Sunday, February 6, 2011
Insider Trading, Congressional Officials, and Duties of Entrustment, by Donna M. Nagy, Indiana University Maurer School of Law, was recently posted on SSRN. Here is the abstract:
A recent hullabaloo in the media put a spotlight on insider trading and Capitol Hill hypocrisy. Both topics have long fascinated the general public and the combination of the two proved irresistible. An October 11, 2010 front page article in the Wall Street Journal ignited the controversy, and by the end of that week, newspapers and the internet were filled with claims that insider trading by members of Congress and their legislative staff is "totally legal" because congressional officials are "immune" from federal insider trading laws. Enactment of the proposed "Stop Trading on Congressional Knowledge Act," dubbed by its sponsors the "STOCK Act," was heralded as the only effective way to render congressional insider trading unlawful.
This article refutes the conventional wisdom and argues that insider trading on the basis of nonpublic congressional knowledge is already illegal under Rule 10b-5 of the Securities Exchange Act, a general anti-fraud provision which prohibits deceptive conduct "in connection with" the purchase or sale of securities. The article further contends that the proposed STOCK Act, if enacted, would actually narrow the scope of the law that would otherwise apply to members of Congress and legislative staffers in the absence of a new prohibition. The principal arguments were first presented at a conference honoring the publication of Boston University Professor Tamar Frankel’s new book on Fiduciary Law. Building on the work of Professor Frankel and others, the article maintains that congressional officials owe fiduciary-like duties of trust and confidence to a host of parties including the citizen-investors whom they serve, as well as the federal government, other members of Congress, and government officials outside of Congress who rely on their loyalty and integrity. The article concludes that members of Congress and legislative staffers breach duties of entrustment, and thereby engage in fraud and deception, if they trade securities on the basis of material nonpublic information obtained through congressional service. For a variety of prudential reasons, however, the article suggests that education, rather than prosecution, may be the SEC’s most effective enforcement tool.