SEC Can Explain Why It's So Good at Selling Stocks
Here is an investment strategy for you:
- Buy all the stocks in the S&P 500 index, weighted by market cap.
- Any time the Securities and Exchange Commission opens an investigation into one of those companies, sell its stock.
That's it! I feel like that would be a good strategy, right? All the benefits of indexing, plus you get to occasionally trade on inside information. Oh, right, for this strategy to work, obviously, you'd need to know about SEC investigations as soon as they start; you can't just wait until the investigations are public.
So I guess the downside of this strategy is that, to use it, you need to work at the SEC. The upside, though, is that if you work at the SEC, this strategy is totally fine!
"Each of the transactions was individually reviewed and approved in advance by the Ethics office," said John Nester, spokesperson for the SEC. "Most of the sales were required by SEC policy. Staff had no choice. They were required to sell."
Nester explained that before staff can work on an issue that involves a company, they have to sell any holdings of stock in that firm. As a result, he said, there shouldn't be any surprise that a sale would precede the announcement of an enforcement action.
This response -- in an update to a Wonkblog post about the SEC trading-skillz paper we discussed the other day -- left me incoherent with delight. The phrase "work on an issue that involves a company" is studiously neutral, but of course SEC staff rarely "work on an issue that involves a company" winning a major award. "SEC Announces Investigation Into How Awesome Enron Is" is not a headline I remember reading. SEC staffers starting to work on a company is not a perfect negative indicator about that company, but it certainly skews negative. Don't take my word for it, though; that paper found that stocks sold by SEC staffers go on to underperform the market by around 8 percent.
But it's okay, because they had no choice! I don't know, I bet they had a choice. One choice would be not to own individual stocks of companies that they might one day find themselves working on. I do this in my own life, with one glaring exception, 2 and I do not find it particularly onerous. But I seem to be significantly less interested in personally trading stocks than the SEC staff is, which might correspondto some of our different views on market structure.
What should the SEC policy be? I mean, "don't own any individual stocks" is an obviously pretty good one, used by lots of companies that deal in sensitive financial information. 3 Once you do allow staffers to own individual stocks, your options are obviously more limited: You can force them to sell any stock that they start investigating, or you can force them to keep it. 4 If you force them to sell, you get outperformance by SEC staffers trading on inside information. 5 If you force them to hang on, you get the conflict of interest where staffers own stock of the companies they are investigating and therefore have some incentive to go easy on them.
If only insider trading law offered some guidance for the agency in charge of enforcing insider trading law! Classically, someone who obtains inside information in the course of his duties is required to "disclose or abstain": Either don't trade, or disclose the inside information that you have before trading. If the SEC had to put out a press release announcing the start of an investigation before its staffers sold stock, that would be ... well, I mean, it'd probably be pretty terrible for a lot of companies, in that they'd be tainted by news of preliminary investigations even if those investigations end up going nowhere. But on the other hand, it'd be great for market transparency: Everyone would get to share in the 8 percent outperformance that the SEC staff currently keeps for itself. And isn't the SEC all about transparency and creating a level playing field?
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BONUS: When the investigation is over, disclosed, and fully baked into the market price, buy it back, why not. That seems to be allowed too?
Ask me about the time I worked at Goldman Sachs and they gave me some stock.
Or "put all your individual stocks in a blind trust" would probably be fine. "Don't own any stocks in your sector" is a plausible one for sectorized businesses, but I'm pretty sure it wouldn't work for SEC enforcement.
A third choice is to leave them the unrestricted choice of selling or keeping the stock of a company that they're investigating, but that is pretty obviously dumber than the other two choices.
I suppose there's also a theoretical conflict of interest where you could open an investigation with the purpose of (1) triggering a forced sale of your own stock and (2) driving the price down, though I don't really see how you'd monetize this so it doesn't worry me much.
(Matt Levine writes about Wall Street and the financial world for Bloomberg View.)
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