Negative Trading in Congress

We previously have investigated short selling in several empirical settings, including “negative activism” that targets companies. In our most recent study, we turn to short selling by members of Congress – “negative trading in Congress” – a controversial topic that might seem more appropriate for a blockbuster film than for academic study.

Yet we show that truth is as strange as fiction: Congressional negative trading is not only common but is associated with positive abnormal financial returns. Simply put, when members of Congress bet on stock price declines, they make money. In contrast, we do not find a similar association for long positions taken by members of Congress. There exists an asymmetry between “positive” versus “negative” Congressional trading.

As we document for the first time in the literature, negative trading by members of Congress is widespread. Dozens of members of Congress have shorted shares, bought put options, sold call options, or gained negative exposure by purchasing mutual funds during the previous decade. Our dataset provides an opportunity not only to analyze negative trading by members of Congress, but to revisit several fundamental concepts related to the regulation of both political and market activity.

We study transactions reported by members of Congress from July 2012 through May 15, 2023. This database includes approximately 150,000 transactions by 1,000 current and former members of Congress and their families, including data capturing the owner of the account, the amount and value of the trades, and any reporting delay. We focus on short sales, purchases of negative or inverse mutual funds, and long put option and short call option positions, all of which profit when underlying asset prices decrease. For example, twenty members of Congress engaged in options trading with negative price exposure (a surprising fact to us, and perhaps to others who assume Congressional officials are not options traders).

We note several limitations to our study, including data reporting limits and the fact that we do not observe the filer’s overall portfolio positions or certain details about their trading, such as the strike price of options. Nevertheless, our examination reveals that negative trading is significant both in number and size. The numbers are not economically meaningful compared to many other market phenomena, but they are significant given that they involve a relatively small number of political leaders; we observe a total of 587 negative trades overall, with a total value of approximately $15.5 million. The most common trades are in various index options, though members of Congress also trade in several individual companies, including Stryker, Cleveland-Cliffs, Alibaba, and U.S. Steel.

We analyze the buy-and-hold returns of negative Congressional trading positions using standard empirical methodologies to construct portfolios based on various weightings. We compare the compounded returns of these portfolios to compounded market returns. Our results suggest that members of Congress earn positive financial profits from their negative trades during short-term trading windows. These returns are greatest approximately ten to fifteen trading days after the transaction for all position types, when they reach 1% to 2%.

We also analyze cumulative abnormal returns based on widely-used models in the finance literature, calculating these returns over multiple trading windows and multiple portfolio weightings. Our results show an analogous story to the buy-and-hold abnormal return analysis: for most portfolios and holding periods, targets experience meaningful, statistically significant decreases in value when members of Congress disclose their negative trades. The results suggest that public disclosure of a Congressional negative trade is new, material information that decreases companies’ market valuations.

Our results for negative positions contrast sharply with our results for positive transactions, where we find that members of Congress on average suffer modest losses. Moreover, financial markets view these disclosures with indifference, suggesting that these trades do not reveal new, material information.

Our results show that ongoing policy discussions around Congressional stock trading should address negative trading as a separate phenomenon from positive trading. Unfortunately, most existing and proposed regulatory approaches, disclosure rules, and reform proposals do not distinguish between the two. Proposals to regulate Congressional trading should reflect the empirical evidence that reveals key differences between positive and negative trading, and we show how current approaches fail to do so.

The main costs and benefits undergirding proposals to restrict or ban Congressional trading can be grouped into two goals. We label these rationales “trust” goals and “efficiency” goals. Trust goals’ objectives relate to concerns about public trust in the legislative process by preventing one party from improperly taking advantage of superior information to achieve financial profits. In contrast, efficiency goals focus on market incentives and efficient allocations of capital. Efficiency goals are more economic in focus than judicial or jurisprudential and encompass informational benefits and costs of Congressional trading, effects on firms’ investment in information, and the potential for traders to destroy (or create) value at companies to affect stock prices.

To the extent restrictions on Congressional trading are designed to promote trust goals, our findings indicate that negative Congressional trading should be regarded as more problematic than positive Congressional trading. But focusing on efficiency goals leads to very different conclusions given that, in theory, negative Congressional trading provides new information to markets that positive Congressional trading does not. We are aware of political realities that make it unlikely policymakers would support subsidizing or otherwise encouraging negative Congressional trading. Nevertheless, our empirical results suggest that cogent and well-informed policy should consider the unique costs and benefits from negative trading in Congress.