From the WSJ:
At least 72 aides on both sides of the aisle traded shares of companies that their bosses help oversee, according to a Wall Street Journal analysis of more than 3,000 disclosure forms covering trading activity by Capitol Hill staffers for 2008 and 2009. ...
The Journal analysis showed that an aide to a Republican member of the Senate Banking Committee bought Bank of America Corp. stock before results of last year's government stress tests eased investor concerns about the health of the banking industry. A top aide to the House Speaker profited by trading shares of Freddie Mac and Fannie Mae in a brokerage account with her husband two days before the government authorized emergency funding for the companies. Another aide to Republican lawmakers interested in energy issues, among other things, profited by trading in several renewable-energy firms.
The aides identified by the Journal say they didn't profit by making trades based on any information gathered in the halls of Congress. Even if they had done so, it would be legal, because insider-trading laws don't apply to Congress.
The reporters who wrote the story are wrong about the insider trading laws. I addressed these issues in my article Insider Trading Inside the Beltway:
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.
While members of Congress probably are not covered by existing insider trading laws, their staffers are covered by those laws. In the article, I explain that:
In United States v. Newman, … employees of an investment bank misappropriated confidential information concerning proposed mergers involving clients of the firm. … The Newman defendants’ employers worked for prospective acquiring companies, while the trading took place in target company securities. As such, the Newman defendants owed no fiduciary duties to the investors with whom they traded.
In upholding the Newman defendant’s convictions, the Second Circuit … 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.
In U.S. v. O’Hagan, the Supreme Court … endorsed the misappropriation theory as a valid basis for insider trading liability…. As defined by the court, the misappropriation theory … holds that a fiduciary’s undisclosed use of information belonging to his principal, without disclosure of such use to the principal, for personal gain constitutes fraud in connection with the purchase or sale of a security and thus violates Rule 10b-5.
The Court acknowledged that misappropriators have no disclosure obligation running to the persons with whom they trade. 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.” 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.” 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.
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, … 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 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.” 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 confidence with the government. 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.” 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. 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.” 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, 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.” 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].”
The Congressional staffers whose trading activity was discovered by the Journal thus are potentially liable for their trading activity, assuming the other elements of the crime can be made out. The key point is that the staffers have no blanket immunity from those laws in the way that members of Congress do. The problem is that the gutless SEC has been even less willing to go after staffers than it was to go after, say, Madoff for all those years.
Anyway, check out the Journal article for tons of tawdry financial details. It's appalling what those folks in DC get up to, especially when most of them spend so much of their time demonizing business.
