Cashing in on capitol hill: insider trading and the use of political intelligence for profit.

• Author: Jerke, Bud W.

Government officials have recently been scrutinized for using information acquired in the performance of their official duties to gain market-trading advantages. Lobbyists have similarly been criticized for collecting material non-public political information from Capitol Hill contacts and selling it to their clients--notably hedge funds--who presumably use the information in their market transactions. Is this insider trading? Most likely not. Should it be? A few members of Congress have responded by introducing legislation in the past three Congresses that would bring trading on this "political intelligence," by government insiders and outsiders, under the umbrella of the federal securities laws. Unsurprisingly, the legislation has failed to garner significant political support. But a renewed fervor for "cleaning up" Washington ushered in by the Obama Administration, coupled with the current economic crisis, has reinvigorated the campaign. The legislation was reintroduced and received a hearing in 2009. In addition, recent academic scholarship is now calling for the passage of this legislation in order to bring trading on political intelligence under the federal insider trading regime.

This Comment takes issue with the insider trading approach. It argues that the federal securities laws are an inappropriate and ineffective legal mechanism for remedying issues of political ethics. First, as it pertains to government insiders, this Comment recommends an ethics approach, such as mandatory blind trusts, to deal with financial conflicts of interest. Second, with gard to outside actors, such as lobbyists and hedge funds, it argues for public disclosure of political-intelligence gathering activities. This Comment argues against prohibiting trading on political intelligence by outside actors because these actors are merely the Washington equivalents of market analysts, whose information gathering functions are perfectly legitimate, if not desirable. Lastly, this Comment warns that insider trading regulation of political intelligence would have two distinct chilling effects: one on democratic process, by hampering dialogue between lawmakers and constituents, and another on market efficiency, by discouraging valuable information gathering.

INTRODUCTION I. TRADING ON POLITICAL INTELLIGENCE A. Government Insiders: Elected Officials and Capitol Hill Staffers 1. Prevalence of Trading by Government Insiders 2. Current Laws and Ethics Rules Affecting Government Insiders' Trading Practices B. Outside Actors: K Street Lobbyists and Wall Street Funds 1. The Rise of Political-Intelligence Gathering 2. Current Laws Affecting Political-Intelligence Gathering II. ANALYSIS UNDER THE CURRENT FEDERAL SECURITIES LAWS A. Current Law and Doctrine. 1. Classic Insider Trading: The Disclose-or-Abstain Rule 2. Tipper/Tippee Liability 3. Misappropriation Theory B. Application to Political Intelligence 1. Government Insiders 2. Outside Actors 3. Conclusion III. LEGISLATIVE PROPOSALS IN THE U.S. CONGRESS AND COMPARATIVE ANALYSIS OF U.K. INSIDER TRADING LAW A. Recent Legislative Proposals Considered by the U.S. Congress 1. Stop Trading on Congressional Knowledge Act 2. Political Intelligence Disclosure Act B. Insider Trading Law in the United Kingdom IV. SHOULD THE UNITED STATES ADOPT A DEFINITION OF INSIDER TRADING THAT INCLUDES TRADING ON POLITICAL INTELLIGENCE? A. Fairness B. Economic Justifications for Prohibiting Insider Trading 1. Injury to Investors 2. Injury to Issuers 3. Property Rights 4. Corporate Governance and Moral Hazard C. Fundamental Goal: Financial Market Integrity V. ANALYSIS AND PROPOSALS A. Nature and Characteristics of Political Intelligence 1. Government Insiders 2. Outside Actors B. Proposals 1. Blind Trusts: An Ethics Approach to Regulating Trading by Members of Congress and Selected Staff 2. Disclosure by Outside Actors: Shining Light on Political-Intelligence Activities C. Chilling Effects 1. Don't Make It a Crime to Write My Congressman 2. Don't Discourage Market Efficiency CONCLUSION INTRODUCTION

On Tuesday, November 15, 2005, day traders grew perplexed by irregular price fluctuations in USG Corporation's stock. (1) USG stock was trading at double its normal volume and gained $2.12 to close at $61.55. (2) USG was not alone. W.R. Grace and Crown Holdings--companies like USG that had used asbestos materials in manufacturing and that had been mired in litigation for years--experienced similar irregular gains. (3) At the same time, stock prices of peer companies in the same sector remained flat, as did the market as a whole. (4)

The following day, Senate Majority Leader Bill Frist delivered news promising a full Senate vote on a bill that would create a $140 billion government-backed trust fund for liability claims against asbestos-using manufacturers. (5) The announcement marked a great advance for the legislation, which had been on Congress's agenda for four years and had previously made little progress. (6) A full Senate vote was welcomed by shareholders of affected companies, as asbestos-related litigation had plagued hundreds of companies that had once used asbestos in their manufactured goods. (7) The legislation therefore had broad market implications for affected companies. One Washington lobbyist noted that "[e]very advancement or setback and every hint of activity on the bill had a direct impact on this small but well-defined group of companies." (8) To demonstrate the market effects of an asbestos-liability trust fund, when the Senate Judiciary Committee gave its approval to a similar bill in 2003, USG's share price immediately rose by 8.3%, W.R. Grace's by 7.9%, and Georgia-Pacific's by 9.2%. (9)

Senator Frist's announcement, coupled with the irregular trading that had preceded it, drew suspicion. (10) Senator Frist, who as Majority Leader had discretion to schedule full Senate votes, had been careful to keep his intentions quiet. (11) Nevertheless, in the two days prior to the public announcement, share prices of USG increased 5.4%, W.R. Grace jumped 4.2%, and Crown Holdings grew by 3.2%. (12) The positive market reaction to the trust-fund approval by the Senate Judiciary Committee in 2003 indicated that the market would react positively again this time. (13) But this time the bounce occurred prior to the public announcement.

The legislation eventually died the following February when it failed to receive the sixty-member vote needed "to waive a budget objection raised about the legislation." (14) The episode, however, left many questions surrounding the irregular trading that occurred prior to the official announcement of the full Senate vote: How did material nonpublic political information find its way to the market? Through whose lips did the information pass? And for whose benefit?

The asbestos-announcement leak has been credited to the discreet and virtually unknown Washington practice of "political intelligence" gathering. (15) Fueled primarily by hedge funds, K Street lobbyists (including lawyer-lobbyists at several prominent law firms) have cultivated the lucrative niche of ferreting out little-known political information and funneling it to Wall Street They translate political knowledge into economic profit. (16) As just demonstrated, when political intelligence signaled that companies bogged down by asbestos litigation might be salvaged through a trust fund, their market value instantly rose. (17)

U.S. federal securities laws police abusive insider trading practices that threaten the integrity of the financial markets. Corporate insiders who possess material nonpublic information about their firms are precluded from trading in their companies' securities based on that information. (18) In many instances, outsiders who receive inside "tips" are similarly precluded.

In recent years, the investment behavior of elected public officials has received scrutiny. (19) Additionally, the practice of political outsiders acquiring material nonpublic political information from Capitol Hill insiders has received a great deal of publicity. (20) Hedge funds employ Washington lobbyists to gather political intelligence that is then presumably relied upon in making investment decisions.

Are government insiders who trade on material nonpublic political information violating insider trading laws? And are outsiders who trade on advance political knowledge gathered by highly paid lobbyists similarly in violation of U.S. securities laws? If not, should they be?

This Comment explores the relevance and application of the federal securities laws to the trading practices of actors who are privy to material nonpublic political information--i.e., political intelligence. These actors include (1) "government insiders," (21) such as politicians and their staff members who have direct access to inside political information, (22) and (2) outside actors, such as lobbyists and investment funds who receive political intelligence indirectly.

The contemporary literature dealing with government insider trading is relatively sparse. Several scholars--at different times and on different theories--have argued that insider trading doctrine supports liability for government officials who trade on inside political information. (23) Others disagree and advocate a legislative solution. (24) While divided on approach, this literature shares a common desire to bring trading on political information by government insiders under the umbrella of the federal securities laws.

This Comment takes issue with regulating political intelligence through federal securities law. First, it challenges the literature's assumption that insider trading law should regulate government insiders' use of political intelligence. Second, it extends the debate beyond government insiders and considers the application of insider trading liability to outside actors who trade on political information, a topic that has not yet been addressed and that has...