The theory here is that the longer a party controls Congress the greater is the flow of information which might be exploitable through a trade.
The study showed only "very weak evidence" of what it calls "informed trading" for non-powerful members of Congress.
Stock Act
To explore the impact of relative power while in Congress on stock trading, the study looked at 50 powerful Republicans whose status shifted from having a powerful committee assignment to not having one. The results were striking: these 50 members traded almost five times more when they were in power compared to when they were not. Their performance was also vastly better while in the inner circle: abnormal excess returns were above 30 percentage points annualized for under one-week holding periods while in power. While out of power the same group showed "some evidence of underperformance."
Earlier studies have looked at congressional stock trading with differing methodologies and mixed results. A 2004 study found strong outperformance during the 1994-1998 period, while one in 2013, covering 2004-2008, did not. This study uses different methods, and purports to be the first to look at the joint impact of party membership and powerful committee assignments on portfolio performance.
To be sure, implying something is not proving it, but these results give cause for concern that public officials were using their position for personal gain in unethical or unsavory ways.
And while the study attempted to control for the sophistication of the member of Congress making the trades, there is no way to completely rule out that outperformance was a matter of luck or skill, persistent as the outperformance was.
Concern over potential insider trading by members of Congress was the backdrop for the passage of the Stop Trading On Congressional Knowledge (STOCK) Act of 2012 which prohibits the use of non-public information for private profit and tightened reporting requirements. It remains to be seen, of course, if we will see members' performance revert to the mean, much less if senators and representatives will now trade less frequently.
The STOCK Act, however, does not explicitly address the legality of members trading on non-public information they are given from sources outside Congress, a clear weakness of the legislation and something the study found evidence was occurring. People do, after all, want to put powerful politicians under an obligation, and what more effective way than giving them some profitable information.
The study both justifies the passage of the STOCK Act and suggests the need for even more transparency in congressional stock trading with easier access to data.