I commend Senator Scott Brown and his cosponsors for introducing the Stop Trading on Congressional Knowledge (STOCK) Act. I've now had a chance to review the Act, however, and it's seriously lacking in several important respects.
The key operative language of S. 1871 is contained in section 2. It reads as follows:
Not later than 270 days after the date of enactment of this Act, the Commission shall, by rule, prohibit any person from buying or selling the securities or security-based swaps of any issuer while such person is in possession of material nonpublic information relating to any pending or prospective legislative action relating to such issuer, if--
(A) such information was obtained by reason of such person being a Member or employee of Congress; or
(B) such information was obtained from a Member or employee of Congress, and such person knows that the information was so obtained.
Identical language appears in the House version of the bill (H.R. 1148).
An SEC rule comporting with this requirement 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. (As to those problems, see my article Insider Trading Inside the Beltway.)
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. 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 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.” 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. 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.
Another key provision of the STOCK Act is the rule it would impose on Congressmen to report their trading activities. The operative language is as follows:
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Within 90 days after the purchase, sale, or exchange of any stocks, bonds, commodities futures, or other forms of securities that are otherwise required to be reported under this Act and the transaction of which involves at least $1,000 by any Member of Congress or officer or employee of the legislative branch required to so file, that Member, officer, or employee shall file a report of that transaction with the Clerk of the House of Representatives in the case of a Representative in Congress, a Delegate to Congress, or the Resident Commissioner from Puerto Rico, or with the Secretary of the Senate in the case of a Senator.'.
A member thus would have up to 90 days after the transaction is effected to disclose it. This compares quite unfavorably with the two days corporate insiders have to report transactions covered by Section 16 of the Securities and Exchange Act. A shorter disclosure window is in order.
Again, identical language appears in the House version of the bill (H.R. 1148), which therefore likewise needs a shorter disclosure window.
I have not yet seen the text of the version introduced by Senator Kirsten Gillibrand and her cosponsors (S. 1903), as it is not yet available on Thomas. Initial press reports, however, are not promising:
Sen. Kirsten Gillibrand’s move to end insider trading by members of Congress is so full of loopholes it would do almost nothing to end the lucrative practice among lawmakers and their families, experts say.
It might not even deter Gillibrand’s husband, Jonathan, who regularly trades stocks and whose risky trades seem to have benefited from the downturn in the housing market.
Gillibrand’s proposed STOCK Act does not specifically bar lawmakers and their employees from sharing information with their spouses and family members — meaning Gillibrand could pass on tips that her husband could use in trades. ...
Another expert scorned a section in the bill giving lawmakers 90 days to report trades.
“Stock trades need to be reported in real time,” said Alan Ziobrowski, a real-estate professor at Georgia State University who has researched insider trading by members of Congress.
“After 90 days, these reports will simply end up in the bowels of Congress where they will probably be forgotten,” he said.
Jonathan Gillibrand made more than 250 stock transactions in 2008 at the height of the mortgage crisis, according to the senator’s financial disclosures.
He made dozens of risky investments in home-building stocks, using put options, which let him take advantage of falling real-estate prices.
