Insider trading is a key enforcement priority for the SEC and the DOJ. Now however it has become a populist issue centered on members of congress. There have been repeated reports of Congressional members raking in huge profits by using information they obtain through their office to trade in the securities markets. Those stories of course have sparked cries for legislation to prohibit members of Congress from insider trading. Legislation has been drafted and hearings are being held.
While there has not been a case brought against a member of Congress for using information learned during the legislative process, that does not mean members are somehow exempt from the insider trading laws. There is nothing in Exchange Act Section 10(b), the predicate for most insider trading cases, or the case law which developed alternate theories known as the “classic theory” or the “misappropriation theory,” which suggests that members of congress are not subject to prosecution on these theories. Stated differently, there is no reason to believe members of Congress are exempt.
SEC Enforcement Director Robert Khuzami made it clear in testimony before the House Committee on Financial Services on December 6, 2011 that Congressional members are not exempt: “[T]rading by Congressional Members or their staffs is not exempt from the federal securities laws, including the insider trading prohibitions.” Testimony by Robert Khuzami, Director, Division of Enforcement, SEC, on H.R. 1148, the Stop Trading on Congressional Knowledge Act.”
The principles which govern a possible insider trading case against a member of Congress or their staff member are the same as in any other case, according to the Director. At the same time, such a prosecution would have unique challenges. First there is the question of duty which is typically at the core of any insider trading case. For members of Congress there is no case law which discusses the duty of a member with respect to trading on the basis of information learned in an official capacity. There is however case law which notes in other contexts that members have a fiduciary relation with the United States. Commentators differ on whether trading while in possession of information learned in an official capacity breaches that duty. For staff members in, contrast, the question is more straight forward, the Director noted. They have a duty to their employer.
Second, the question of materiality would have to be considered. The analysis here is the same mixed question of fact and law which must be analyzed in any other case. In some instances this question may be clear. In others the materiality of the information may be more questionable.
Finally, the information must be nonpublic. Here the question “would likely depend on the circumstances under which the Member or staff learned the information and the extent to which the information had been disseminated to the public,” Mr. Khuzami told the Committee. Again the issue does not significantly differ from what is considered in other cases.
The Director cautioned however, that insider trading investigations involving members or their staff could pose unique issues. Those might in part arise from the Constitutional privilege afforded to members under the speech and debate clause. That clause is intended to ensure wide freedom of speech, debate and deliberation. In this regard there may be instances in which the privilege covers communications of nonpublic information regarding legislative activity. Overall however, the principles which govern the investigation of congressional members and their staff are the same as those which apply in other contexts.
Mr. Khuzami concluded his testimony with a note of caution: “Any statutory changes in this area should be carefully calibrated to ensure that they do not narrow current law and thereby make it more difficult to bring future insider trading actions against individuals outside of Congress.”
The principles which govern insider trading investigations of members and their staff may be the same as for anyone else. Draft legislation on this subject is being considered. It remains to be seen if the first case will be brought or the legislation will be passed.