The SEC Explains Why It's Okay That SEC Employee Stock Trades Earn 4 to 8.5% Excess Returns

Following up on "Portfolios of SEC Employee Stock Picks Earn Excess returns of 4-8.5% Per Year".
Matt Levine at Bloomberg (footnotes baby, footnotes!):

SEC Can Explain Why It's So Good at Selling Stocks

Here is an investment strategy for you:

1. Buy all the stocks in the S&P 500 index, weighted by market cap.
   
2. Any time the Securities and Exchange Commission opens an investigation into one of those companies, sell its stock.¹
   

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.....MORE