Taking STOCK: Insider and Outsider Trading by Congress

Abstract

Spring 2012 saw the enactment of the "Stop Trading on Congressional Knowledge Act of 2012" or "STOCK Act." It supposedly repealed an exemption from the federal securities laws that made insider trading by members of Congress "totally legal". As every securities lawyer knows, however, there never was such an exemption. Representatives and Senators have always been subject to the same rules as the rest of us. It is just that insider-trading law is so incoherent that legal scholars sharply disagreed as to when, or even if, trading by government officials on the basis of material nonpublic information gleaned from their positions would be unlawful. It clearly would not constitute "classic" insider trading, and it was not clear if it constituted "misappropriation" or "outsider" trading. Consequently, despite circumstantial evidence that such trading is not unusual, neither the Securities and Exchange Commission (the "SEC") nor the Department of Justice (the “DOJ”) has ever brought an insider trader action against a member of Congress.

The law of insider trading is so unclear because, infamously, neither the Securities Exchange Act of 1934 (the '34 Act'), nor the regulations promulgated under it, expressly prohibit insider trading generally, let alone define what it might be. It is unfortunate, therefore, that Congress ducked this golden opportunity either to amend the '34 Act' in order to define insider trading or, at least, to give the SEC authority to do so. Consequently, we are left with the jurisprudential scandal that insider trading is largely a common law federal offense.

Even after the STOCK Act it will continue to be difficult to curtail undesirable Congressional trading through insider-trading law because the concerns that animate the former involves a perceived evil different from that addressed by the securities laws. The former is worried primarily about the integrity of governmental actors and the potential for corruption. In contrast, courts tend to describe the goals of the latter as preventing fraud and promoting market integrity. It is hard to see how a law developed to address these latter issues can be contorted to effectively address improprieties by governmental actors. Consequently, although the STOCK Act might clarify when Congressional trading would violate Congress’s internal ethical rules, it may still not be clear whether the SEC can successfully bring civil actions against, or the DOJ successfully prosecute, members and staffers under the securities laws.

All the STOCK Act does is to try to shed some light on one element of a potential Congressional insider trading case – namely the nature of the relationship of members or employees of Congress to the source of certain nonpublic information. It does not, however, address the numerous other reasons why it is difficult to charge them with insider or outsider trading. Ironically, the most important legacy of the STOCK Act might be that it could be construed as an implicit endorsement of a controversial SEC regulation applicable to other persons.