Tuesday, March 28, 2006
An article in the Wall Street Journal (here) discusses proposed legislation that would make it illegal for members of Congress and their staff to trade on nonpublic information related to legislative action that affects the price of a stock. The legislation is not yet available, and the article notes that it covers more than just insider trading: "In addition to banning trading on inside information, the proposal would require that lawmakers and their top aides disclose within 30 days any stock trades. Congressional rules now require lawmakers to disclose their trades once a year. The bill also would require that companies register with Congress if they sell information about congressional activity to Wall Street investors."
As Peter Lattman on the WSJ's Law Blog (here) notes so well, "If you’re asking yourself, 'Wait a minute, members of Congress are allowed to commit insider trading?' you’re not alone. We asked the same question." Can Capitol Hill's investors really do better than Wall Street's? Bruce Carton on the Securities Litigation Watch blog (here -- welcome back from that nasty flu bug) points out that a study of securities investing by Senators in the 1990s showed that their picks beat the market by 12%, a strikingly high return. The legislation introduced by Reps. Louise Slaughter and Brian Baird is motivated in part by the trading of a former aide to Rep. Tom DeLay in 1999 and 2000, although it is not clear whether his trading was based on nonpublic information.
While the usual basis for insider trading cases (civil and criminal) is Sec. 10(b) and Rule 10b-5, the Supreme Court's interpretation of those provisions requires that there be a duty to maintain the confidentiality of the information. That duty appears to be lacking for our elected officials and their staff, unlike corporate executives, employees, lawyers, accountants, journalists (particularly from the Wall Street Journal), printers, consultants, and many, many others.
It may be possible to solve the insider trading problem without having to enact legislation which -- here's a shocker -- could get bogged down in partisan bickering. Instead, the House and Senate could adopt rules imposing on each member and their staff a duty to maintain the confidentiality of information arising from the legislative process that could affect a company's business or share price. Companies, professional firms, and other organizations routinely require employees to sign forms acknowledging such a duty, and a similar requirement could be adopted by Congress for those working on Capitol Hill. Once such a duty is in place, an insider trading case can be pursued for violating the antifraud provisions of the federal securities laws.
While Congressional hearings and legislation can affect a whole industry, it would seem better to restrict trading in the shares of individual companies to avoid questions about whether legislation that negatively affects one industry and helps another means there can be no trading in either. It would hardly make sense to put the entire energy or pharmaceutical industry off-limits for investing (either buying or selling). A prohibition on trading based on nonpublic information about single-company proposals, which are common in the tax area, would be more workable.
After the Supreme Court endorsed the misappropriation theory in U.S. v. O'Hagan, the source of the information was rendered largely irrelevant so long as the defendant owed a duty of trust and confidence to the source of the information and breached that duty by trading. By changing its rules, Congress can effectively adopt a prohibition on insider trading for its members and staff by imposing a duty to maintain confidentiality and abstain from trading before information is disclosed.
Whether information arising from the legislative process is "material" is another issue. Moreover, there are few real secrets on Capitol Hill, so it might be that an insider trading action could not succeed except in particularly blatant situations. That is where the disclosure requirements of the proposed legislation might be useful by shining a light on trading that, while not up to the standard of insider trading under Rule 10b-5, is still questionable and possibly unethical. (ph)