even the most well-meaning men when their personal economic interests are affected by the business they transact on behalf of the government."8 All of us, if we are part of any sort of organized commercial enterprise, need to abide by conflict-of-interest laws.
As we've seen, this applies at the local, county, and state levels. Recently a city councilman in Sparks, Nevada, was censured by his state because he cast a vote in favor of a casino project that involved his campaign manager. He sued, claiming that he had a First Amendment right to vote on the matter. The Supreme Court, in a unanimous decision, denied his argument and found that conflict-of-interest laws were constitutional. Justice Antonin Scalia, writing for the court, said that conflict-of-interest rules "have been commonplace for over 200 years." He went on to note that when a public official votes, it "is not personal to the legislator but belongs to the people. The legislator has no personal right to it."9
Some states are going beyond simply censuring officials who have conflict-of-interest dealings. The State of Florida recently convened a statewide grand jury to consider how to deal with public corruption. Among its recommendations: "We also find voting conflicts of interest should be criminally punished ... In essence, the law would tell public officials that they have a fiduciary duty to the public and that they must separate themselves from anything given to them while serving in this fiduciary duty. When a public official has a conflict, he or she should step aside and disclose the conflict. The only benefit the public official should receive is for the public, not for the public official or anyone else." Although Florida has not criminalized conflicts of interest, other states have.10
Land Deals
Why not apply to Congress the same ethical standards faced by members of county councils in most states? If they are asked to vote on a project that will benefit them directly, they must disclose that fact publicly and recuse themselves. Also, as a rule, a politician should not be a party to a land deal involving a campaign contributor. If someone has given an elected official more than $1,000 in campaign contributions, she should be barred from engaging in land deals with the donor.
Real Disclosure
The current financial disclosure forms required of politicians offer only a superficial look at finances and possible conflicts of interest. Here's an idea: make the House and Senate subject to the Freedom of Information Act. After all, Congress deemed it necessary that the executive branch be subject to the act. Even the CIA and the National Security Agency fall under its purview. Are congressional secrets more important to the safety and security of our nation? Such secrets are important only to the safety and security of our politicians. We should apply the Freedom of Information Act to Congress members and congressional committees.
Grants, Loans, and Insider Deals
As we have seen, when the federal government hands out billions of dollars in cash, there is often little transparency in the process. Corporations and nonprofit organizations keep records of major financial decisions. They also establish policies to protect against cronyism. When a compensation committee meets, for example, as a rule there can be no direct financial ties between any member and the company's CEO, and the committee must keep records of its votes and decisions. But at the federal level, when a $150 million guaranteed loan is offered, the process includes little transparency and no clearly established standards. Presidents should not be able to steer billions of dollars in taxpayer money to their friends, campaign fundraisers, and cronies, disguised as some so-called social good.
Breaking the Cycle of Crony Capitalism
Here are some initiatives that we must undertake to break the cycle of crony capitalism:
Create a legal code that makes trading on nonpublic government information illegal both for those who pass the information and for those who trade on it. This is the standard in Europe, and it makes sense. But we need to be realistic and assume that the SEC will be a reluctant enforcer, so we will need to put additional checks in place.
Corporate insiders trading their own company's stock are required to disclose these transactions to the SEC within two days. Why not apply the same standard to Congress? Members should disclose all transactions above, say, $5,000 within two days. The disclosure should be detailed, including the price and number of shares, and then placed online in a database. That will make potential insider trades easier to identify.
Members of Congress should not be allowed to trade stock in companies that are overseen by their committees. If you sit on the Senate Banking Committee, for example, you should not be allowed to trade bank stocks. If you serve on the Senate Armed Services Committee, you should not be able to buy and sell defense stocks. Does your subcommittee deal with health issues? No pharma stock. This is the area where insider trading is most likely to occur, and where lawmakers are most likely to obtain market-moving information from which they or their friends can profit.
Apply whistleblower laws to Congress. If it's good enough for federal workers and corporate employees, it should be good enough for Congress. We should encourage congressional staffers, when they see financial irregularities like insider trading, to report them. But they will report them only if they know they will be protected from retaliation. They should be afforded that protection.
Disallow "sweetheart" IPOs. One of the fastest ways for a member to make a quick buck is through an IPO. You can't legally hand a congressman $10,000 in cash, but you can arrange for him to participate in a lucrative IPO that is worth far more. "Special-friend" IPOs should be disallowed. Unless the initial public offering goes through a public auction, in which people can openly compete for shares in a bidding contest, members of Congress should not be allowed to participate.
Review, revise, and enforce existing conflict-of-interest laws. Restricting stock trades based on committee assignments is a start, but not an end. Another possible way to avoid conflicts of interest would be for members either to abstain from voting when a conflict exists or to place their assets in mutual funds rather than individual stocks. Also, enforce the conflict-of-interest laws for senior White House officials and political appointees. Cronyism is cronyism, and political appointees should not be allowed to steer taxpayer money to former employees or business associates.
Earmarks in which a member of Congress will receive a direct financial benefit should be disallowed, period. Taxpayer money should not be used as a resource to boost your property values.
Family members of legislators should not be allowed to become lobbyists.
Don't allow campaign contributions when Congress is in session. Twenty-eight states place restrictions on politicians receiving campaign contributions when the state legislature is in session. Extending this prohibition to Congress will make it harder for politicians to extort money from businesses.
The federal government needs to get out of the business of offering grants and taxpayer-backed loans. It's a nice idea in theory, but in practice it's a disaster. The process is rife with corruption, favoritism, and cronyism. Don't let our lawmakers or political appointees in the executive branch pick winners and losers based on who their friends are. Today we have a form of socialism for the very poor and the very rich. It's unfair, and we can't afford it.
The problems we face today are not the result of the individual failings of a few leaders. What we face is a system that is compromised by the perception that U.S. public policy is a marketable commodity. It's time to fix it. Let's relegate the Government Rich to the ashbin of history. If you want to get rich, do it the legitimate way. Go out and produce a useful good or service that you have a right to sell.