Under the insider trading laws that apply to Congress, legal liability is hard to prove and convictions are even harder to place; this should not sit well with the American people.
Therefore, it should come as no surprise to the American people that multiple Senators have been accused of insider trading for trading hundreds of thousands of dollars in stock–based upon information they likely learned through their positions in Congress. Take the example of Senator Perdue. In his six years in office, Senator Perdue had been considered a master trader, sometimes reporting twenty or more transactions in a single day. This pattern of trading might be of no consequence for an average broker trading on the markets. It raises suspicion, however, when the trader is a member of Congress, especially considering that many of his recent trades were made while he possessed confidential COVID-19 information.
Overall, Senator Purdue made a total of 2,596 trades during his six-year term. Notably, some of the industries in which he traded fell within the jurisdiction of his Senate committees. Examples include buying and selling stocks of cybersecurity company FireEye while sitting on the Cybersecurity Subcommittee, trading stocks of banking companies like JP Morgan and Bank of America while sitting on the Senate Banking Committee, and trading on several pandemic-related stocks like Pfizer.
Senator Perdue’s trading activities, and the scandal garnered, begged the question: Is there any way to hold members of Congress accountable for trading on information they gain through their positions in Congress? Unfortunately, the answer is “not really.”
In 2012, President Obama signed into law the Stop Trading on Congressional Knowledge (STOCK) Act, which prevents members of Congress from trading stocks based on nonpublic information they have obtained by virtue of holding their office. It is, however, a somewhat impotent provision; no member of Congress has ever been successfully prosecuted under the Act. This evasion of liability under the STOCK Act is likely because members of Congress can claim their trades are either based upon public knowledge or that their trading portfolios are managed by independent trusts.
Another potential source of liability for members of Congress is the prohibition against insider trading within companies found in the SEC’s Rule 10b-5. Under the classical interpretation of this Rule, an insider may not trade upon “material” nonpublic information, nor can he “tip” the information to another person who trades on the inside information, provided the insider receives some quid pro quo for the tip. This classical theory of insider trading required that the source of the information be an insider of the company in which stock was traded.
In 1998, another theory not only expanded the scope of insider trading liability but expanded the scope of events that fall within Rule 10b-5. The misappropriation theory established that insider trading occurs when someone learns material non-public information, violates the duty of confidentiality to the source of the information, and then trades upon that information. The duty to refrain from trading on the information is premised upon the presence of any fiduciary or fiduciary-type relationship between the trader and the source of the information. The misappropriation theory initially was hotly debated because the source of information can be a “non-insider” of the company in which the stock is traded. However, the theory was solidified into law by the 1998 Supreme Court opinion United States v. O’Hagan.
Misappropriation theory, however, has proved to be similarly ineffective for holding members of Congress liable for insider trading. While the STOCK Act may have created a duty of “trust and confidence” required by members of Congress to the American people, other elements of insider trading under the misappropriation theory are often harder to prove. This difficulty was detailed in a March 2020 article noting prosecutors must determine whether the information congressional members were trading on was nonpublic, material, and whether the trades by congressional members truly were based on the information received in confidence.
Therefore, the misappropriation theory requires the SEC or DOJ to demonstrate concretely the presence of duty, potentially rooted in the STOCK Act, while simultaneously establishing that non-public information obtained by, and traded upon, by members of Congress was made available to them solely through their congressional positions.
Senator Perdue’s case demonstrates the inefficacies of these laws. Senator Perdue had a duty of trust and confidence to Congress and the congressional committees upon which he served. Although it has not been determined by any court of law, the information surrounding his case raises suspicion that Senator Perdue breached that duty of confidence by trading on information he acquired from sitting on those congressional committees. Unfortunately, both the DOJ and the SEC completed individual investigations into Senator Perdue’s trades and decided not to pursue charges. The specific reasons as to why charges were not pursued remain unclear, as neither the DOJ nor the SEC has provided commentary. Thus, the STOCK Act and securities law failed to hold Senator Perdue accountable, despite the mountain of evidence that points to wrongdoing. Another notable example of a congressional member skating away from securities liability is Senator Richard Burr, who most recently had his insider trading investigation dropped by the DOJ as well.
The very fact that securities law and the STOCK Act have failed to curb congressional trading is a flaw within the system itself. The idea that the American people once again must be comfortable with the thought that their members of Congress may be gaining millions while they struggle, especially during the current pandemic, is a glaring infection that continues to plague government and markets. The fact that neither the DOJ nor the SEC was able to take action against Senators whose activities strongly indicate they were trading on inside information gained by virtue of their positions, signifies a need for clearer guidelines within Congress. More importantly, it calls for stricter laws prohibiting insider trading that specifically targets members of Congress.
Academics, practitioners, and regulators have acknowledged this institutional flaw that allows Congressional members to evade insider trading liability. For example, Professor Greg Shill highlighted that enforcement agencies are unable to bring cases under certain federal laws. These shortcomings often leave only the U.S Attorney’s Office with the power to enforce insider trading law. Given that most of those offices are held by appointees of the Executive’s political party, Shill argues that prosecution of same-party officeholders might be chilled given the hyper-partisan political culture we find ourselves in.
Likewise, prominent scholars Richard Painter and Donna Nagy have argued for legislation that would ban members of Congress from owning publicly traded securities while in office. This may ruffle the feathers of a few corporate heavy-hitters that have established a long-term presence on the Hill, as well as new recruits, as some have noted that restriction may have the effect of deterring people from running or holding office. These concerns should not be given any credence. To establish clear and uncompromising standards for financial trading, the tree must be shaken for the foul fruit to drop.
Most recently, a bipartisan bill, the Ban Conflicted Trading Act, has been introduced in the House of Representatives and the Senate by Senators Jeff Merkley, Sherrod Brown, and Raphael Warnock. The bill would bar members of Congress, and their senior staffers, from buying or selling individual stocks and other investments, as well as serving on corporate boards while in office. The bill would impose stricter restrictions than the STOCK Act and is directly targeted at curbing congressmen from trading on information they have gained by virtue of their office. Time will only tell if this bill will not only be passed or if it will be effective in stopping members of Congress from buying and selling stocks for personal gain.
Legislation like the Ban Conflicted Trading Act needs to be passed as members of Congress must be held accountable for their personal portfolios and trades while holding office. Stringent prohibitions should be established legislatively, with enforcement remedies available to government agencies like the DOJ and SEC. Until that happens, Americans must use their voting power to both demand a strict prohibition on trades and remove corrupt opportunists from elected office.
Once a member of Congress has shown they may be benefitting from information gained by their office to trade in securities, that information must be flagged and publicized. This unethical trading activity should be relatively easy to spot since all congressional members are required to log and disclose all of their stocks and trades. Suspicious activity can be easily recognized when members of Congress are trading in stocks that their particular committee oversees or are actively advocating for legislation to benefit a company under the supervision of their committee. This is the information that needs to be broadcast to the American public, so we can be informed voters and active watchdogs when it comes to our representatives.
Those in Congress that believe they are immune from securities law need a wake-up call that, eventually, actions have consequences, and sooner or later, the American people will get the accountability they deserve. Over 200 years ago, our Founders solidified this idea into one of our country’s most symbolic documents when they wrote, “That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it . . . .” It is now up to us to follow through.
Karen E. Woody is an Associate Professor at Washington & Lee University School of Law. Senuri Rauf is a law student at Washington & Lee University School of Law.