CAPITOL GAINS.(The Talk of the Town)(Bill Frist, insider trading)

Earlier this year, Senate Majority Leader Bill Frist told the trustee in charge of managing his stock portfolio to sell all of his shares in Hospital Corporation of America, the giant company founded by the Senator's father and brother. Just two weeks after the shares were sold, H.C.A. announced that its earnings would not meet Wall Street expectations, and the company's stock price tumbled almost nine per cent. Frist, it happened, had got out pretty much at the top, and his continued connections to H.C.A.--his brother, for instance, is on the company's board of directors--raised the possibility that he'd been tipped off.

Frist is now the target of a probe by the Securities and Exchange Commission, although he insists that he did nothing wrong, and that he sold the shares to defuse concerns about potential conflicts of interest. Frist's colleagues in the Senate, meanwhile, have remained noticeably quiet about the affair. Perhaps that's because he's far from the only senator to demonstrate uncanny investing smarts. Last year, Alan Ziobrowski, a professor at Georgia State, headed the first-ever systematic study of politicians as investors. Ziobrowski and his colleagues looked at six thousand stock transactions made by senators between 1993 and 1998. Over that time, senators beat the market, on average, by twelve per cent annually. Since a mutual-fund manager who beats the market by two or three per cent a year is considered a genius, the politicians' ability to foresee the future seems practically divine. They did an especially good job of picking up stocks at just the right time; their buys were typically flat before they bought them, but beat the market by thirty per cent, on average, in the year after. By those standards, Frist actually looks like a bit of a piker.

Are senators really that smart? The authors of the study suggest a more likely explanation: at least some senators must have been trading "based on information that is unavailable to the public"--in other words, they were engaged in some form of insider trading. It's impossible to pin down exactly how it happened, but it's easy to imagine senators getting occasional stock tips from corporate supplicants, and their own work in Congress often deals with confidential matters that have a direct impact on particular companies.

That the senators have done this without a hint of censure shouldn't come as a surprise. Corporate insider trading is illegal, in theory, but prosecutions are rare. Economists have known for a long time that corporate insiders outperform the market by something like six or seven per cent a year. The only way they could pull that off is by trading on privileged information. And some people think that's as it should be. Beginning in the nineteen-sixties, when Henry Manne published "Insider Trading and the Stock Market," many theorists have argued that insider ...