Friday, November 18, 2011

Insider Trading in Congress

Insider trading by members of Congress and their staff is back in the headlines after a CBS report on 60 minutes. See video below:

The 60 Minutes report has renewed attention in H.R 1148, the Stop Trading on Congressional Knowledge Act which would prevent members of Congress and their staffs from using information not available to the public to guide them in making or selling investments. This proposal goes back to 2006 when Rep. Louise Slaughter (D-NY) first proposed the bill in response to a story about day trading by the chief of staff of then-House Majority Leader Tom DeLay(R-TX). The Chairman of the House Financial Services Committee, Rep. Spencer Bachus (R- AL), has announced that he will schedule the first-ever House hearing on legislation to prevent lawmakers from trading on nonpublic information. Sen. Kirsten Gillibrand (D-NY) announced that she and other Senators will introduce a Senate version of the STOCK Act to prohibit members of Congress from engaging in insider trading.

Insider trading in Congress is nothing new. See Abnormal Returns from the Common Stock Investments of Members of the United States Senate, 39 J. Fin. & Quantitative Analysis 661 (2004) which studied congressional insider deals dating to the mid-1990s. The SEC has not taken any action against insider trading by senators and other congressional officers, leaving Congress to police itself so far without success. Such "insider trading" is illegal for most Americans, but the question whether it applies to members of Congress and their staff is the subject of some debate. Insider trading is not explicitly prohibited by law. The SEC website says “the term actually includes both legal and illegal conduct.” The offense is prosecuted as a violation of Rule 10b-5 of the Securities Exchange Act of 1934, a general anti-fraud rule that prohibits deception “in connection with the purchase or sale of any security.”

Commentators claim that Congressional officials are immune from federal insider trading law. But Prof. Donna M. Nagy argues that the “conventional wisdom that there is some type of legal loophole for Congressional insider trading is simply wrong. Any Member of Congress or legislative staffer who trades securities on the basis of material nonpublic information obtained through Congressional service is already doing so in violation of existing federal securities law.” See her article Insider Trading, Congressional Officials, and Duties of Entrustment, 91 B.U. Law Rev. 1105 (2011).

On the other hand, Prof. Stephen Bainbridge argues the opposite in Insider Trading Inside the Beltway saying “As to members of Congress, however, current law provides a strong argument that their trading cannot be punished under either the classic disclose or abstain or the misappropriation theory.” He concludes: “Insider trading by corporate insiders has been banned for over four decades. Throughout that period, we have known that insider trading by members of Congress was a potential problem that arguably presented even more serious policy concerns than trading by classic insiders. Congressional insider trading creates perverse legislative incentives and opens the door to serious corruption. Yet, both Congress and the SEC have turned a blind eye.”

60 Minutes reported that Chairman Bachus made bets that financial markets would collapse at the same time he met with officials from the Fed and Treasury Department in 2008 by buying options when the Dow opened at 8,604 and selling them a few days later after the market fell doubling his investment. If the STOCK Act becomes law, the true test of equal enforcement will be if the SEC will pursue civil actions and the DOJ pursue criminal actions against a powerful chairman of Congress with oversight of their funding.

For more on insider trading, see the Brooklyn Law School Library copy of the 3d edition of Insider Trading by William Wang and Marc Steinberg, an 1178 page comprehensive and up-to-date resource by two experts who provide clear and concise information on insider trading liability. Chapters include: Impact on society, the issuer, and the insider trader's employer -- The harm to individual investors from a specific insider trade -- Some basic elements of insider trading liability under Section 10(b) and Rule 10b-5 -- Those who violate Section 10(b) and Rule 10b-5 by insider trading or tipping -- The Rule 10b-5 private plaintiffs who can sue a stock market insider trader for damages -- Government enforcement.

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