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Why Are Politicians Allowed to Own Stocks?

By Daniel Ferry - Dec 1, 2012 at 1:00PM

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A case for banning stock ownership by our elected leaders.

Susan Rice is not only the U.S. ambassador to the United Nations and a leading contender to take over the Secretary of State position from Hillary Clinton; she is also a rather successful investor. As is often the case when public officials get financially involved with the companies they oversee, the ambassador has recently attracted some criticism over the propriety of her investments. Some progressive Democrats and environmentalists are questioning whether Rice is fit to be the next Secretary of State after discovering some troubling financial positions in her surprisingly large portfolio.

At issue is the role of the State Department in approving energy infrastructure operator TransCanada's (TRP 0.55%) proposed Keystone XL project, an oil pipeline that would transport oil produced in Canada's Tar Sands to refineries and export terminals on the Gulf Coast. Keystone XL promoters claim the pipeline would generate good jobs and encourage North American energy independence, but the project is controversial.

Some of the proposed routes for the pipeline would traverse highly sensitive environments like Nebraska's Sandhills wetlands area and the watershed of the Ogallala aquifer, which provides drinking water for 2 million people and supports $20 billion in agriculture. A leak in these areas could contaminate water supplies and harm wildlife.

Since the project crosses national borders, TransCanada needs a permit from the State Department to proceed. Now, nobody wants to risk contaminating water supplies or miss out on a way to create thousands of jobs, so no matter what side of the issue you come down on, it's clear that the Secretary of State has an important decision to make. Ideally, that decision will be made as intelligently and transparently as possible, but if Susan Rice becomes the next Secretary of State, her judgment may well be unduly biased.

According to financial disclosure reports first highlighted by the environmentalist magazine OnEarth, Ambassador Rice has a good portion of her $23 million to $43 million net worth invested in companies that stand to directly benefit if the project goes forward. Besides a $300,000 to $600,000 investment directly in TransCanada, Rice and her husband have invested at least $5 million in Canadian oil companies including Enbridge (ENB 0.32%) that are working on the Tar Sands, with at least another $5 million in Canadian banks such as Toronto-Dominion (TD -0.64%) that are expected to finance the project and at least $2 million invested in infrastructure providers, among them railroad Canadian Pacific (CP 0.66%) and electric utilities that are expected to benefit from the project.

Rice's impressive investment portfolio is heavily tilted toward energy companies and Canadian companies, with as much as half of her net worth at least partially dependent on the success of the Keystone project. Even if the ambassador means well, it's difficult to ignore that approving the Keystone XL pipeline would provide an immediate and substantial payoff for Rice. Is a truly independent decision even possible in such a case?

Rice is not alone. There's an elite group of investors that has managed to produce spectacular returns for decades, outperforming not only the market, but also corporate insiders. They're not a private equity group, or a hedge fund, or even Motley Fool subscribers. They're members of Congress. Researchers have found that between 1985 and 2001, members of the House of Representatives outperformed the market by about 6% per year (PDF). Members of the Senate did even better, crushing market returns by more than 12% annually in the study period of 1993 to 1998 (PDF). Either our lawmakers just happen to be some of the best investors in the world, or they're using their position to gain information not available to regular investors and writing regulations to enrich themselves.

Example after example of public officials who were exploiting their insider knowledge for personal gain led to the passage of the STOCK Act in April, a bill meant to curb such behavior. However, the bill only bans using "inside information" to make a trade and doesn't prevent members of Congress from trading in industries that they personally regulate, a practice still alive and well.

When The Washington Post contacted more than a dozen lawmakers who had traded companies that would be affected by legislation they were working on, the nearly unanimous response was that the timing was "coincidental." Since the STOCK Act forbids only using non-public information to influence an investment decision, and proving that an official used non-public information is very difficult, citizens and regulators are left with little ability to police these trades.

Well, I suppose we could take their word for it. Politicians, after all, are known for their scrupulous devotion to being forthcoming and honest, and would certainly never gloss over the truth for personal gain.

Skepticism aside, one doesn't need to believe public officials are corrupt to think that their investments can bias their decisions. Something that all investors need to be wary of is the tendency to become emotionally attached to an investment. This can lead to blind spots, as that psychological commitment can lead investors to seek out or acknowledge only the information that confirms their preconceived notions, a phenomenon known as confirmation bias.

Going back to Ambassador Rice, even should she earnestly try to make an unbiased decision, the fact that she has several million dollars in companies backing the project leaves her predisposed to view the pipeline favorably. She is liable, therefore, to subconsciously give more weight to positive information and to downplay potential risks. Do we really want someone who can't be expected to be impartial about an issue to have final authority over it?

All this invites a simple question: Why do we let our public officials own stocks at all? There are plenty of privileges a private citizen enjoys that a politician gives up when taking public office, and in the interests of good governance, why shouldn't owning stocks be one of them? If voters demanded it, officials could be compelled to sell their stocks upon taking office, and invest instead in a blind trust or government pension system that they cannot influence. No matter where you land on the political spectrum, we should all expect our lawmakers and public officials to make decisions based on what's best for the people they represent, not what's best for their own portfolios.

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Stocks Mentioned

Enbridge Inc. Stock Quote
Enbridge Inc.
ENB
$42.40 (0.32%) $0.14
TC Energy Corporation Stock Quote
TC Energy Corporation
TRP
$52.09 (0.55%) $0.28
The Toronto-Dominion Bank Stock Quote
The Toronto-Dominion Bank
TD
$65.16 (-0.64%) $0.42
Canadian Pacific Railway Stock Quote
Canadian Pacific Railway
CP
$70.30 (0.66%) $0.46

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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