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The STOCK Act will not make whistle blowing illegal

A friend sent along a link to an NRO article by two guys from the Competitive Enterprise Institute -- named John Berlau and David Bier -- in which they claim that the STOCK Act banning insider trading by members of Congress will also ban whistle blowing.

There are so many mistakes in this article that it's hard to know where to start or what order in which to take them up. (As you can see, they caught me on a bad day. But even on a good day we're so close to finally passing the STOCK Act that misinformation about the Act is going to light a very short fuse. And if the civility nannies have a problem with that, they can [colorful but highly uncivil suggestion deleted].)

First, it's critical for you to understand that there are two basic theories of insider trading liability. As the Supreme Court explained in US v. O'Hagan, 521 U.S. 642, 652 -53 (1997):

The two theories are complementary, each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities. The classical theory targets a corporate insider's breach of duty to shareholders with whom the insider transacts; the misappropriation theory outlaws trading on the basis of nonpublic information by a corporate “outsider” in breach of a duty owed not to a trading party, but to the source of the information. The misappropriation theory is thus designed to “protec[t] the integrity of the securities markets against abuses by ‘outsiders' to a corporation who have access to confidential information that will affect th[e] corporation's security price when revealed, but who owe no fiduciary or other duty to that corporation's shareholders.”

The concern in whistle blowing cases, of course, is not the whistle blower will himself trade on the basis of material nonpublic information, but rather that someone to whom he discloses the information will do so. Berlau and Bier thus set up the following hypothetical:

You are a conscientious congressional staffer who still takes seriously the need to be a steward of taxpayers’ money. ... Suddenly, you hear about an outrageous earmark about to be slipped into the bill that would enrich a Fortune 500 company. You decide to alert a network of fiscal watchdogs you’ve met with over the years to wage an instant campaign against this piece of corporate welfare. ...

You sit back and think, “It is indeed possible that someone I send this to could buy stock in the company, or could short the company based on the coming outrage.” You stare at the computer screen wondering how virtually no one noticed how this law could have potentially criminalized an act of whistleblowing as abetting “insider trading.”

They thus claim that the STOCK Act bans whistle blowing. It's possible they could be more wrong, but it's hard to see how.

1. As currently drafted, the STOCK Act broadly bans insider trading by members of Congress, Congressional staffers, and other federal employees. As currently drafted, however, the STOCK Act is unnecessarily broad. As I demonstrated (conclusively, if I may so myself who shouldn't) in my article Insider Trading Inside the Beltway, insider trading and tipping by Congressional staffers and executive branch employees is already illegal under current law. It was only Members of Congress who fell through the cracks of current law. If whistle blowing constitutes an illegal tip, accordingly, it's illegal under current law. The STOCK Act thus doesn't change the liability exposure of Congressional staffer whistle blowers in a single iota.

Berlau and Bier's hysteria is thus wholly misplaced. But even if the STOCK Act did change the law applicable to staffers, it still wouldn't make whistle blowing illegal. You see, all the STOCK Act does is to extend current law to members of Congress etc. And there's no way whistle blowing is illegal under current law.

2. In insider trading jargon, disclosure to someone who uses the information to trade is known as "tipping." Under the classical theory of insider trading, it is clear beyond the shadow of a doubt that a tipper can only be held liable if he gets a personal benefit for making the tip. as the Supreme Court explained in Dirks v. SEC, 463 US 646, 661-63 (1983):

In determining whether a tippee is under an obligation to disclose or abstain, it thus is necessary to determine whether the insider's “tip” constituted a breach of the insider's fiduciary duty. All disclosures of confidential corporate information are not inconsistent with the duty insiders owe to shareholders. ... Whether disclosure is a breach of duty therefore depends in large part on the purpose of the disclosure. This standard was identified by the SEC itself in Cady, Roberts: a purpose of the securities laws was to eliminate “use of inside information for personal advantage.” Thus, the test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach.

The Dirks case itself in fact involved whistle blowing, albeit in the corporate context. The Court held that the whistle blower got no personal benefit (Id. at 666-67):

It is clear that neither Secrist nor the other Equity Funding employees [i.e., the tippers] violated their Cady, Roberts duty to the corporation's shareholders by providing information to Dirks. The tippers received no monetary or personal benefit for revealing Equity Funding's secrets, nor was their purpose to make a gift of valuable information to Dirks. As the facts of this case clearly indicate, the tippers were motivated by a desire to expose the fraud. In the absence of a breach of duty to shareholders by the insiders, there was no derivative breach by Dirks [i.e., the tippee].

Berlau and Bier's claim -- based on a single 2003 law review article -- that "courts are split on whether a 'personal benefit' is even required for guilt" is thus obviously erroneous insofar as the classical theory is concerned.

3. To be sure, most (all?) Congressional staffer tipping would implicate the misappropriation theory (since they're unlikely to be insiders of the issuer about whom they tipped information). And it is true that some older district court opinions cast doubt on whether the Dirks personal benefit requirement applies to misappropriation theory.

BUT (and it's a big but) those cases were almost all district court opinions. The relevant passages of most are dicta rather than holding. They are all older cases. And they are clearly in the minority.

In a 2011 PLI outline, Michael S. Schachter and Ian M. Christy of Willkie Farr & Gallagher (1903 PLI/Corp 447, 453) explain that:

Most courts considering the issue have held that the personal benefit test does apply in misappropriation cases for policy reasons. The Eleventh Circuit noted in SEC v. Yun that attaching different requirements “constructs an arbitrary fence” between the two theories, while the harm to the securities market would be the same in both cases. Additionally, because insiders who tip are often misappropriating information as well, employing different tests for liability would, according to Yun, “essentially render Dirks a dead letter” by creating a loophole for the government to avoid the personal benefit test in many cases involving corporate insiders.

Law professor Donna Nagy likewise explains that (94 Iowa L. Rev. 1315, 1348 n.196): "courts generally apply Dirks' requirement of a personal benefit in misappropriation cases, notwithstanding that Dirks was a case under the classical theory." As support she cites the leading treatise Ralph C. Ferrara, Donna M. Nagy & Herbert Thomas, Ferrara on Insider Trading and the Wall 2-71 to -74 (2008).

4. It's probably not enough that the tipper think it is "possible that someone I send this to could buy stock in the company." In Elkind v. Liggett & Myers, Inc. 635 F.2d 156, 167 (2d Cir. 1980), the Court held that:

One who deliberately tips information which he knows to be material and non-public to an outsider who may reasonably be expected to use it to his advantage has the requisite scienter. ... One who intentionally places such ammunition in the hands of individuals able to use it to their advantage on the market has the requisite state of mind for liability under [sec.] 10(b) and Rule 10b-5.

Granted, the Second Circuit subsequently rejected the argument that "that tippers must specifically know that their breach of a fiduciary obligation in misappropriating information will lead to trading on the information." U.S. v. Libera, 989 F.2d 596, 600 (2d Cir. 1993). As Professor Donna Nagy has observed (59 Ohio St. L.J. 1223, 1263 n.199), however:

This aspect of Libera's holding certainly must be reevaluated in light of O'Hagan. If the tippers did not have any knowledge that the information conveyed would be used by the tippees for securities trading purposes, it is difficult to see how the tippers' breach of duty (in which the tippees are co-participants) can satisfy even the broadest interpretation of Section 10(b)' s “in connection with” nexus. And without a breach of duty on the part of the tipper “in connection with” a securities transaction, there is simply no basis for imposing Section 10(b) and Rule 10b-5 liability on either the tippers or the tippees.

On top of which, I don't see how Libera could ever have been squared with the scienter requirement under Rule 10b-5.

5. In an especially egregious piece of fearmongering, Berlau and Bier claim that the SEC might extend Regulation FD to Congress, such that it will "require meetings and calls in which Congress members and staffers participate to be open to the public or not occur at all. The result would be less outflow of information from Congress and a less informed public." There is NOTHING in the STOCK Act that would require, encourage, or authorize the SEC to do so. Nada. Zilch. Zip. On top of which, Regulation FD was adopted precisely because the Dirks framework did not make selective disclosure by corporate insiders to analysts illegal. The SEC authority to adopt Reg FD thus does not depend on insider trading law. Accordingly, in the incredibly unlikely event that the SEC decides to extend Regulation FD to Congress, it could do so even if the STOCK Act never passes.

6. I admit that I've long suspected that the SEC thinks there is an invisible footnote to the First Amendment that exempts it from the prohibition on interfering with the right of free speech. After all, what is disclosure regulation if not a regulation of speech? What is the rule on shareholder proposals, if not forced speech? But surely not even the SEC would argue that it can police political speech in the same manner it polices corporate speech. And even if the SEC did so, have Berlau and Bier never heard of the courts? I'm prepared to wager the best bottle of wine in my cellar (probably the 1982 Chateau Gruaud Larose or the 1982 Chateau Montrose) that if the SEC tried to apply the insider trading laws to whistle blowing or Reg FD to Congress that the courts would invalidate in a heartbeat.

To SUM up: I don't know why Berlau and Bier decided to peddle this load of codswallop, but a load of codswallop it is. The STOCK Act doesn't change the law applicable to Congressional staffers. Under current law, whistle blowing is not illegal tipping. Ergo, whistle blowing by staffers will still be perfectly legal once Congress passes the STOCK Act.

Further reading:

Bainbridge, Stephen M., The Stop Trading on Congressional Knowledge Act (August 13, 2009). UCLA School of Law, Law-Economics Research Paper No. 09-16. Available at SSRN: http://ssrn.com/abstract=1449744

Bainbridge, Stephen M., Insider Trading Inside the Beltway (June 30, 2010). UCLA School of Law, Law-Econ Research Paper No. 10-08. Available at SSRN: http://ssrn.com/abstract=1633123

Quoted re STOCK Act's impact on political intelligence

The WSJ ran a story today on the potential impact of the STOCK Act on gathering of political intelligence, in which yours truly was quoted:

The new concern of the political-intelligence industry stems from the legislation giving lawmakers an explicit "duty" not to act on nonpublic, material information. Prior to the legislation, many securities lawyers thought it was unclear if such a duty—a key tenet of insider-trading law—existed on Capitol Hill.

In establishing that legal duty, however, the legislation also could put lawmakers and aides in legal jeopardy if they divulge that same information to individuals who then trade on the information. "Now that Congress is covered by the insider-trading law, if a member of Congress gives a tip to a hedge fund manager, that is going to be illegal," says Stephen Bainbridge, a securities-law professor at the University of California, Los Angeles School of Law.

Of course, it also would have to be shown that the Member got a personal benefit from making the tip, such as a political contribution, log-rolling support for legislation, or enhanced repuation.

Does the STOCK Act's impending passage argue for self-funding by the SEC?

The STOCK Act is intended to make clear that the SEC can successfully bring insider trading cases against members of Congress who trade on the basis of material nonpublic information. The practical question that will be posed by passage of the Act is whether the SEC will actually dare bite the hand that feeds it. With that in mind, consider Broc Romanek's argument that:

I've written repeatedly how absurd it is for a so-called independent federal agency - like the SEC - to be subject to the very real political pressures and whims of Congress. And the political pressures faced by the SEC have only grown since the passage of Dodd-Frank a mere two years ago. You may recall that the Senate's version of Dodd-Frank envisioned a self-funded SEC - a concept to be lost during the House-Senate conferencing leading up to the bill's enactment (if I recall, House conferees had accepted self-funding but some Senators stripped it from the final bill). Dodd-Frank also was supposed to dramatically bolster the SEC's resources, a notion that was quickly buried after it became law.

So what to do with the front-page article in the Washington Post today that Rep. Spencer Bachus (R-Ala.), Chair of the House Financial Services committee - the one that oversees the SEC - is being investigated for insider trading by the Office of Congressional Ethics? The case is the first of its kind involving a member of Congress. 

It's a legitimate problem. On the one hand, there have to be mechanisms for holding the SEC politically accountable and control of the budget is a critical mechanism for doing so. Second, we know from watching law enforcement agencies enforcing laws that allow them to get a slice of money forfeited by defendants that self-funding leads to abuses, some very serious. Third, in a democracy founded on the principle of no taxation without representation, the people's House is supposed to control the purse strings.

On the other hand, will the SEC bite the hand that feeds it? I'm not at all sure.

My preference would be to find ways to encourage the SEC to enforce the STOCK Act without moving to a self-funding model.

House passes STOCK Act

House majority leader Eric Cantor kept his word and got the House to pass the STOCK Act, 417-2!, albeit only after stripping out the so-called political intelligence provision. I'm okay with that change for reasons Richard Painter explained:

... some hedge funds and other investment firms learn nonpublic government information before the rest of the investing public.  Sometimes this is done through “political intelligence” firms that arrange meetings and conference calls with government officials and use other techniques to obtain nonpublic information which is then made available to clients for a fee.   As I told the Wall Street Journal last year, gathering and selling confidential government information is a very good business model, if you can get away with it.  This isn’t fair and something should be done about it.

The Grassley amendment responds to this problem by requiring firms that gather political intelligence to register under the LDA.   The problems with this approach are many.  First, persons who do not fit the definition of a “political intelligence” firm in the statute will not be required to register and will continue to gather nonpublic government information and use it for securities trading.   Second, a definition of a “political intelligence” firm will need to be exceedingly broad if it hopes to include a significant portion of the persons and entities that use nonpublic government information for securities trading.  Drafting such a definition is nearly impossible.  Third, a broad definition of “political intelligence” firm that is coupled with a registration requirement imposes an undue burden on persons who seek to gather information about what their government is doing, a critical function in any democratic society. ...

The answer to selective disclosure (“leaks”) by government officials of nonpublic government information is not requiring people to register before they gather information about their government.  The answer is stricter rules for government employees who selectively disclose government information to persons outside the government without disclosing the same information publicly.  As I pointed out in a chapter on insider trading in my 2009 book on government ethics, selective disclosure by government officials needs to be regulated just as selective disclosure by officials in public companies is regulated by the SEC’s Regulation FD (“Fair Disclosure”).  Donna Nagy and I are presently writing an article on how the executive and legislative branches could adopt and adhere to a Regulation FD regime.  In short Congress should consider imposing on government some of the rules it imposes on the private sector, rather than trying to solve a problem in government ethics by enacting yet more regulation and a burdensome registration requirement for the private sector.

Anyway, I've been deeply suspicious of Cantor throughout this process. Whether he was really on the side of the angels all along or just saw the political handwriting on the wall, however, is now irrelevant. He got the job done and for that he gets my thanks.

Cantor promises to move Senate STOCK Act

Interesting development. House Majority Leader Eric Cantor has announced that:

“I’m pleased that the Senate passed a stronger STOCK Act today to prevent Members of Congress and staff from using insider information for their financial benefit. Insider trading at any level of the federal government is unacceptable. We will quickly review the entire bill and the amendments that were added today to ensure that public servants, whether in the legislative or executive branch, do not personally profit from insider information. It is critical that the bill we send to the President guarantees that the same rules apply to those in the federal government as they do to everyone else. Therefore, it is my intention to schedule consideration of the Senate-passed STOCK Act on the House floor next week.” 

Very interesting. Up until now, Cantor had planned to load the bill up with all sorts of poison pills, like extending it to irrelevancies like land transactions. I believe that was an effort to kill the bill. But even if he had brought up the current House version of the bill, without all the poison pills, it still wouldn't be as good a bill as the one the Senate passed (see this post).

So now the big question is: Does Cantor really intend to let the House vote on a clean version of the Senate bill without all the poison pills? Or has he left himself wiggle room?

When I write the next volume of the history of insider trading law, this will be the pivotal moment.

Slaughter prods Cantor on STOCK Act, but pushes wrong version

As I detailed in my article Insider Trading Inside the Beltway, Rep. Louise Slaughter (D-NY) and former Rep. Brian Baird for years fought an honorable but lonely uphill battle to get people to pay attention to the problem of Congressional insider trading. With the Senate having passed the STOCK Act, Congresswoman Slaughter is now prodding House majority leader Eric Cantor to bring the Act to a House vote:

Slaughter, D-Fairport, and Rep. Tim Walz, D-Minn., filed a discharge petition on the bill — and if a majority of members sign it, the Stop Trading on Congressional Knowledge Act will have to come up for a vote within seven legislative days.

Slaughter said the move was necessary because the House Republican Majority Leader, Rep. Eric Cantor of Virginia, has not moved the legislation to the floor even though 272 lawmakers — 54 more than are needed for passage — have cosponsored it.

“An overwhelming and bipartisan majority of Congress sees the urgent need to pass the STOCK Act and so far it hasn’t happened,” said Slaughter. “After stopping this bill in its tracks in December ... it’s time for Leader Cantor to end the partisan games and bring this bill to the floor.” ...

Slaughter has a reason for trying to force Cantor’s hand. She believes her bill is stronger than the Senate’s version.

I honor Congresswoman Slaughter for her years of service to the cause and applaud her efforts to hold Cantor's feet to the fire. Unfortunately, I cannot support her version of the STOCK Act in light of the far superior Senate version. Put simply, Slaughter's dead wrong about her bill being stronger. It's much worse.

I detailed the problems with Slaughter's version of the STOCK Act in my article Insider Trading Inside the Beltway, and updated them in a post discussing the original Scott Brown version (which tracked Slaughter's House bill). In that post, I explained that the bill had many loophole and problemss:

... 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:

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.

In a subsequent post, by contrast, I supported the version that became the current Senate bill:

1. It takes a broad approach to the problem rather than the prior version, whose "too narrow" approach Macey and I have criticized.
2. It brings the law governing Congress into line with the law governing the rest of us, solving a clear fairness problem.
3. Although I would prefer a clear and bright-line definition of insider trading that applies to everyone, I understand that that's politically very difficult. Indeed, Congress has consistently chosen to leave the task of defining insider trading to the SEC and the courts. So simply extending that judge-made law to Congress is a more than acceptable second best solution.
4. The Act is no longer limited to insider trading on the basis of information about pending legislation, closing a major loophole.
5. By incorporating current law, the bill implicitly bans tipping by members of Congress, closing another major loophole.
6. The requirement that Congressional transactions be disclosed within 30 days is an improvement on the current requirement of annual disclosures and on the 90 day disclosure requirement in the original version of the Stock Act, although still far shorter than the 2 days corporate insiders have to disclose their trades.

In sum, Senator Gillibrand and her staff are to be highly commended for coming up with a ban on Congressional insider trading that is simple, effective, comprehensive, and workable.

I urge both Representatives Cantor and Slaughter to support the Senate's " simple, effective, comprehensive, and workable" version. As I have been tweeting for a while now, #PassThe SenateSTOCKAct!

Gillibrand and Brown celebrate STOCK Act win

Senator Kirsten Gillibrand (D-NY) celebrates passage of the STOCK Act:

“We are entrusted with a profound responsibility by the American people to look out for their best interests, and nothing else, certainly not our own financial interests,” said Senator Gillibrand, the first member of Congress to post her official daily schedule, all earmark requests and personal financial disclosure online. “Today, we took the first step toward restoring the trust that’s been lost in Washington by ensuring that members of Congress play by the exact same rules as everyday Americans.” 

The press release details the main provisions of the bill. I had the privilege of working with the Senator's staff on the bill and was extremely impressed by them. Indeed, if I lived in NY, I'd break my no voting for Democrats rule and vote for Senator Gillibrand as thanks for the tremendous work she and her staff put into the bill.

Kudos also to Senator Scott Brown (R-MA) and his staff, who also worked really hard to make this day--which I never thought would come--happen. Senator Brown is also taking a well-deserved victory lap:

I became the first Senator to address the problem and introduce the STOCK Act.

In the past few months, my bill gathered bipartisan support, and even President Obama said he would help me push the Senate leadership to move things forward. Now, I’m proud to say that the STOCK Act has passed the United States Senate.

Here’s what the bill does: it makes the law clear by banning members of Congress and staff from engaging in insider trading and using public office for personal gain. It also demands that personal financial transactions are filed more frequently, and available online.

Bottom line, members of Congress have to live by the same laws everyone else. 

Time to send a few bucks to Brown's reelection campaign as thanks.

Now we just have to convince House Majority Leader Eric Cantor that members of Congress, as Senator Brown aptly puts it, ought to "have to live by the same laws everyone else."

Senate passes STOCK Act, but with what amendments?

CBS News reports that the Senate just passed the STOCK Act to ban Congressional insider trading, but only after subjecting it to 20 proposed amendments:

The STOCK Act - legislation to bar members of Congress from trading stocks based on nonpublic information they have obtained in the course of their congressional work - passed the Senate Thursday in a 96 to 3 vote. ...

Senate Democrats and Republicans began voting on 20 amendments, one by one, early Thursday afternoon, after an agreement was worked out between Senate Majority Leader Harry Reid and Senate Minority Leader Mitch McConnell following contentious negotiations. The amendment barring lawmakers from directly holding individual stocks failed Thursday 26 - 73; the amendment mandating that lawmakers lose their pensions for lobbying was not among those brought to a vote.

One criticism of the original legislation - raised by House Majority Leader Eric Cantor - was that the original bill did not also focus on the executive branch. That issue seems to have been addressed: An amendment to extend the new rules to cover the executive branch passed on Thursday 58-41.

I had hoped that the Senate would pass the bill as reported out of Committee, but I can live with the amendment to extend the bill to the Executive Branch. It wasn't necessary, for the reasons I discuss in Insider Trading Inside the Beltway, but it's like chicken soup--can't hurt and might help. But what about all those other amendments? Did any pass? And, if so, what did they do? Stay tuned.

Who were the three inside trading loving senators who voted no?

How Eric Cantor's going to kill the STOCK Act

In legislative parlance, a poison pill amendment is one intended not to improve a bill but to kill it. A classic example is one that loads the bill up with contentious additional matters, so as to provoke a defeat of the bill by those who support the original bill's goals but have legitimate (or otherwise) objections to the extraneous provisions. The poison pill may also extend the bill's original scope, so as to take "a good idea too far."

Which is precisely what Cantor is doing to the STOCK Act. Politico reports that:

House Majority Leader Eric Cantor (R-Va.) said Tuesday the Senate’s version of the STOCK Act didn’t go far enough and that he’ll push through a stricter version in the House if the Senate doesn’t “strengthen” the bill.

Bull shit. Cantor tried to kill the bill in committee:

Cantor, who controls legislation that comes onto the House floor, has come under Democratic accusations that he was holding up progress on the lower chamber’s version of the STOCK Act after he privately pressured a committee chairman to delay a mark-up on the bill.

Having failed in that effort, he's now trying to extend the STOCK Act "so it includes land deals and other types of transactions and not just stock trades." Classic taking a good idea too far. The problem is insider trading in stocks, not insider trading in land deals. Cantor obviously hopes that incuding a vast array of economic activity within the bill, exposing members of Congress to disclosure obligations and other restrictions, as well as increasing their liability exposure, will make the bill sufficiently unpopular so as to prevent its passage.

Eric Cantor's going to try killing the STOCK Act by taking a good idea too far. We've got to find a way to stop him. We've got to find a way to make him #PassThe SenateSTOCKAct. Tweeting that message to him at @GOPLeader's a start.

As for me, as I've noted before, in my day job as a corporate law professor, I've written the history of insider trading law, and will continue to do so for the next 20 years or so (God willing), I intend to make damn sure that if Eric Cantor manages to kill the STOCK Act that he will go down in history as the man who defended Congress' right to commit insider trading with impunity.

"The Time Is Now: Let's Stop Congressional Insider Trading"

So says the Motley Fool's Rich Smith in a roundup of developments.

STOCK Act passes Senate cloture vote. I call Bull Sh*t on Eric Cantor.

Great news: The Senate voted 93-2 in favor of a cloture motion on the STOCK Act, which bans Congressioal insider trading. Unfortunately, it looks like Eric Cantor still wants to kill the bill with kindness:

A House Republican leadership aide told CBS News that lawmakers will take up their version of the STOCK Act by the end of February. House Republicans plan to expand the legislation beyond the Senate bill to include non-stock investments and also include executive branch officials and employees.

"Building upon the Senate bill, this common-sense proposal will not only deal with insider trading of stocks, but also prevent all federal officials and employees from using insider information for profit in other areas in a constitutionally sound way," Laena Fallon, a spokesperson for House Majority Leader Eric Cantor, told CBS News. "As Leader Cantor has said, he strongly supports increased disclosure to prevent any sense of impropriety and ensure the public's confidence and trust in our elected officials."

I call bull shit. What Cantor wants to do is to broaden the bill so as to weigh it down with irrelevancies, many of which are legitiimately controversial (rumor has it he still will include a blind trust provision).

As one of those people who has written the history of insider trading law, and will continue to do so for the next 20 years or so (God willing), I intend to make damn sure that if Eric Cantor manages to kill the STOCK Act that he will go down in history as the man who defended Congress' right to commit insider trading with impunity.

Senator Gilibrand on the need for the STOCK Act

STOCK Act to come up for cloture vote?

I heard from Senate sources that the STOCK Act to ban Congressional insider trading will come up for a cloture vote next week. This is great news. As regular readers know, I'm a strong advocate of the bill in general and, in particular, of the version that was passed out of the Senate Committee on Homeland Security and Governmental Affairs. Coupled with the fact that President Obama asked Congress in his State of the Union address Tuesday to pass this legislation and send it to his desk for signature, a positive Senate vote might light a sufficient fire under Eric Cantor to get the bill moving in the House. We might actually finally win this thing.

Speaking of Cantor, I'm still trying to get a Twitter campaign going to send the message to Eric Cantor that it's time for Congress to ban insider trading by its members by passing the Senate version of the STOCK Act. If you want to help, tweet the hash tag #PassTheSenateSTOCKAct to both his accounts:  @EricCantor @GOPLeader

For prior PB.com coverage, go to the archive. 

For extended analysis, see my article Insider Trading Inside the Beltway, which argues that:

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.

Also, don't forget that you can buy a personally signed copy of my book on insider trading at  eBay. Other eBay sellers charging up to $20. I'm selling it at $4.99 plus S&H

"Insider" Trading by the Representative Plaintiff in Shareholder Litigation

If a plaintiff's class action or derivative lawyer tells the representative shareholder material nonpublic information about the status of the litigation, on the basis of which the shareholder then trades in the issuer's stock, there's doubtless some sort of state law violation. As Peter Ladig reports, the Delaware Chancery Court's newly issued guidelines for practicing before it make clear that "litigants who engage in this type of behavior should expect to be subject to "intensive scrutiny" and face a host of possible penalties." (See also Francis Pileggi's summary of the case.)

Ladig further reports that a recent Delaware case imposed sanctions in just such a case:

... in Steinhardt v. Howard-Anderson, ... the court ordered the plaintiffs it had found to have traded while in possession of confidential, nonpublic information to (i) self-report to the Securities Exchange Commission; (ii) disclose their improper trading in any future application to serve as lead plaintiff; and (iii) disgorge any profits made from the trades. The court then dismissed the trading plaintiffs from the case with prejudice and barred them from receiving any recovery from the litigation.

Query, however, whether the trading representative shareholder violated the federal insider trading prohibition. The Supreme Court has consistently made clear that insider trading liability is premised on breach of a duty to disclose rising out of a fiduciary relationship. 

Outside the traditional categories of Rule 10b-5 defendants—insiders, constructive insiders, and their tippees—things become quite complicated. As the Second Circuit observed in United States v. Chestman:

[F]iduciary duties are circumscribed with some clarity in the context of shareholder relations but lack definition in other contexts. Tethered to the field of shareholder relations, fiduciary obligations arise within a narrow, principled sphere. The existence of fiduciary duties in other common law settings, however, is anything but clear. Our Rule 10b-5 precedents . . ., moreover, provide little guidance with respect to the question of fiduciary breach, because they involved egregious fiduciary breaches arising solely in the context of employer/employee associations.[1]

In Chestman, the question was whether the relationship between spouses was fiduciary in nature. In answering that question, the court laid out a general framework for dealing with nontraditional relationships. First, unilaterally entrusting someone with confidential information does not by itself create a fiduciary relationship.[2] This is true even if the disclosure is accompanied by an admonition such as “don’t tell.” Second, familial relationships are not fiduciary in nature without some additional element.

Turning to factors that could justify finding a fiduciary relationship on these facts, the court first identified a list of “inherently fiduciary” associations. "Counted among these hornbook fiduciary relations are those existing between attorney and client, executor and heir, guardian and ward, principal and agent, trustee and trust beneficiary, and senior corporate official and shareholder."

Once one moves beyond this class of “hornbook” fiduciary relationships, the requisite relationship exists solely where one party acts on the other’s behalf and “great trust and confidence” exists between the parties:

A fiduciary relationship involves discretionary authority and dependency: One person depends on another—the fiduciary—to serve his interests. In relying on a fiduciary to act for his benefit, the beneficiary of the relation may entrust the fiduciary with custody over property of one sort or another. Because the fiduciary obtains access to this property to serve the ends of the fiduciary relationship, he becomes duty-bound not to appropriate the property for his own use.

Because the spousal relationship at issue in Chestman did not involve either discretionary authority or dependency of this sort, it was not fiduciary in character.

According to Ladig, the Delaware Chancery Court characterized the relationship between the representative shareholder and the class s/he represents as a fiduciary one:

"Trading by plaintiff-fiduciaries on the basis of information obtained through discovery undermines the integrity of the representative litigation process. Consequently, it is unacceptable for a plaintiff-fiduciary to trade on the basis of nonpublic information obtained through litigation."

In theory, I suppose the representative plaintiff has discretionary authority over the litigation. Also, in theory, I suppose that the other shareholders depend the representative shareholder to serve their interests. In theory, it's therefore hard to quibble with Vice Chancellor Lasker's statement that:

When a stockholder of a Delaware corporation files suit as a representative plaintiff for a class of similarly situated stockholders, the plaintiff voluntarily assumes the role of fiduciary for the class. See Emerald P'rs v. Berlin, 564 A.2d 670, 673 (Del. Ch.1989); Youngman v. Tahmoush, 457 A.2d 376, 379 (Del. Ch.1983). As a fiduciary, the representative plaintiff “owes to those whose cause he advocates a duty of the finest loyalty.” Barbieri v. Swing–N–Slide Corp., 1996 WL 255907, at *5 (Del. Ch. May 7, 1996) (internal quotation marks omitted). [2012 WL 29340 at *8]

In practice, however, the real party in interest in shareholder litigation is the class counsel. It is the class counsell who really runs the show and upon whomn the class members really depend. In practice, the representative shareholder is simply the name on the lawsuit's title. See Bell Atlantic Corp. v. Bolger
2 F.3d 1304, 1309 n.8 (3d Cir 1993):

See Ralph K. Winter, Paying Lawyers, Empowering Prosecutors, and Protecting Managers: Raising the Cost of Capital in America, 42 Duke L.J. 945, 948 (1993) (in derivative actions, “plaintiffs are generally figureheads”); Jonathan R. Macey & Geoffrey P. Miller, The Plaintiffs' Attorney's Role in Class Action and Derivative Litigation: Economic Analysis and Recommendations for Reform, 58 U.Chi.L.Rev. 1, 3 (1991) (plaintiffs' class and derivative action attorneys “subject to only minimal monitoring by their ostensible ‘clients' who are either dispersed and disorganized (in the case of class litigation) or under the control of hostile forces (in the case of derivative litigation).”); Geoffrey P. Miller, Some Agency Problems in Settlement, 16 J.Legal Stud. 189, 190 (1987) (“the interests of plaintiff and attorney are never perfectly aligned”); John C. Coffee Jr., Understanding The Plaintiff's Attorney: The Implications of Economic Theory for Private Enforcement of Law Through Class and Derivative Actions, 86 Col.L.Rev. 669, 677-78 (1986) (in derivative and class actions client “generally has only a nominal stake in the outcome of litigation” and cannot closely monitor and control plaintiff's attorney's conduct); Daniel R. Fischel & Michael Bradley, The Role of Liability Rules and the Derivative Suit in Corporate Law: A Theoretical and Empirical Analysis, 71 Corn.L.Rev. 261, 271 & n. 26 (1986) (“real party in interest is the attorney”); Deborah L. Rhode, Class Conflicts in Class Actions, 34 Stan.L.Rev. 1183, 1203 (1982) (“as a practical matter, once a class is certified, named plaintiffs generally are neither highly motivated nor well situated to monitor the congruence between counsel's conduct and class preferences”) ....

Which suggests that the representative shareholder's discretionary authority may not rise to the level Chestman requires or that the other shareholders' dependency on the representative plaintiff rises to that level either.

I'm not saying that representative plainitffs ought to be allowed to trade on the basis of nonpublic information about the lawsuit. I'm just saying we don't need to make a federal case out of it. Before we do so there ought to be a meaningful showing under the Chestman standard, rather than just a label casually slapped on the relationship without a realistic examination of the relationship as it exists in the real world.

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[1] 947 F.2d 551, 567 (2d Cir. 1991) (citations omitted), cert. denied 503 U.S. 1004 (1992).

[2] Repeated disclosures of business secrets, however, could substitute for a factual finding of dependence and influence and, accordingly, sustain a finding that a fiduciary relationship existed in the case at bar. Chestman, 947 F.2d at 569. 

Obama supports STOCK Act

Politico:

“Send me a bill that bans insider trading by members of Congress and I will sign it tomorrow,” President Barack Obama said Tuesday night, to applause.

OTOH, so what? Did anybody think he'd veto it? OTOH, give him credit for being on the right side of the issue while GOP Congressional old bulls like Eric Cantor likely still hope to kill it.