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					                        Insider Trading Inside the Beltway
                              Stephen M. Bainbridge

UCLA School of Law                                         bainbrid@law.ucla.edu.
Box 951476                                                          310.206.1599
405 Hilgard Avenue
Los Angeles, California 90095-1476

Abstract: A 2004 study of the results of stock trading by United States Senators
during the 1990s found that that Senators on average beat the market by 12% a
year. In sharp contrast, U.S. households on average underperformed the market by
1.4% a year and even corporate insiders on average beat the market by only about
6% a year during that period. A reasonable inference is that some Senators had
access to—and were using—material nonpublic information about the companies
in whose stock they trade.
Under current law, it is unlikely that Members of Congress can be held liable for
insider trading. The proposed Stop Trading on Congressional Knowledge Act
addresses that problem by instructing the Securities and Exchange Commission to
adopt rules intended to prohibit such trading.
This article analyzes present law to determine whether Members of Congress,
Congressional employees, and other federal government employees can be held
liable for trading on the basis of material nonpublic information. It argues that
there is no public policy rationale for permitting such trading and that doing so
creates perverse legislative incentives and opens the door to corruption. The
article explains that the Speech or Debate Clause of the U.S. Constitution is no
barrier to legislative and regulatory restrictions on Congressional insider trading.
Finally, the article critiques the current version of the STOCK Act, proposing
several improvements.

Keywords: insider trading, Congress
JEL Classification: K22
                                 Insider Trading Inside the Beltway

                                         Stephen M. Bainbridge*


                                                  Contents
   I. Introduction ................................................................................................... 2 
   II. Current Law.................................................................................................. 6 
       A. The Doctrinal Sources of the Insider Trading Prohibition ....................... 7 
       B. The Classical Theory ................................................................................ 8 
          1. The Legal Standard............................................................................... 8 
          2. Application to Members of Congress and Other Government
             Employees ........................................................................................... 12 
       C. The Misappropriation Theory ................................................................ 13 
          1. The Legal Standard............................................................................. 13 
          2. Application to Members of Congress and Other Government
             Employees ........................................................................................... 16 
       D. Summation ............................................................................................. 22 
   III. Policy ........................................................................................................ 22 
       A. Should Members of Congress be Allowed to Inside Trade? ................. 23 
          1. Perverse Incentives ............................................................................. 24 
          2. Unfairness ........................................................................................... 26 
          3. Summary............................................................................................. 27 
       B. Who Should Enforce the Prohibition? ................................................... 28 
          1. A Constitutional Barrier? ................................................................... 28 
          2. Prudential Considerations ................................................................... 30 
   IV. The Stop Trading on Congressional Knowledge Act ............................... 32 
       A. The Prohibition on Trading and Tipping ............................................... 32 
       B. Reporting Provision................................................................................ 35 

   *
      William D. Warren Professor of Law, UCLA School of Law. Portions of this article
were adapted from an earlier essay published on-line as The Stop Trading on
Congressional Knowledge Act, 10 ENGAGE 59 (October 2009), available at
http://www.fed-soc.org/doclib/20091116_BainbridgeEngage10.3.pdf, and are used here
by permission.

                                                           1
2                                                                                                       Bainbridge


    V. Conclusion ................................................................................................. 35 


                                 I. Introduction
    The common stock investment portfolios of United States Senators beat the
market by 12% a year, on average, between 1993 and 1998, according to a study
by economist Alan J. Ziobrowski and his collaborators.1 In sharp contrast, the
common stock investment portfolios of U.S. households as a whole
underperformed the market on average by 1.4% a year during the relevant period.2
Even more striking, corporate insiders investing in their own company’s stock
only beat the market by about 6% a year on average during that period.3
    The Ziobrowski study’s results strongly imply that some Members of
Congress are using nonpublic information to make trading decisions. Over time,
even professional investors do not systematically beat the market.4 This basic
premise of efficient capital markets theory has been confirmed by many academic
studies.5 The only important exception to the rule is corporate insiders trading in

    1
      Jane J. Kim, U.S. Senators’ Stock Picks Outperform the Pro’s, WALL. St. J., Oct.
26, 2004. More precisely, “a portfolio that mimics the purchases of U.S. Senators on a
trade-weighted basis outperforms the market by 85 basis points per month, while a
portfolio that mimics the sales of Senators underperforms the market by 12 basis points
per month.” Alan J. Ziobrowski et al., Abnormal Returns from the Common Stock
Investments of the U.S. Senate, 39 J. FIN. & QUANT. ANAL. 661 (2004). The study
examined multiple factors to determine whether the anomalous results were being driven
by the trading of an identifiable subset of Senators. They found no statistically significant
difference between Senators based on political party affiliation. Id. at 675. Disparities in
the amount of trading by individual Senators also did not result in statistically significant
differences, leading the authors to conclude “that our results are not biased by the heavy
trading volume of some Senators and that trading with an informational advantage is
common among Senators.” Id. at 670. In contrast, seniority did matter. “Senators with the
least seniority (in their first Senatorial term) earn statistically higher returns than those
Senators with the longest seniority (over 16 years in the Senate).” Id. at 675.
    2
      Kim, supra note 1.
    3
      Id.
    4
       See STEPHEN A. ROSS ET AL., CORPORATE FINANCE 353 (6th ed. 2002) (“The
overwhelming evidence … is that mutual funds, on average, do not beat broad-based
indices.”).
    5
       See BOB RYAN, CORPORATION FINANCE AND VALUATION 84 (2006) (“The
empirical evidence is absolutely solid, fund managers cannot out perform the market
….”).
Beltway Insider Trading                                                                  3


their own corporation’s stock.6 The obvious and generally accepted explanation
for insiders’ ability to beat the market is their access to and use of material
nonpublic information about their company.7
    It seems unlikely that United States Senators as a group have such unique
investment skills that they can outperform not only the market as a whole but also
corporate insiders over an extended period. Instead, it seems more reasonable to
assume that the superior returns found by Ziobrowski result from Senatorial
access to—and use of —material nonpublic information about the companies in
whose stock they traded:
        Looking at the timing of cumulative returns, the senators also appeared to
        know exactly when to buy or sell their holdings. Senators would buy stocks
        just before the shares suddenly would outperform the market by more than
        25%. Conversely, senators would sell stocks that had been beating the market
        by about 25% for the past year just when the shares would fall back in line
        with the market’s performance.
             The researchers say senators’ uncanny ability to know when to buy or sell
        their shares seems to stem from having access to information that other
        investors wouldn’t have. “I don’t think you need much of an imagination to
        realize that they’re in the know,” says Alan Ziobrowski, a business professor
        at Georgia State University in Atlanta and one of the four authors of the
        study.8
    Congressional access to nonpublic information and the potential for the
misuse thereof is hardly a new phenomenon. Over 40 years ago, Henry Manne
observed that “the federal government is the largest producer of information
capable of having a substantial effect on stock-market prices.”9 Not only does the
government itself generate such information, vast amounts of information must be
disclosed to the federal government before it becomes public.10 Congressmen are
especially well positioned to receive information from these sources, Manne
argued.11 In addition to their direct interactions with nongovernmental
information sources, they are also “focal points for receiving information


    6
       HASAN NEJAT SEYHUN, INVESTMENT INTELLIGENCE FROM INSIDER TRADING 312
(2000).
    7
      Id. at 74.
    8
      Kim, supra note 1.
    9
      HENRY G. MANNE, INSIDER TRADING AND THE STOCK MARKET 171 (1966)
    10
       Id. at 172.
    11
       Id. at 179.
4                                                                               Bainbridge


produced or learned in all the various executive departments and agencies” that
report to them.12
    More recent circumstantial evidence that at least some Members of Congress
are “in the know” comes from a June 2010 Washington Post report, which found
that “a host of [Congressional] committee chairmen and ranking members have
… have millions invested in business sectors that their panels oversee.”13 The
reporters explained that their findings with respect to committee chair and ranking
member investments are especially significant because it is those Members of
Congress who have the most power “to raise questions, hold hearings and push
through targeted legislation that in some cases governs the industries in which
they have investments.”14 As such, they not only have better access to nonpublic
information, they also have the power to control the timing of legislative events so
as to maximize their trading profits (e.g., delay a bill until they buy more stock).
    The report continues:
           Steve Ellis, vice president of the nonpartisan Taxpayers for Common
     Sense, said there has been a long-standing suspicion, difficult to verify, about
     committee assignments: that lawmakers tend seek out certain committees to
     suit their own interests.
           “It is part of the problem with the committee system. People try to get on
     the committees in which they have a vested interest,” said Ellis, whose group
     closely tracks congressional activity. “Committees can have a huge impact on
     the sectors of the economy under their jurisdiction, and they’re going to know
     more about what’s going on in those sectors than the average lawmaker.”
           “By being on a committee with a particular jurisdiction, they’re in a
     better position of influencing the performance of their investments,” he said,
     “or at least appearing to have that ability.”15


    12
        Id. During President George Washington’s administration, many Members of
Congress used nonpublic information about a plan to redeem government securities to
buy up those securities cheaply before the plan was made public. Comment, Bud W.
Jerke, Cashing in on Capitol Hill: Insider Trading and the Use of Political Intelligence
for Profit, 158 U. PA. L. REV. 1451, 1461-62 (2010).
    13
        Robert O’Harrow Jr. & Dan Keating, Lawmakers’ Committee Assignments and
Industry Investments Overlap, WASH. POST, June 14, 2010, available at
http://www.washingtonpost.com/wp-
dyn/content/article/2010/06/13/AR2010061304881.html.
    14
       Id.
    15
       Id. An earlier academic study of Congressional financial disclosures for the year
1994 found that 25% of Members of Congress “were investing in companies that faced
Beltway Insider Trading                                                                 5


    To be sure, there are not many known cases of improper trading by Members
of Congress.16 Even so, however, the Zibrowski study concluded that “trading
with an informational advantage is common among Senators.”17 This conclusion
rested on evidence that “the prices of common stocks bought by Senators tended
to stagnate prior to purchase, soar after purchase, and then stagnate again after
sale …. The prices for common stocks sold by Senators tended to increase
dramatically just before the sale, followed by no further increases.”18 Taken
together, these findings provide the study’s “most robust evidence for
Congressional insider trading.”19
    Senators and Members of the House of Representatives are not the only
government officials who have access to inside information, of course.
Congressional staffers, and employees of the Executive Branch and federal
agencies all potentially could come into possession of material nonpublic
information on which they could make trading profits.20 In May 2009, for
example, press reports indicated that two Securities and Exchange Commission
(SEC) attorneys were under investigation for allegedly trading on the basis of
information they learned on the job.21 In several earlier cases, government
employees were charged with tipping material nonpublic information to persons
who used that information to trade in government securities.22
    Part II of this Article provides a doctrinal analysis of the legality of insider
trading by both elected officials and government employees. It concludes that
Congressional staffers and other government officials and employees could be
prosecuted successfully for insider trading under the federal securities laws, but

ongoing legislative action.” Jerke, supra note 12, at 1463 (describing study). An analysis
of 1997 Congressional disclosures produced similar findings. Id. at 1464.
     16
        For overviews of cases involving potentially improper trading by legislators and
their aides, see Jerke, supra note 12, at 1453-55, 1463-64.
     17
        Zibrowski et al., supra note 1, at 670.
     18
        Matthew Barbabella et al., Insider Trading in Congress: The Need for Regulation,
available at http://ssrn.com/abstract=1318682.
     19
        Id. at 8.
     20
        See, e.g., U.S. v. ReBrook, 837 F. Supp. 162 (S.D. W. Va. 1993) (employee of
state lottery commission traded on knowledge a certain manufacturer was likely to get
government contract), rev’d, 58 F.3d 961 (4th Cir.), cert. denied, 516 U.S. 970 (1995).
     21
        Bernie Becker, S.E.C. Lawyers Investigated for Insider Trading, N.Y. TIMES, May
15, 2009, at B3.
     22
         Harvey L. Pitt, A Tale of Two Instruments: Insider Trading in Non-Equity
Securities, 49 BUS. LAW. 187, 240-41 (1993) (describing such cases).
6                                                                                    Bainbridge


the quirks of the relevant laws almost certainly would prevent Members of
Congress from being successfully prosecuted.23 Part III sets out the policy
justifications for extending those laws to include Members of Congress. Part IV
describes The Stop Trading on Congressional Knowledge Act (the “STOCK Act”
or “Act”),24 introduced by Congressmen Louise Slaughter (D-NY) and Brian
Baird (D-WA), if adopted, “will prohibit Members of Congress and their staff
from using nonpublic information they are able to obtain through their official
positions to enrich their personal portfolios.”25 Part IV then critiques the STOCK
Act’s approach to banning Congressional insider trading.

                                 II. Current Law
    The phrase “insider trading” is properly understood as a term of art, because it
in fact is a misnomer in two significant ways, both of which are relevant to the
analysis of the legality of such trading by government employees. First, the
federal securities laws’ prohibition of so-called “insider” trading encompasses
many corporate outsiders.26 Accordingly, Congressmen, their staffers, and other
government officials and employees are not exempt from liability for trading on
the basis of material nonpublic information simply because they are not corporate
insiders.
    Second, the prohibition encompasses not just inside information, but also so-
called market information. “Inside information” refers to “information which

    23
        Insider trading potentially can give rise to both civil and criminal actions. The SEC
is authorized by Section 21A(a)(1) of the Securities Exchange Act to bring a civil action
against insider traders in a United States district court, seeking a variety of civil penalties,
including disgorgement and fines of up to three times the defendant’s profits. 15 U.S.C. §
78u-1(a)(1). Under Section 32 of the Exchange Act, the Department of Justice may bring
felony criminal charges against those who willfully violate, inter alia, the rules against
insider trading. 15 U.S.C. § 78ff(a). Unless the context requires otherwise, the term
“prosecute” will be used herein, for purposes of semantic convenience, to refer to both
SEC civil and DOJ criminal proceedings.
    24
        H.R. 682, 111th Cong., 1st Sess. (2009).
    2525
          Press Release, Brian Introduces Legislation to Prohibit Insider Trading on
Capitol Hill (Jan. 27, 2009). The STOCK Act has been introduced in each session of
Congress since 2006 but has never made it out of committee. See Barbabella et al., supra
note 18, at 3-4.
    26
        See S.E.C. v. Tome, 638 F. Supp. 596, 616 (S.D.N.Y. 1986) (“The term ‘insider
trading’ actually is a misnomer, only imperfectly describing the proscribed conduct, since
liability under the securities laws can extend to those who are not insiders, as that term is
commonly understood …”).
Beltway Insider Trading                                                                  7


comes from within the corporation or affects the price of corporate stock because
of its reflection of a corporation’s expected earnings or assets.”27 “‘Market
information’ refers to information that affects the price of a company’s securities
without affecting the firm’s earning power or assets. … Examples include
information that an investment adviser will shortly issue a ‘buy’ recommendation
or that a large stockholder is seeking to unload his shares or that a tender offer
will soon be made for the company’s stock.”28 The distinction rarely matters in
insider trading cases, however, because the law imposes liability for misuse of
both inside and market information.29
    Members of Congress and government employees potentially have access to
both inside and market information. They can learn inside information when a
corporation confidentially discloses such information during the course of a
Congressional hearing or investigation, for example. Examples of market
information to which Congressmen and government employees might have access
include knowing that “tax legislation is apt to pass and which companies might
benefit” or being aware “that a particular company soon will be awarded a
government contract or that a certain drug might get regulatory approval ….”30

A. The Doctrinal Sources of the Insider Trading Prohibition
    The core prohibition of insider trading in the federal securities laws arises out
of § 10(b) of the Securities Exchange Act31 and SEC Rule 10b-5 thereunder.32
    27
        Victor Brudney, Insiders, Outsiders, and Informational Advantages Under the
Federal Securities Laws, 93 HARV. L. REV. 322, 329 (1979).
     28
        U.S. v. Chiarella, 588 F.2d 1358, 1365 n.8 (2d Cir. 1978), rev’d on other grounds,
445 U.S. 222 (1980).
     29
         The mere fact that information may have originated outside the company is
irrelevant, so long as the information is material to the company’s stock price. See
Chiarella v. U.S., 445 U.S. 222, 240 n.1 (1980) (Burger, C.J., dissenting) (“Academic
writing in recent years has distinguished between ‘corporate information’—information
which comes from within the corporation and reflects on expected earnings or assets—
and ‘market information.’ … It is clear that § 10(b) and Rule 10b-5 by their terms and by
their history make no such distinction.”); see also Dirks v. S.E.C., 463 U.S. 646, 656 n.15
(1983) (citing Chief Justice Burger’s dissent approvingly).
     30
        Kim, supra note 1.
     31
        15 U.S.C. § 78j(b). Other bases of insider trading liability, such as Rule 14e-3’s
restrictions on the use of information about a tender offer, 17 C.F.R. § 240.14e-3, or the
federal mail and wire fraud statutes, 18 U.S.C. § 1341 and 1343, are outside the scope of
this article.
     32
        17 CFR § 240.10b-5.
8                                                                               Bainbridge


Although neither provision expressly refers to insider trading, a long series of
judicial decisions has created a body of interstitial common law defining when
persons possessing material nonpublic information are prohibited from trading in
the securities to which that information relates.33
     [T]he Supreme Court has recognized two theories of insider trading liability:
     the “classical theory” and the “misappropriation theory.” The classical theory
     generally only imposes liability when a trader or tipper is an insider of the
     traded-in corporation. The classical insider-trader thus breaches a fiduciary
     duty owed to the corporation’s shareholders. The misappropriation theory,
     however, creates liability when a tipper or trader misappropriates confidential
     information from his source of the information. The misappropriator thus
     breaches a fiduciary duty owed to the source.34
As we shall see below, in the vast majority of cases, only the misappropriation
theory will be relevant to insider trading by Members of Congress and other
governmental officials.

B. The Classical Theory

   1. The Legal Standard
   The federal insider prohibition as we know it today originated in S.E.C. v.
Texas Gulf Sulphur Co.35 The TGS opinion rested on a policy of equality of

    33
         Although the claim is somewhat controversial, I have argued elsewhere that
Congress in 1934 did not intend for section 10(b) to prohibit insider trading as we know it
today. Stephen M. Bainbridge, Incorporating State Law Fiduciary Duties into the
Federal Insider Trading Prohibition, 52 WASH. & LEE L. REV. 1189, 1228-34 (1995).
     34
        S.E.C. v. Rocklage, 470 F.3d 1, 5 (1st Cir. 2006).
     35
         401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969). The most
important pre-TGS precedent was the SEC’s enforcement action In re Cady, Roberts &
Co., 40 S.E.C. 907, 1961 WL 3743 (1961), in which the SEC held partners of a broker-
dealer liable for tipping information one of them had learned in his capacity as a member
of the board of directors of Curtiss-Wright Corporation. As the SEC itself acknowledged,
Cady, Roberts was “a case of first impression.” Id. at *1. Although Rule 10b-5 had
sometimes been invoked prior to Cady, Roberts to deal with insider trading-like issues,
those cases typically had involved issues of tortious fraudulent concealment in face-to-
face or control transactions. The handful of Rule 10b-5 decisions cited as precedent by
Cady, Roberts uniformly involved face-to-face transactions and/or control transactions.
See, e.g., Speed v. Transamerica Corp., 99 F. Supp. 808 (D.Del. 1951) (omissions in
connection with what amounted to a tender offer); Kardon v. Nat’l Gypsum Co., 73 F.
Supp. 798 (E.D. Pa. 1947) (sale of control negotiated face to face); In re Ward La France
Truck Corp., 13 S.E.C. 373 (1943) (same). In addition, it was not immediately clear what
Beltway Insider Trading                                                                   9


access to information.36 The court contended that the federal insider trading
prohibition was intended to assure that “all investors trading on impersonal
exchanges have relatively equal access to material information.”37 Put another
way, the majority thought Congress intended “that all members of the investing
public should be subject to identical market risks.”38 Accordingly, under TGS and
its progeny, virtually anyone who possessed material nonpublic information—
presumably including a Member of Congress—was required either to disclose it
before trading or abstain from trading in the affected company’s securities.39 If



precedential value Cady,Roberts would have. See, e.g., Recent Decision, 48 Va. L. Rev.
398, 403-04 (1962) (“in view of the limited resources of the Commission, the unfortunate
existence of more positive and reprehensible forms of fraud, and the inherent problems
concerning proof and evidence adhering to any controversy involving a breach of duty of
disclosure, there is little prospect of excessive litigation evolving pursuant to [Cady,
Roberts]”). It thus was not until the Second Circuit accepted the SEC’s views about
insider trading in TGS that the expansive federal insider trading prohibition as we know it
today began to evolve. See S.E.C. v. National Student Marketing Corp., 457 F. Supp. 682
(D.D.C. 1978) (referring to TGS as “the seminal case”).
     36
        See, e.g., Ray J. Grzebielski, Friends, Family, Fiduciaries: Personal Relationships
as a Basis for Insider Trading Violations, 51 CATH. U. L. REV. 467, 470 n.25 (2002)
(“Texas Gulf was based on a premise that parties to a securities transaction are entitled to
equal access to information ….”).
     37
        TGS, 401 F.2d at 848.
     38
        Id. at 851-52.
     39
        See id. at 848 (holding that “anyone in possession of material inside information”
must either disclose it or abstain from trading; emphasis supplied). In U.S. v. Chiarella,
588 F.2d 1358 (2d Cir. 1978), rev’d, 441 U.S. 942 (1979), the Second Circuit explained
that “the principle underlying” TGS meant that:
       In enacting the securities laws, Congress did not limit itself to protecting
       shareholders from the peculations of their officers and directors. A major
       purpose of the antifraud provisions was to “protect the integrity of the
       marketplace in which securities are traded. Anyone corporate insider or not
       who regularly receives material nonpublic information may not use that
       information to trade in securities without incurring an affirmative duty to
       disclose. And if he cannot disclose, he must abstain from buying or selling.
Id. at 1365 (emphasis supplied; citation and footnote omitted). The sole constraint on the
breadth of this requirement is that the defendant must have “regular access to market
information.” Id. at 1366. As we have seen, Members of Congress satisfy that condition.
See supra text accompanying note 30.
10                                                                               Bainbridge


the would-be trader’s fiduciary duties precluded him from disclosing the
information prior to trading, abstention was the only option.40
    In Chiarella v. U.S.,41 the United States Supreme Court confirmed the basic
disclose or abstain rule, but rested it on a different policy foundation.42 Instead of
the TGS equal access policy, the Chiarella majority held that the duty to disclose
or abstain arises out of a fiduciary relationship between the inside trader and the
persons with whom he trades.43 The Chiarella opinion thus made clear that the
disclose or abstain rule is not triggered merely because the trader possesses
material nonpublic information.44 When a securities fraud action is based upon
nondisclosure, there can be no fraud absent a duty to speak, and no such duty
arises from the mere possession of nonpublic information.45
    As the court explained in its subsequent decision in Dirks v. S.E.C.:46
      We were explicit in Chiarella in saying that there can be no duty to disclose
      where the person who has traded on inside information “was not [the
      corporation’s] agent, . . . was not a fiduciary, [or] was not a person in whom
      the sellers [of the securities] had placed their trust and confidence.” Not to
      require such a fiduciary relationship, we recognized, would “[depart] radically
      from the established doctrine that duty arises from a specific relationship
      between two parties” and would amount to “recognizing a general duty
      between all participants in market transactions to forgo actions based on
      material, nonpublic information.”47
The need for a fiduciary relationship between the alleged inside trader and those
with whom he trades raised a question critical to the problem of trading by
Congress members and government employees; namely, whether anyone other

     40
       See TGS, 401 F.2d at 848 (holding that “anyone in possession of material inside
information must either disclose it to the investing public, or, if he is disabled from
disclosing it in order to protect a corporate confidence, or he chooses not to do so, must
abstain from trading in or recommending the securities concerned while such inside
information remains undisclosed”).
    41
       445 U.S. 222 (1980).
    42
       See id. at 226-27 (discussing history of the “obligation to disclose or abstain”).
    43
       See id. at 230 (holding that “liability is premised upon a duty to disclose arising
from a relationship of trust and confidence between parties to a transaction”); see also id.
at 231-33 (discussing and rejecting the equal access policy).
    44
       Id. at 235.
    45
       Id. at 232.
    46
       463 U.S. 646 (1983).
    47
       Id. at 254-55.
Beltway Insider Trading                                                                     11


than classical insiders—i.e., directors, officers, and perhaps large shareholders—
could be held liable for dealing on the basis of insider information.
    Dirks confirmed that the classical theory reached at least two other categories
of potential defendants. First, certain outsiders with especially close relationships
with the issuing corporation can become constructive insiders:
     Under certain circumstances, such as where corporate information is revealed
     legitimately to an underwriter, accountant, lawyer, or consultant working for
     the corporation, these outsiders may become fiduciaries of the shareholders.
     The basis for recognizing this fiduciary duty is not simply that such persons
     acquired nonpublic corporate information, but rather that they have entered
     into a special confidential relationship in the conduct of the business of the
     enterprise and are given access to information solely for corporate purposes.
     … For such a duty to be imposed, however, the corporation must expect the
     outsider to keep the disclosed nonpublic information confidential, and the
     relationship at least must imply such a duty.48
    Second, the Dirks court held that the insider trading applies not only when an
insider—whether classical or constructive—trades, but also when such an insider
tips inside information to an outsider who then trades.49 The court held that a
tippee’s liability is derivative of that of the tipper, “arising from [the tippee’s] role
as a participant after the fact in the insider’s breach of a fiduciary duty.”50 A
tippee therefore can be held liable only when the tipper breached a fiduciary duty
by disclosing information to the tippee, and the tippee knows or has reason to
know of the breach of duty.51


    48
        Id. at 655 n.14.
    49
        Id. at 659-60.
     50
        Id. at 659 (quoting Chiarella, 445 U.S. at 230).
     51
         Id. at 660. Specifically, what Dirks proscribes is not merely a breach of
confidentiality by the insider, but rather the breach of a fiduciary duty of loyalty to refrain
from profiting on information entrusted to the tipper. See Kevin V. Haynes, Insider
Trading Under Rule 10b-5, in Fundamentals of Securities Law, WL SP057 ALI-ABA
411 (“In Dirks the Court alludes to the inherent unfairness of insiders’ trading on
information that was intended to be available only for corporate purposes. This suggests
that the insider breaches a fiduciary duty to refrain from self-dealing when he trades on
inside information.”); see also Keith Valory, Comment, The Misappropriation Theory of
Insider Trading: What Constitutes a “Similar Relationship of Trust and Confidence?,”
39 SANTA CLARA L. REV. 287, 296 (1998) (“It is clear from the Court’s rulings on the
Classical Theory of insider trading that it is most concerned with curtailing deceptive
self-dealing in material, non-public corporate information.”).
12                                                                                Bainbridge


    Looking at objective criteria, courts must determine whether the insider-tipper
personally benefited, directly or indirectly, from his disclosure.52 Obviously, such
a benefit exists where the insider sells information for cash.53 Non-pecuniary
gains by the insider can also qualify, however.54 Liability could be imposed, for
example, on a corporate CEO who discloses information to an influential investor
not for any legitimate corporate purpose, but solely to enhance his own
reputation.55 Likewise, liability could be imposed where the tip is a gift, because
that transaction is regarded as analogous to the situation in which the tipper trades
on the basis of the information and then gives the tippee the profits.56

    2. Application to Members of Congress and Other Government Employees
    Cases in which Members of Congress or other government officials qualify as
classical insiders or constructive insiders present no enforcement difficulties
under current law. Nothing in the Chiarella/Dirks analytical framework exempts
either Congressmen or government employees so qualifying. Instead, such
individuals would be fiduciaries of those with whom they trade, just as is the case
with any other insider. Liability therefore would follow unless they either
disclosed before trading or abstained from trading.
    Such cases, however, presumably are quite rare. Members of Congress and
their senior staff may not, inter alia, “serve for compensation as an officer or
member of the board of an association, corporation, or other entity.”57
Opportunities to serve as either a classical or constructive insider thus are unlikely
to arise.

     52
         See Dirks, 463 U.S. at 663 (stating that the test of whether a disclosure by an
insider amounts to a breach of fiduciary duty focuses on “objective criteria, i.e., whether
the insider receives a direct or indirect personal benefit from the disclosure”).
     53
        See Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299, 311 n.21 (1985)
(holding that the requisite benefit can be found, inter alia, where the insider tipped the
information “to secure a ‘pecuniary gain’”).
     54
        See S.E.C. v. Yun, 327 F.3d 1263, 1275 (11th Cir. 2003) (holding that “the gain
does not always have to be pecuniary. A reputational benefit that translates into future
earnings, a quid pro quo, or a gift to a trading friend or relative all could suffice to show
that the tipper personally benefitted.”).
     55
        Id.
     56
        Id.
     57
        COMMITTEE ON STANDARDS OF OFFICIAL CONDUCT, RESTRICTIONS ON OUTSIDE
EMPLOYMENT APPLICABLE TO MEMBERS AND SENIOR STAFF, available at
http://ethics.house.gov/Subjects/Topics.aspx?Section=153.
Beltway Insider Trading                                                                 13


    In contrast, tipping liability seems a more likely candidate in this context. It
seems plausible that Congressmen or other government officials might sometimes
receive tips from corporate insiders.58 Such a tip would be the functional
equivalent of a bribe. Nothing in current law would prohibit prosecution of both
tipper and tippee in such cases. Instead, it would be treated the same way as gifts
of information.59

C. The Misappropriation Theory

    1. The Legal Standard
    Dirks did not resolve the most significant question posed by Chiarella;
namely, to what extent does the insider trading prohibition apply where the
defendant traded on the basis of market information derived from sources other
than the issuer?60 The classic case is where an insider of a takeover bidder trades
in stock of the target company on the basis of information about the bidder’s
plans.61 Such a person is not one in whom the shareholders of the target have




    58
        See infra note 152 (discussing use of information as a bribe).
    59
        Suppose the insider claimed that he gave the tip not for personal benefit, however,
but so that the company would benefit. In effect, the tipper claims, he bribed the
Congressman so the Congressman would do a favor for the company. The logic of Dirks
suggests there could be no insider trading liability in such a case. Cf. 65 Fed. Reg.
51,716 n.7 (2000) (SEC release acknowledging that selective disclosures to analysts was
viewed as protected from insider trader liability because the tipper received no personal
benefit but rather provided the tip so as to benefit corporation). There may, however, be
liability under Regulation FD. See 17 C.F.R. § 243.100-03 (setting forth rules restricting
selective disclosure).
    60
        O’Connor & Associates v. Dean Witter Reynolds, Inc., 529 F. Supp. 1179, 1185
(S.D.N.Y. 1981) (“Chiarella had left open the issue whether Rule 10b-5 is violated when
the conduct alleged constitutes a fraud upon the clients of the trader’s employer but when
no duty is owed to those with whom the trader deals….”).
    61
        See, e.g., U.S. v. Newman, 664 F.2d 12 (1981), cert. denied, 464 U.S. 863 (1983)
(employees of an investment bank who were constructive insiders of takeover bidder
rather than target company in whose stock they traded).
14                                                                             Bainbridge


placed their trust and confidence.62 Accordingly, under Chiarella no liability
should arise.63 Indeed, Chiarella itself involved just such facts.64
    The eventual solution to this perceived problem began life in Chief Justice
Warren Burger’s dissent in Chiarella. Chief Justice Burger contended that the
way in which the inside trader acquires the nonpublic information on which he
trades could itself be a material circumstance that must be disclosed to the market
before trading.65 Accordingly, he argued, “a person who has misappropriated
nonpublic information has an absolute duty [to the persons with whom he trades]
to disclose that information or to refrain from trading.”66 The majority did not
address the merits of this theory, instead rejecting it solely on the ground that such
a theory had not been presented to the jury and therefore could not sustain a
criminal conviction.67
    The way was thus left open for the SEC to urge and the lower courts to adopt
the misappropriation theory as an alternative basis of insider trading liability. In
United States v. Newman,68 for example, employees of an investment bank
misappropriated confidential information concerning proposed mergers involving
clients of the firm.69 As had been true of Vincent Chiarella, the Newman
defendants’ employers worked for prospective acquiring companies, while the




     62
       Moss v. Morgan Stanley Inc., 719 F.2d 5 (2d Cir. 1983) (holding the employees of
an investment bank engaged by hostile takeover bidder had no duty of disclosure to
shareholders of target because they were “complete strangers” to the target shareholders).
    63
        See Chiarella v. U.S., 445 U.S. 222, 224 (1980) (“The question in this case is
whether a person who learns from the confidential documents of one corporation that it is
planning an attempt to secure control of a second corporation violates § 10(b) of the
Securities Exchange Act of 1934 if he fails to disclose the impending takeover before
trading in the target company's securities.”). ,
    64
        See U.S. v. O’Hagan, 521 U.S. 642, 662 (1997) (noting that “the printshop
employee defendant in [Chiarella] ‘was not a person in whom the sellers had placed their
trust and confidence’”).
    65
       Chiarella v. U.S., 445 U.S. 222, 240 (1980) (Burger, C.J., dissenting).
    66
       Id.
    67
       See id. at 236 (Powell, J., for majority) (“We need not decide whether this theory
has merit for it was not submitted to the jury.”).
    68
       664 F.2d 12 (2d Cir. 1981), cert. denied, 464 U.S. 863 (1983).
    69
       Id. at 15.
Beltway Insider Trading                                                                    15


trading took place in target company securities.70 As such, the Newman
defendants owed no fiduciary duties to the investors with whom they traded.71
    In upholding the Newman defendant’s convictions, the Second Circuit did not
follow the approach suggested in Chief Justice Burger’s Chiarella dissent. It
rejected the notion that the defendants owed a duty of disclosure to the investors
with whom they traded.72 Instead, the court held that by misappropriating
confidential information for personal gain, the defendants had defrauded their
employer and its clients and that that fraud sufficed to impose insider trading
liability on the defendants.73
    In U.S. v. O’Hagan,74 the Supreme Court resolved an emergent split between
those circuits that had accepted the misappropriation theory, as the Second had
done in Newman,75 and those that had rejected it, as the Fourth and Eighth had
done.76 Although the Court endorsed the misappropriation theory as a valid basis
for insider trading liability,77 it did so in a way that left the misappropriation
theory as yet another misnomer. As defined by the court, the misappropriation
theory does not deal with theft of inside information—or, at least, not directly—
but rather holds that a fiduciary’s undisclosed use of information belonging to his
principal, without disclosure of such use to the principal, for personal gain



    70
        See id. (noting that “the three conspirators purchased stock in companies that were
merger and takeover targets of clients of Morgan Stanley and Kuhn Loeb”).
     71
        U.S. v. Newman, 664 F.2d 12, 20 (2d Cir. 1981) (Dumbauld, J., concurring and
dissenting) (“The culprits in the case at bar (as in Chiarella) owed no duty to the sellers of
the target company securities which they purchased.”), cert. denied, 464 U.S. 863 (1983).
     72
        See id. at 15 (Van Graafeiland, J., for majority) (“To remedy the deficiency in
Chiarella, the Government here has pointed its charge of wrongdoing in a different
direction.”).
     73
        Id. at 16.
     74
        521 U.S. 642 (1997).
     75
        See supra notes 68-73 and accompanying text (discussing Newman).
     76
        For discussion of the Fourth and Eighth Circuit precedents, see Donna M. Nagy,
Reframing the Misappropriation Theory of Insider Trading Liability: A Post-O’Hagan
Suggestion, 59 OHIO ST. L.J. 1223 (1998); Richard W. Painter et al., Don’t Ask, Just Tell:
Insider Trading After United States v. O’Hagan, 84 VA. L. REV. 153 (1998); Sean P.
Leuba, Note, The Fourth Circuit Breaks Ranks in United States v. Bryan: Finally, a
Repudiation of the Misappropriation Theory, 53 WASH. & LEE L. REV. 1143 (1996).
     77
        See O’Hagan, 521 U.S. at 650 (“We hold … that criminal liability under § 10(b)
may be predicated on the misappropriation theory.”).
16                                                                            Bainbridge


constitutes fraud in connection with the purchase or sale of a security and thus
violates Rule 10b-5.78
    The Court acknowledged that misappropriators have no disclosure obligation
running to the persons with whom they trade.79 Instead, it grounded liability under
the misappropriation theory on deception of the source of the information; the
theory addresses the use of “confidential information for securities trading
purposes, in breach of a duty owed to the source of the information.”80 According
to the Court, “a fiduciary’s undisclosed, self serving use of a principal’s
information to purchase or sell securities, in breach of a duty of loyalty and
confidentiality, defrauds the principal of the exclusive use of that information.”81
So defined, the Court held, the misappropriation theory satisfies § 10(b)’s
requirement that there be a “deceptive device or contrivance” used “in connection
with” a securities transaction.82

     2. Application to Members of Congress and Other Government Employees
     Where a Member of Congress, a Congressional staffer, or other government
information obtains material nonpublic information in the course of their duties
and then uses it to trade in the stock of the relevant issuer, their conduct could be
colloquially described as a theft of the information, but under O’Hagan any
potential insider trading liability under the misappropriation theory would require
proof of a duty of disclosure between the official and the source of the
information. The initial question is whether that duty must arise out of a fiduciary
duty or whether the requisite duty can be created, inter alia, by agreement. This is
so because, as we shall see, while Congressional aides and other government
employees have duties arising out of both their fiduciary relationship with their
employer and their employment contract, Members of Congress are bound only
by the implied obligations created by Congressional ethics rules.83 Whether those
latter obligations rise to the level of a contractual duty to refrain from insider
trading is debatable, but they clearly do not rise to the level of a fiduciary duty.
     SEC Rule 10b5-2 purports to resolve this issue by providing “a nonexclusive
list of three situations in which a person has a duty of trust or confidence for
     78
       Id. at 652.
     79
       Id. at 653.
    80
       Id. at 652.
    81
       Id.
    82
       Id. at 656-57.
    83
       See generally Jerke, supra note 12, at 1467-70 (describing relevant provisions of
the House and Senate ethics manuals and rules).
Beltway Insider Trading                                                                17


purposes of the ‘misappropriation’ theory....”84 First, such a duty exists whenever
someone agrees to maintain information in confidence.85 Second, such a duty
exists between two people who have a pattern or practice of sharing confidences
such that the recipient of the information knows or reasonably should know that
the speaker expects the recipient to maintain the information’s confidentiality.86
Third, such a duty exists when someone receives or obtains material nonpublic
information from a spouse, parent, child, or sibling.87
    Whether the SEC has authority to create a rule imposing misappropriation
liability on the basis of an arms-length contractual duty of confidentiality—as
opposed to a fiduciary duty-based duty of confidentiality—has not been fully
tested. In S.E.C. v. Cuban,88 a district court held that a non-fiduciary could be help
liable for misappropriation-based insider trading liability only where the trader
had agreed both to keep information confidential and not to use the information
for personal gain.89 In doing so, the court criticized Rule 10b5-2 and held that the
SEC lacked authority to adopt the rule as drafted:
     The court concludes that, by its terms, Rule 10b5-2(b)(1) attempts to base
     misappropriation theory liability on an agreement that lacks an obligation not
     to trade on or otherwise use confidential information. … Nothing in Rule
     10b5-2(b)(1) requires that the agreement encompass an obligation not to trade
     on or otherwise use the information.
          That Rule 10b5-2(b)(1) relates to an agreement to preserve confidentiality
     is supported by the language and design of Rule 10b5-2 as a whole. …
         Because Rule 10b5-2(b)(1) attempts to predicate misappropriation theory
     liability on a mere confidentiality agreement lacking a non-use component, the
     SEC cannot rely on it to establish Cuban’s liability under the misappropriation
     theory. To permit liability based on Rule 10b5-2(b)(1) would exceed the
     SEC’s § 10(b) authority to proscribe conduct that is deceptive. … This is
     because, as the court has explained, under the misappropriation theory of



    84
       Exchange Act Rel. No. 43,154 (Aug. 15, 2000).
    85
       17 C.F.R. § 240.10b5-2(b)(1).
    86
       17 C.F.R. § 240.10b5-2(b)(2).
    87
       17 C.F.R. § 240.10b5-2(b)(1).
    88
       ___ F.Supp.2d ___, 2009 WL 2096166 (N.D. Tex. 2009).
    89
        Id. at *8 (“Because under O’Hagan the deception that animates the
misappropriation theory involves at its core the undisclosed breach of a duty not to use
another’s information for personal benefit, there is no apparent reason why that duty
cannot arise by agreement.”).
18                                                                               Bainbridge


      liability, it is the undisclosed use of confidential information for personal
      benefit, in breach of a duty not to do so, that constitutes the deception.90
    The present state of the law thus leaves unresolved which of three viable
alternatives is correct:
        • As per Rule 10b5-2, a fiduciary duty is not required; rather, a mere
            agreement to keep information confidential suffices.
        • As per Cuban, a fiduciary duty is not required; rather, an agreement is
            sufficient provided it explicitly bans the undisclosed use of the
            information in question sufficient.
        • In light of the emphasis in Chiarella and Dirks that liability is
            premised on a duty arising out of a fiduciary relationship, the SEC
            lacked authority to adopt Rule 10b5-2 and a fiduciary duty is required.
As it turns out, however, we need not resolve which of these approaches is
correct.91 Executive Branch and Congressional employees can be held liable
under the misappropriation theory under all three alternatives, while Members opf
Congress cannot be held liable under any of them.
    The Standards of Ethical Conduct for Employees of the Executive Branch
provide that: “Public service is a public trust, requiring employees to place loyalty
to the Constitution, the laws and ethical principles above private gain.”92
Accordingly, an employee of the Executive Branch should be deemed an agent of
the government or, at least, to stand in a similar relationship of trust and

     90
        Id. at *12-13.
     91
        Suffice it to say that this author regards both Rule 10b5-2 and Cuban decision as
being inconsistent with the well-accepted proposition that a fiduciary relationship is
required. See, e.g., Regents of the Univ. of Cal. v. Credit Suisse First Boston (USA), Inc.,
482 F.3d 372, 389 (5th Cir. 2007) (holding that “the [Supreme] Court . . . has established
that a device, such as a scheme, is not ‘deceptive’ unless it involves breach of some duty
of candid disclosure”); see generally Donna M. Nagy, Insider Trading and the Gradual
Demise of Fiduciary Principles, 94 IOWA L. REV. 1315 (2009) (arguing that, although the
Supreme Court precedents mandate a fiduciary relationship, some lower courts are
disregarding that requirement in favor of a broad rule banning wrongful use of material
nonpublic information).
     92
        5 C.F.R. § 2635.101. I assuming here that government ethics rules embodied in the
terms of employment of government employees banning the use of nonpublic
information for personal gain will be deemed to constitute the requisite agreement. In
fact, however, the question of whether an employee handbook constitutes a contract
arises in many legal settings and, in general, does not admit of easy resolution. See
generally 19 WILLISTON ON CONTRACTS § 54:10 (4th ed. 2009) (discussing cases).
Beltway Insider Trading                                                              19


confidence with the government.93 The Standards further provide that: “An
employee shall not engage in a financial transaction using nonpublic information,
nor allow the improper use of nonpublic information to further his own private
interest or that of another, whether through advice or recommendation, or by
knowing unauthorized disclosure.”94 As such, the relationship between the
government and one of its employees is such that the undisclosed use by the latter
of information gained in the course of his employment would give rise to liability
under the misappropriation theory.
    Likewise, both members of a Congressman’s staff and Committee staffers are
employees of their respective houses.95 In addition, both are subject to an ethical
obligation never to “use any information received confidentially in the
performance of governmental duties as a means for making private profit.”96
These employment relationships should suffice for Congressional staffers to be
deemed to have an agency or other relationship of trust and confidence with their
employing agency. In S.E.C. v. Cherif,97 for example, the court held that “a person
violates Rule 10b-5 and Section 10(b) by misappropriating and trading upon
material information entrusted to him by virtue of a fiduciary relationship such as
employment.”98 Put into O’Hagan’s terminology, “a [staffer’s] undisclosed, self
serving use of [Congressional] information to purchase or sell securities, in breach
of a duty of loyalty and confidentiality, defrauds the [Congress].”99

    93
        Joseph Kalo, Deterring Misuse of Confidential Government Information: A
Proposed Citizens’ Action, 72 MICH. L. REV. 1577, 1581 (1974) (“The application of
fiduciary duties to activities of government employees is not novel.”).
    94
        5 C.F.R. § 2634.703(a). Nonpublic information is defined for this purpose as
“information that the employee gains by reason of Federal employment and that he
knows or reasonably should know has not been made available to the general public.” Id.,
§ 2634.703(b).
    95
       Email from Mary Baumann, U.S. Senate Historical Office, to Jenny Lentz, UCLA
School of Law Library, Friday, July 31, 2009 (copy on file with author).
    96
       HOUSE ETHICS MANUAL 249 (2008).
    97
       933 F.2d 403 (7th Cir. 1991), cert. denied, 502 U.S. 1071 (1992).
    98
       Id. at 410. See also SEC v. Clark, 915 F.2d 439, 453 (9th Cir. 1990) (“[A]n
employee’s knowing misappropriation and use of his employer’s material nonpublic
information regarding its intention to acquire another firm constitutes a violation of §
10(b) and Rule 10b-5.”).
    99
       U.S. v. O’Hagan, 521 U.S. 642, 652 (1997). See generally Andrew George, Public
(Self)-Service: Illegal Trading on Confidential Congressional Information, 2 HARV. L. &
POLY’ REV. 161, 165-66 (2008) (concluding that staffers can be held liable either for
trading on or tipping of material nonpublic information learned on the job).
20                                                                            Bainbridge


    A different answer seemingly obtains, however, when we turn to the case of
Members of Congress. Of whom are Members of Congress agents or fiduciaries?
With whom do they have the requisite relationship of trust and confidence out of
which the requisite duty to disclose before trading arises? The only logical
candidate is the electorate. Although there is some precedent in other contexts for
the proposition that “a public official … owe[s] a fiduciary duty to the public to
make governmental decisions in the public’s best interest,”100 such a duty would
be irrelevant to the problem at hand. What is needed under insider trading law is
either a duty to the person with whom one trades or to the source of the
information, not some generalized duty to members of the public in the abstract.
Accordingly, the predominant view, as stated by former SEC enforcement official
Thomas Newkirk, is that “[i]f a congressman learns that his committee is about to
do something that would affect a company, he can go trade on that because he is
not obligated to keep that information confidential …. He is not breaching a duty
of confidentiality to anybody.”101
    To be sure, if either Rule 10b5-2 or the Cuban opinion alternative prevails,
and the Congressional ethics manuals’ prohibition of insider trading by members
are deemed to provide the requisite agreement, liability might be imposed on
members who violate that obligation. As we have seen, however, those
alternatives remain controversial.102 In addition, unlike ethics rules embedded in
an employee policy manual that is incorporated into an employment contract, it is
conceptually more difficult to regard the Congressional ethics rules as an



     100
        United States v. Woodard, 459 F.3d 1078, 1086 (11th Cir. 2006). See generally
Jerke, supra note 12, at 1483-85 (describing views of courts and commentators who
believe that elected officials owe a duty to the public).
    One court has noted that some statutes make “a distinction between Members of
Congress and its officers and employees,” while others “treat Senators and
Representatives as officers and employees of the government.” Operation Rescue Nat'l
v. United States, 975 F.Supp. 92, 103 (D.Mass.1997), aff'd, 147 F.3d 68 (1st Cir.1998).
The same court posited that “Senators are elected by the people, but employed in the
legislative branch and, therefore, fit within the literal definition of ‘employee of the
government ….’” Id. The court cited no authority for that proposition, however. In any
case, there is no precedent treating Members of Congress as fiduciaries, agents, or
employees of the federal government for purposes of the insider trading laws.
    101
        Brody Mullins, Bill Seeks to Ban Insider Trading by Lawmakers and Their Aides,
WALL ST. J., Mar. 28, 2006, at A1.
    102
        See supra note 91 and accompanying text.
Beltway Insider Trading                                                                   21


agreement of the sort contemplated by the Cuban decision.103 With whom is a
Member of Congress in privity? If consideration is required, is there a quid pro
quo?
    An apt precedent for treating stock trading by Congressional staffers and
Members of Congress differently is provided by U.S. v. Carpenter.104 R. Foster
Winans wrote the widely read “Heard on the Street” column for the Wall Street
Journal, which provides investing information and advice. Because that column
apparently had a short lived effect on the price of the stocks it covered, someone
who knew the column’s contents in advance could profit by trading in the affected
stocks. Although Wall Street Journal policy stated that prior to their publication
the contents of columns were the Journal’s confidential property, Winans, before
publication, disclosed the contents of his columns to several friends who then
traded in the affected stocks. Winans and his friends were convicted of mail and
wire fraud and insider trading under Rule 10b-5 pursuant to the misappropriation
theory.105
    In Carpenter, the Second Circuit held that Winans and his fellow conspirators
committed illegal insider trading by “secreting, stealing, purloining or otherwise
misappropriating material non-public information in breach of an employer-
    103
         But see George, supra note 99, at 166-68 (arguing that the House and Senate
ethics manuals constitute the requisite agreement). George notes that “some observers
appear to believe” the House ethics rules “cannot provide a basis for applying the
misappropriation theory” because they are “not a law.” George, supra note 99, at 167. He
goes on to assert that “there is simply no reason why this need be the case under SEC
Rule 10b5-2(b)(1), because the Rule seeks an agreement, not a law.” Id. The problem is
that he gives us no reason to think that the ethics rules constitute an “agreement.”
     104
         791 F.2d 1024 (2d Cir. 1986), aff’d on other grounds, 484 U.S. 19 (1987).
     105
         The Supreme Court affirmed on all counts, but the securities fraud convictions
were affirmed only by an evenly divided Court (4-4). Carpenter v. U.S., 484 U.S. 19
(1987). By long standing tradition, a decision by an evenly divided court affirms the
lower court result but has no precedential or stare decisis effect, which left the legitimacy
of the misappropriation theory uncertain until the O’Hagan decision validated it.
     The federal mail and wire fraud statutes, 18 U.S.C. §§ 1341 and 1343, respectively
prohibit the use of the mails and “wire, radio, or television communication” for the
purpose of executing any “scheme or artifice to defraud.” The mail and wire fraud
statutes protect only property rights, McNally v. U.S., 483, U.S. 350 (1987), but
confidential business information is deemed to be property for purposes of those statutes.
Carpenter v. U.S., 484 U.S. 19, 25 (1987). Hence, the Supreme Court held, the Wall
Street Journal owned the information used by Winans and his co-conspirators and,
moreover, that their use of the mails and wire communications to trade on the basis of
that information constituted the requisite scheme to defraud.
22                                                                              Bainbridge


imposed fiduciary duty of confidentiality,” on the basis of which they then traded
in the stock of issuers mentioned in Winans’ columns.106 In dicta, the court
indicated that the Wall Street Journal could have traded on the basis of the
information in question:
      Appellants argue that it is anomalous to hold an employee liable for acts that
      his employer could lawfully commit. Admittedly, … the Wall Street Journal or
      its parent, Dow Jones Company, might perhaps lawfully disregard its own
      confidentiality policy by trading in the stock of companies to be discussed in
      forthcoming articles. … Although the employer may perhaps lawfully destroy
      its own reputation, its employees should be and are barred from destroying
      their employer’s reputation by misappropriating their employer’s
      informational property. … Here, appellants, constrained by the employer’s
      confidentiality policy, could not lawfully trade by fraudulently violating that
      policy, even if the Journal, the employer imposing the policy, might not be
      said to defraud itself should it make its own trades.107
Nothing in O’Hagan is inconsistent with the distinction drawn in Carpenter. The
misappropriation theory bans undisclosed trading by an agent or other fiduciary in
breach of a duty of loyalty to the principal; it does not ban trading by the principal
in the same information, even if the agent in question developed the information
for the principal. As an employer, a Member of Congress is free to trade; as an
employee, the staffer is not.

D. Summation
    Under current law, there is no serious doctrinal obstacle to applying the
misappropriation theory to employees of the Congress, the Executive Branch, and
other governmental agencies. As to Members of Congress, however, there is a
strong argument under current law that their trading cannot be punished under
either the classic disclose or abstain or the misappropriation theory. The
remainder of this article therefore focuses exclusively on Members of Congress to
the exclusion of other government employees and officials, because that is where
new legislation is most clearly required.

                                 III. Policy
    Members of Congress have undoubted access to material nonpublic
information.108 The Zibrowski study leaves little doubt that misuse thereof is

     106
         Carpenter, 791 F.2d at 1032.
     107
         Id. at 1033-34.
     108
         See supra notes 9-15 and accompanying text.
Beltway Insider Trading                                                                  23


common.109 The policy questions now pending therefore are (1) whether
Members of Congress should be allowed to trade on the basis of information they
acquire by virtue of their position and, if not, (2) whether extension of the insider
trading laws to create such a prohibition and SEC enforcement thereof is the
appropriate regulatory vehicle.

A. Should Members of Congress be Allowed to Inside Trade?
    Insider trading by corporate insiders and misappropriators has been the subject
of extensive policy debate between those who favor maintaining or even
extending the current prohibition and those who favor deregulation of insider
trading.110 Rehashing that debate is beyond the scope of this article. In the first
place, many of the issues on which the debate has joined are essentially irrelevant
to the problem at hand. Whether or not one believes that a prohibition of insider
trading by corporate insiders is necessary to ensure the effectiveness of the SEC’s
system of mandatory disclosure by public corporations,111 for example, says
nothing about inside trading by Members of Congress. Whether or not one
believes that insider trading causes the market price of the affected security to
move toward the price which the security would command if the inside
information were publicly available,112 to cite another example, trading by
Members of Congress is unlikely to move prices very significantly.113
Accordingly, it will be most productive to focus herein on those policy arguments
directly relevant to the question of Congressional insider trading.114




    109
         Zibrowski et al., supra note 1, at 670 (finding that “trading with an informational
advantage is common among Senators”).
     110
         See generally STEPHEN M. BAINBRIDGE, SECURITIES LAW—INSIDER TRADING
133-81 (2d ed. 2007) (reviewing policy debate).
     111
         See id. at 154-56 (discussing relationship between the insider trading prohibition
and the mandatory disclosure regime).
     112
         See id. at 136-44 (describing this argument)
     113
         Barabella et al., supra note 18, at 43 (“The limited available empirical evidence
seems to support the view that Congressional trading does not have a significant effect on
pricing efficiency.”).
     114
         Other commentators have undertaken more exhaustive reviews, which apply the
arguments developed in the corporate context to the problem at hand, see, e.g., Barabella
et al., supra note 18, at 33-52; Jerke, supra note 12, at 1500-10.
24                                                                          Bainbridge


    1. Perverse Incentives
    Henry Manne famously argued that allowing corporate insiders to trade on the
basis of material nonpublic information was an effective means of compensating
entrepreneurs in large corporations.115 His argument was premised on the
differing roles within the corporation of managers and entrepreneurs.116 The
former simply operate the firm according to predetermined guidelines, while the
latter develop new valuable information.117 Entrepreneurs are inherently more
difficult to compensate than mere managers. As to the latter, because the service
is known and easy to monitor, the manager’s “service can be purchased like any
commodity in the marketplace.”118 In contrast, an entrepreneur’s compensation
must not only compensate him for the value of his services but also incentivize
him to continue producing valuable information.119 Because it is rarely possible to
ascertain information's value to the firm in advance, however, predetermined
compensation, such as salary, is inappropriate for entrepreneurs.120 Instead,
claimed Manne, insider trading is an effective way to compensate entrepreneurs
for innovations.121 Because the increase in the price of the security following
public disclosure provides a relatively accurate measure of the value of the
innovation to the firm, insider trading allows the entrepreneur to recover some
substantial portion of the value of his discovery.122
    The validity of this argument vis-à-vis corporate insiders is sharply
contested.123 Even Manne himself, however, recognized that “it has no substantial
application to government” employees and officials.124 This is so because the
compensation argument rests on the need to incent entrepreneurs to produce
information. Members of Congress, however, “are peculiarly in a position to
receive valuable market information, not create it.”125 The information on whose
basis Members of Congress thus are likely to trade “would not ordinarily reflect

     115
         See MANNE, supra note 9, at 182.
     116
         Id. at 115-17.
     117
         Id.i
     118
         Id. at 115.
     119
         Id. at 133.
     120
         Id. at 134.
     121
         Id. at 138-41.
     122
         Id.
     123
         See BAINBRIDGE, supra note 110, at 136-39 (describing argument).
     124
         MANNE, supra note 9, at 182.
     125
         Id. at 179 (emphasis in original).
Beltway Insider Trading                                                               25


entrepreneurial developments for which they are responsible.”126 Accordingly,
there is no socially valuable activity on their part to be incentivized.127
    To the contrary, “the ability of elected officials to profit on the basis of
material nonpublic information creates perverse incentives for these officials, and
introduces innumerable distortions and the potential for immeasurable harm in a
legal system in which public trust and confidence is critical.”128 As Larry Ribstein
observes:
     Congress’s insider trading is bad because it gives our lawmakers the wrong
     incentives. Do we really want to give Congress more reasons to hurt and help
     particular firms?
     In fact, Congress’s trading is worse than trading by corporate insiders, which
     at least might be rationalized as a way to let employees cash in on their
     productive efforts. It’s far worse than the usual trading on non-public
     information by outsiders without any breach of duty, which may encourage
     socially productive investigation and monitoring ....129
     Congressional insider trading thus is undesirable, in the first instance, because
it creates incentives for members and staffers to steal proprietary information for
personal gain. The massive increase in federal involvement in financial markets
and corporate governance as a result of the financial crisis of 2008 has made
opportunities to steal such information even more widely available to government
officials. Second, it gives members and staffers incentives to game the legislative
process so as to maximize personal trading profits. Third, inside information can
be utilized as a pay-off device.130 Fourth, it gives members and staffers incentives
to help or hurt firms, which distorts market competition.



    126
        Id. at 183.
    127
        What about creating an incentive to serve in office? An “argument can be made
that government employment frequently is not financially attractive and that insider
trading would encourage public service by able citizens otherwise unwilling to make the
necessary financial sacrifice.” MANNE, supra note 9, at 182. One suspects, however, that
non-pecuniary benefits associated with the trappings of power and the potential for
substantial deferred compensation provides more than adequate incentives for citizens—
able or otherwise—to seek Congressional office.
    128
        Jonathan R. Macey & Maureen O’Hara, Regulation and Scholarship: Constant
Companions or Occasional Bedfellows?, 26 YALE J. ON REG. 89, 108 (2009).
    129
        Larry E. Ribstein, Congress’ Insider Trading, Ideoblog, Mar. 29. 2006.
    130
        Manne, supra note 9, at 184.
26                                                                               Bainbridge


    2. Unfairness
    “No citation is needed to assert that [giving Members of Congress the
opportunity to earn abnormally high returns by virtue of their service as elected
officials] strikes many people as unfair.”131 The difficulty with such a confident
pronouncement is that while there is a widely shared belief that insider trading is
inherently sleazy,132 converting that impression into a coherent policy basis for
developing specific legal rules has proven quite difficult.133As Jonathan Macey
complains, “scholarship that decries insider trading as ‘unfair’ completely lacks
reasoned argument. Often those who brand insider trading as unfair do not even
attempt to explain what insider trading is, much less why it is unfair.”134
    In the present context, however, we may be able to some meat on the bones of
a fairness argument. Congress routinely imposes rules on the public and the
executive branch that it does not impose upon itself.135 Until recently, “one of the
most notorious of these congressional exemptions” arose out of Congress
exempting ‘itself from federal anti-discrimination and other workforce protection
laws.”136 In arguing in favor of the Congressional Accountability Act of 1995,137
which ended that practice, Senator Grassley contended that;
      I hold a strong belief that we, in Congress, are merely representatives of the
      people. We are not better than the people we represent and we are not, by
      definition and determination, different from the people we represent. We are,
      as representative government intends, the people themselves.
      It is simply not fair, or good governance, for the Congress of the United States
      to enact laws for the American people, while exempting itself from

     131
         Barbabella et al., supra note 18, at 34.
     132
         Cf. Michael P. Dooley, Enforcement of Insider Trading Restrictions, 66 Va. L.
Rev. 1, 55 (1980) (observing that insider trading “is behavior that falls below a standard
of conduct to which many, including the author, aspire”).
     133
         See Frank H. Easterbrook, Insider Trading, Secret Agents, Evidentiary Privileges,
and the Production of Information, 1981 SUP. CT. REV. 309, 324 (“I suspect that few
people who invoke arguments based on fairness have in mind any particular content for
the term.”).
     134
         Jonathan R. Macey, Ethics, Economics, and Insider Trading: Ayn Rand Meets the
Theory of the Firm, 11 HARV. J.L. & PUB. POL’Y 785, 787 (1988)
     135
         Cheryl D. Block, Congress and Accounting Scandals: Is the Pot Calling the Kettle
Black?, 82 NEB. L. REV. 365, 374 (2003).
     136
         Id.
     137
         Pub. L. No. 104-1, 109 Stat. 3 (1995) (codified as amended, at 2 U.S.C. §§ 1301-
1438).
Beltway Insider Trading                                                               27


     compliance…. This is a democracy, and therefore, we make laws for the
     people, and we, too, must follow these laws.138
Grassley began this line of argument by quoting Madison in Federalist No. 57:
     [Members of Congress] can make no law which will not have its full operation
     on themselves and their friends, as well as on the great mass of society. This
     has always been deemed one of the strongest bonds by which human policy
     can connect the rulers and the people together. It creates between them that
     communion of interests and sympathy of sentiments of which few
     governments have furnished examples, but without which every government
     degenerates into tyranny. … If this spirit shall ever be so far debased as to
     tolerate a law not obligatory on the legislature as well as on the people, the
     people will be prepared to tolerate anything but liberty.139
As the Supreme Court has noted, Thomas Jefferson likewise believed that
“legislators ought not to stand above the law they create but ought generally to the
bound by it as are ordinary persons.”140
    The present exemption of Congress from the insider trading laws violates
these basic principles of good government. Accordingly, even if we cannot state a
universal definition of fairness in the insider trading context, the loophole through
which Congressional insider trading escapes those penalties validly may be called
unfair because it breaks the “bonds” of which Madison spoke. Given the harsh
and Draconian penalties Congress has seen fit to impose on those who commit
insider trading,141 moreover, the exemption of Congress from those penalties is
particularly egregious.

    3. Summary
    The problem at hand needs no further belaboring. Indeed, it might have
sufficed to note that Henry Manne advocated “a strong condemnation of [insider
trading’ by government officials.”142 Manne is widely acknowledged to be not
just the leading critic of insider trading regulation, but also the champion of

    138
        Senator Charles Grassley & Jennifer Shaw Schmidt, Practicing What We Preach:
A Legislative History of Congressional Accountability, 35 HARV. J. ON LEGIS. 33, 34-35
(1998), quoted in Block, supra note 135, at 375.
    139
        THE FEDERALIST NO. 57 (James Madison).
    140
        Gravel v. U.S., 408 U.S. 606, 615 (1972).
    141
        See Nagy, supra note 91, at 1368 (noting that “Congress believes that insider
trading is an offense that merits substantial monetary penalties and stiff prison
sentences”).
    142
        MANNE, supra note 9, at 189.
28                                                                            Bainbridge


affirmatively permitting corporate insiders to trade on the basis of material
nonpublic information.143 If Manne thinks insider trading by Members of
Congress ought to be regulated, who shall gainsay him?
    In sum, there is no plausible justification for allowing Members of Congress
or other governmental actors to use material nonpublic information they learn as a
result of their position for personal stock trading gains. To the contrary, the
relevant policy arguments all come down on the side of banning such trading.

B. Who Should Enforce the Prohibition?
    Assuming Congressional insider trading ought to be regulated, there are at
least two vehicles for doing so. On the one hand, we could treat it as a problem of
political corruption to be regulated by Congressional ethics rules.144 On the other
hand, we could amend the securities laws to clearly prohibit Congressional insider
trading and vest the SEC with authority to enforce the new rules. As we shall see
below, the latter is the approach taken by the STOCK Act.145 This section
addresses those alternatives by, first, asking whether there is a constitutional
barrier to assigning responsibility for Congressional insider trading to the SEC. It
then asks whether there are prudential reasons not to do so.

     1. A Constitutional Barrier?
     The Speech or Debate Clause of the U.S. Constitution provides:
           The Senators and Representatives shall … in all Cases, except Treason,
      Felony and Breach of the Peace, be privileged from Arrest during their
      Attendance at the Session of their respective Houses, and in going to and
      returning from the same; and for any Speech or Debate in either House, they
      shall not be questioned in any other Place.146


     143
        See generally Stephen M. Bainbridge, Introduction, in 2 THE COLLECTED WORKS
OF  HENRY MANNE: INSIDER TRADING (2009) (describing Manne’s contributions); see
also Michael Abramowicz & M. Todd Henderson, Prediction Markets for Corporate
Governance, 82 NOTRE DAME L. REV. 1343, 1373-74 (2007) (calling Manne “the leading
anti-establishment thinker in this area”); Douglas M. Branson, Prescience and
Vindication: Federal Courts, SEC Rule 10b-5, and the Work of David S. Ruder, NW. U.
L. REV. 613, (1991) (“The leading advocate of the view that insider trading is a benefit
has always been Dean Henry Manne.”).
    144
        See Jerke, supra note 12, at 1513-16 (arguing for mandatory blind trusts for
Members of Congress and selected staffers).
    145
        See infra Part IV.A.
    146
        U.S. Const., art. I, § 6, cl. 1.
Beltway Insider Trading                                                                29


The clause does not “confer immunity on a Member from service of process as a
defendant in civil matters or as a witness in a criminal case.”147 Indeed, because
the first half of the clause was intended solely to provide an exemption from the
archaic concept of civil arrest, the clause also “does not exempt Members of
Congress from the operation of the ordinary criminal laws, even though
imprisonment may prevent or interfere with the performance of their duties as
Members.”148
    The second half of the Clause was intended by the Founders to ensure that
“legislators are free to represent the interests of their constituents without fear that
they will be later called to task in the courts for that representation.”149
Accordingly, “legislators engaged ‘in the sphere of legitimate legislative activity,’
should be protected not only from the consequences of litigation’s results but also
from the burden of defending themselves.”150 But while the Speech and Debate
Clause therefore confers absolute immunity on Members of Congress, it does so
only within the limited sphere of legislative action:
     Legislative acts are not all-encompassing. The heart of the Clause is speech or
     debate in either House. Insofar as the Clause is construed to reach other
     matters, they must be an integral part of the deliberative and communicative
     processes by which Members participate in committee and House proceedings
     with respect to the consideration and passage or rejection of proposed
     legislation or with respect to other matters which the Constitution places
     within the jurisdiction of either House. As the Court of Appeals put it, the
     courts have extended the privilege to matters beyond pure speech or debate in
     either House, but “only when necessary to prevent indirect impairment of such
     deliberations.”151
How would banning Members of Congress or their staffers from using material
nonpublic information learned on the job for personal trading profit impair
Congressional deliberations? Obviously, it would not. To the contrary, by
removing the perverse incentives such trading opportunities create, the legislative
process would be enhanced. Just as the Speech and Debate Clause does not




    147
        Gravel v. U. S., 408 U.S. 606, 614-15 (1972) (citation omitted).
    148
        Id. at 615.
    149
        Powell v. McCormack, 395 U.S. 486, 503 (1969).
    150
        Dombrowski v. Eastland, 387 U.S. 82, 85 (1967) (citation mitted).
    151
        Gravel v. U.S., 408 U.S. 606, 625 (1972) (citations omitted).
30                                                                               Bainbridge


prohibit Members of Congress from being prosecuted for accepting bribes,152 it
should not bar regulation of Congressional insider trading.153

    2. Prudential Considerations
    Under present law, the SEC has been “unwilling to take any sort of initiative
against insider trading by senators and other congressional officers,” which has
left Congress “to police itself. Not surprisingly, this effort has not been a
success.”154 Despite the restrictions in the Congressional ethics rules on use of


     152
        U.S. v. Brewster, 408 U.S. 501, 526 (1972). Jerke argues that regulating
Congressional insider trading would interfere with Members of Congress ability to
conduct their political functions by, for example, impeding confidential communications
with constituents. Jerke, supra note 12, at 1518-19. In light of the “ease with which inside
information can be utilized as a payoff device,” MANNE, supra note 9, at 184, however,
the Brewster court’s analysis of bribery cases seems equally apt to insider trading by
Members of Congress.
    In Brewster, the Court noted that the Speech or Debate Clause is intended to prevent
inquiry into how a Member of Congress “spoke, how he debated, how he voted, or
anything he did in the chamber or in committee ….” Id. The Court explained that:
           Taking a bribe is, obviously, no part of the legislative process or function;
     it is not a legislative act. It is not, by any conceivable interpretation, an act
     performed as a part of or even incidental to the role of a legislator. It is not an
     “act resulting from the nature, and in the execution, of the office.” Nor is it a
     “thing said or done by him, as a representative, in the exercise of the functions
     of that office,” Nor is inquiry into a legislative act or the motivation for a
     legislative act necessary to a prosecution under this statute or this indictment.
     When a bribe is taken, it does not matter whether the promise for which the
     bribe was given was for the performance of a legislative act as here or … for
     use of a Congressman's influence with the Executive Branch. And an inquiry
     into the purpose of a bribe “does not draw in question the legislative acts of
     the defendant Member of Congress or his motives for performing them.”
Id. Likewise, a prosecution for insider trading would not require “inquiry into a
legislative act or the motivation for a legislative act.” The acts to which such a
prosecution would be directed are “not, by any conceivable interpretation, an act
performed as a part of or even incidental to the role of a legislator.” Accordingly,
purposes of the Speech or Debate Clause are not implicated by such a prosecution.
    153
        Accord Barbabella et al., supra note 18, at 28 (concluding that “it seems unlikely
the Speech or Debate Clause would conflict with attempts to formally regulate
Congressional insider trading”).
    154
        Macey & O’Hara, supra note 128, at 108.
Beltway Insider Trading                                                                 31


nonpublic information,155 insider trading by Members of Congress remains
common.156
    The core problem with self-enforcement by Congress is that the ethics
committees of the House and Senate are notoriously reluctant to prosecute
Members.157 “Watchdog groups have long criticized the House and Senate ethics
committees as ineffective and toothless.”158 Leaving the problem of insider
trading to those committees therefore is an untenable solution if Congressional
insider trading is to be successfully prevented.
    In contrast, the SEC has a long track record of successfully prosecuting
insider trading cases.159 The SEC has a number of investigatory tools and core
competencies that serve it well in insider trading cases.160 It is therefore better
positioned that inexperienced and ineffective Congressional ethics committees to
enforce a ban on Congressional insider trading.
    To be sure, as already noted, the SEC to date has been “unwilling to take any
sort of initiative against insider trading by senators and other congressional
officers.”161 It is plausible that this failure is an intractable one. Any government
agency is likely to be reluctant to bite the budgetary hand that feeds it. To the
extent the SEC’s failure stems from a recognition that current law does not reach
Members of Congress, however, a clear statement of the SEC’s authority to
regulate Congressional insider trading could prompt a more aggressive
enforcement stance on the SEC’s part.

    155
         See generally Barbabella et al., supra note 18, at 29 (describing relevant
provisions of the House and Senate ethics manuals and rules); Jerke, supra note 12, at
1467-70 (same).
    156
        See supra notes 17-19 and accompanying text (discussing evidence of frequency
of Congresisonal insider trading).
    157
        Barbabella et al., supra note 18, at 28-31.
    158
        Dierdre Shesgreen, Congress Split over Handling Ethics Inquiries, ST. LOUIS
POST-DISPATCH, Mar. 12, 2006, at B4.
    159
        See Danné L. Johnson, SEC Settlements: Agency Self-Interest or Public Interest,
12 FORDHAM J. CORP. & FIN. L. 627, 672 (2007) (“A recent survey of SEC cases points
to anecdotal evidence that the SEC is most successful when it is pursuing its core areas of
enforcement, such as standard account fraud cases and insider trading cases.”).
    160
        See generally Stephen M. Bainbridge, Incorporating State Law Fiduciary Duties
into the Federal Insider Trading Prohibition, 52 WASH. & LEE L. REV. 1189, 1262-66
(1995) (discussing the tools the SEC uses in investigating and prosecuting insider trading
cases).
    161
        Macey & O’Hara, supra note 128, at 108.
32                                                                          Bainbridge


            IV. The Stop Trading on Congressional Knowledge Act
   Congressmen Brian and Slaughter introduced versions of the STOCK Act in
the 109th,162 110th,163 and now the 1111th Congresses.164 According to
Congressman Brian’s press release announcing the bill, the current version of the
Act would:
      • Prohibit Members or employees of Congress from buying or selling
           stocks, bonds, or commodities futures based on nonpublic information
           they obtain because of their status;
      • Prohibit Executive Branch employees from buying or selling stocks,
           bonds or commodities futures based on nonpublic information they
           obtain because of their status;
      • Prohibit those outside Congress from buying or selling stocks, bonds,
           or commodities futures based on nonpublic information obtained from
           within Congress or the Executive Branch;165
      • Prohibit Members and employees from disclosing any non-public
           information about any pending or prospective legislative action
           obtained from a member or employee of Congress for investment
           purposes;
      • Require Members of Congress and employees to report the purchase,
           sale or exchange of any stock, bond, or commodities future transaction
           in excess of $1,000 within 90 days. Members and employees who
           choose to place their stock in holdings in blind trusts or mutual funds
           would be exempt from the reporting requirement ….166

A. The Prohibition on Trading and Tipping
    The STOCK Act is not self-executing. To the contrary, it mostly dumps the
problem into the SEC’s lap by directing the Commission to undertake a number
of rulemaking proceedings, of which the most important for our purposes is set
forth in Section 2(a) of the Act:

     162
        H.R. 5015, 109th Cong., 2d Sess. (2006)
    163
        H.R. 2341, 110th Cong., 1st Sess. (2007).
    164
        H.R. 682, 111th Cong., 1st Sess. (2009).
    165
        The problem of so-called “political intelligence” addressed by this section is
beyond the scope of this article. See generally Jerke, supra note 12, at 1471-79
(discussing developments in this area).
    166
        Press Release, supra note 25.
Beltway Insider Trading                                                                33


       (a) Securities Transactions- Section 10 of the Securities Exchange Act of
     1934 is amended by adding at the end the following:
              “(c) Nonpublic Information Relating to Congress- Not later than 270
           days after the date of enactment of this subsection, the Commission shall
           by rule prohibit any person from buying or selling the securities of any
           issuer while such person is in possession of material nonpublic
           information, as defined by the Commission, relating to any pending or
           prospective legislative action relating to such issuer if (1) such
           information was obtained by reason of such person being a Member or
           employee of Congress; or (2) such information was obtained from a
           Member or employee of Congress, and such person knows that the
           information was so obtained.167
The Act further instructs the SEC to conduct a similar rulemaking procedure with
respect to other federal employees.168 In addition, the Commodities Futures
Trading Commission is directed to adopt similar rules pertaining to trading in
“any commodity for future delivery.”169
    An SEC rule comporting with Section 2(a) would ban Members of Congress
and Congressional staffers from trading on the basis of material nonpublic
information obtained by virtue of their position. It also would ban the tippee of a
member or staffer from trading so long as the tippee knew the information was
obtained from a member or staffer. The provision thus solves the basic doctrinal
problems associated with prosecuting Members of Congress who commit insider
trading.
    Note, however, that there is a key limitation on the scope of the prohibition
authorized by the Act; namely, the information must relate to a “pending or
prospective legislative action,” which action in turn must relate to the issuer of the
securities traded.170 As to the former condition, it is unclear how broadly
“legislative action” will be interpreted. As to the latter, it fails to account for the
fact that information about one issuer may often allow one to profit by trading in
the securities of another company.
    The following hypotheticals illustrate the gaps created by the Act’s current
phrasing:
        • After Congress defeats proposed legislation that would have sharply
            increased Acme’s costs of doing business, Acme’s CEO gives a key
    167
        H.R. 682 § 2(a).
    168
        Id.
    169
        Id. § 2(b).
    170
        Id. § 2(a).
34                                                                            Bainbridge


            Congressman a hot tip on Acme stock as a pay off. There was a
            legislative action, but it was in the past and, accordingly, is neither
            pending nor prospective.
        • A Member of Congress learned from a Cabinet member that a
            government agency was about to enter a large procurement contract.
            There is no “pending or prospective” legislative action, but there is
            valuable material nonpublic information on which the member could
            trade.
        • The CEO of Acme is an avid hunter. Congress is considering
            legislative action that would ban hunting of the CEO’s favorite game
            animal. The CEO of Acme gives a key Congressman a hot tip on
            Acme stock as a bribe to oppose the hunting law. This is perhaps the
            most egregious form of Congressional insider trading, yet there is no
            “pending or prospective legislative action relating to such issuer.” To
            the contrary, the legislative action in question is entirely unrelated to
            the issuer.
        • During a confidential committee investigation, a Member of Congress
            learns that Acme is about to announce a major new discovery. The
            member infers that Ajax—Acme’s major competitor—will take a
            serious hit. The member shorts Ajax stock. Technically, the member
            has not traded in the stock of “such issuer.”
    Three other problems with the present statutory language deserve mention.
First, the Act applies only to “the securities of any issuer.”171 The rulemaking
authorized by the Act thus could not proscribe trading in third-party derivatives,
except to the extent they are captured by the commodities provision of the Act.
Second, while the Act authorizes a ban on tippee trading, it does not expressly
authorize a regulatory ban on tipping by members or staffers.172 There is no
reason members and staffers should be allowed to tip with impunity. Finally, Rule
14e-3 prohibits tippees from trading on the basis of material nonpublic
information about a tender offer not only if the tippee knows the information
came from one of the specified sources, but also if the tippee “has reason to
know” that it came from a proscribed source. The STOCK Act should do likewise
with respect to information obtained from a member or staffer.



     171
       Id.
     172
       Id. The Act does amend the Congressional ethics rules to ban tipping with respect
to pending or prospective legislative action. Id. § 3.
Beltway Insider Trading                                                           35


B. Reporting Provision
    The STOCK Act would require that a Member of Congress disclose to the
Clerk of the House or Secretary of the Senate, as the case may be, transactions of
$1,000 or more in “any stocks, bonds, commodities futures, or other forms of
securities that are otherwise required to be reported under” the Ethics in
Government Act.173 A member has up to 90 days after the transaction is effected
to disclose it.174 This compares quite unfavorably with the two days corporate
insiders have to report transactions covered by Section 16 of the Securities and
Exchange Act.175 A shorter disclosure window is in order.

                                  V. Conclusion
    Insider trading by corporate insiders has been banned for over 4 decades.176
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.
    The STOCK Act would fix the doctrinal obstacles to prosecuting Members of
Congress who commit insider trading. If passed, it also might finally give the
SEC political cover to actually bring such cases. Although the present Act still
needs work, it is long over due.




    173
        H.R. 682, 111th Cong., 1st Sess. § 4 (2009).
    174
        Id.
    175
         See 15 U.S.C. § 78p(a) (setting out disclosure rules for specified corporate
insiders).
    176
         The modern federal insider trading prohibition is generally regarded to have
originated with SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert.
denied, 394 U.S. 976 (1969). See supra note 35 and accompanying text (discussing
TGS’s importance in the evolution of the insider trading laws).

				
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