THE STOCK ACT TEN YEARS LATER: THE NEED FOR A NEW CONGRESSIONAL INSIDER TRADING REGULATORY SCHEME.

• Author: Krueger, Andrew
• Position: Proposed Stop Trading on Congressional Knowledge Act of 2011

ABSTRACT

A recent Pew Research poll indicated only 20% of Americans trust the federal government to "do the right thing." (1) Although falling trust in government began in the mid-1960s and must be attributed to many factors, (2) a belief that members of Congress ("Members") exploit their access to confidential information in order to enrich themselves certainly cannot help alleviate this distrust. The recent 2020 congressional insider trading scandal, where senators traded securities after attending a private briefing about the likely effects the coronavirus would have on the United States economy, is a prime example of a way Members may potentially misuse their access to nonpublic information. As of the date of this Note's publication, none of these senators have been charged with violating federal securities laws. This is despite the existence of the STOCK Act, a law which explicitly extended the federal securities laws' insider trading prohibition to members of Congress.

Part I of this Note provides a brief outline of insider trading law in the United States. Part II discusses congressional insider trading, the STOCK Act, and analyzes why investigators likely have struggled to prove Members have violated it. Part III then examines proposed legislation which would restrict Members' ability to trade securities and ultimately rejects this legislation in favor of supplementing the STOCK Act with a regulatory model based on the Rule 10b5-1 plans often used by corporate insiders.

INTRODUCTION

Suspicion of insider trading in Congress is nothing new; one well-known study indicated a group of senators' securities portfolios beat the market by roughly ten percent per year over a five-year period. (3) In 2012, due to the seeming incoherency of insider trading law, (4) and uncertainty as to whether it was unlawful for members of Congress to trade securities on the basis of material, nonpublic information learned from their positions, (5) Congress passed the STOCK Act to clarify such trading would be unlawful. (6)

Despite good intentions, even those who helped write the STOCK Act have criticized it. (7) Since its enactment, the Department of Justice (DOJ) and U.S. Securities and Exchange Commission (SEC) have never charged a member of Congress with insider trading in violation of the STOCK Act. (8) This is despite the fact that there have been several instances of suspicious trading by members of Congress. (9) The evidentiary obstacle posed by the Constitution's Speech or Debate Clause is likely a driving force behind this investigative passivity. (10)

Still, frustration with the perception of congressional insider trading has led lawmakers to introduce a new bill which would, among other things, (11) combat the suspicion of insider trading by members of Congress by prohibiting Members from owning the stock of individual companies unless in a qualified blind trust. (12) Although well intentioned, this Note will ultimately reject this proposed regulatory framework because it is overinclusive and underinclusive in how it restricts and permits securities trading by Members. (13) Moreover, the bill's proposed enforcement structure would likely prove inadequate. (14) Rather, this Note argues a regulatory scheme modeled after Rule 10b5-1 plans would be a more effective and politically-feasible model for regulating securities trading by members of Congress. (15)

1. Federal Insider Trading Law in the United States A. Textual Basis

   In the United States, no federal statute explicitly prohibits insider trading.16 In fact, though some statutes touch on insider trading indirectly17 or in a limited fashion, (18) the federal securities laws do not even define the offense of insider trading. (19) Insider trading is commonly understood to "involvef] trading in a public company's stock by someone who has nonpublic, material information about that stock for any reason." (20) Though partially correct, the equality of access to information rationale undergirding this definition has been explicitly rejected by the Supreme Court. (21) Many people then may be surprised to learn that, in the United States, "insider trading liability is based on breaches of fiduciary duty, not on informational asymmetries." (22) To understand why breaches of fiduciary duty play such an important role in insider trading liability, one must first understand insider trading's statutory basis. (23)

   The doctrine of insider trading law has developed through judicial interpretations of [section] 10(b) of the Securities Exchange Act of 1934 (24) ("[section] 10(b)" or "Section 10(b)") and Rule 10b-5 (25) promulgated thereunder. (26) Section 10(b) states it shall be unlawful, by the use of any means or instrumentality of interstate commerce, the mails, or of any facility of any national securities exchange to:

   [U]se or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors. (27) Pursuant to this rulemaking authority, the SEC in 1942 adopted Rule 10b-5. (28) Rule 10b-5 makes it unlawful for a person, intentionally or recklessly, (29) by the use of any means or instrumentality of interstate commerce, the mails, or of any facility of any national securities exchange:

   (

   1. To employ any device, scheme, or artifice to defraud,

   (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

   (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security. (30)

   Only through various SEC administrative actions and judicial opinions did insider trading come to qualify as a "deceptive device" under [section] 10(b), (31) and a "device, scheme, or artifice to defraud" as well as an "act, practice, or course of business which operates ... as a fraud or deceit" under Rule 10b5. (32) Insider traders may face civil and criminal liability for violating [section] 10(b) and Rule 10b-5. (33)

   2. Theories of Insider Trading Liability

   The Supreme Court has recognized two forms of insider trading liability: the "classical" or "traditional" theory and the "misappropriation" theory. (34) The Court views these theories as complementary, with "each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities." (35) Under both theories, the crucial element in determining whether a person's trading on the basis of nonpublic information violates [section] 10(b) and Rule 10b-5 is whether the person's silence regarding their informational advantage can be characterized as fraudulent or deceptive. (36) This element has led to fiduciary duties taking center stage in the doctrine of insider trading. (37)

   1. The Classical Theory

   Under the classical theory, [section] 10(b) and Rule 10b-5 are violated when "a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information." (38) Such trading violates [section] 10(b) and Rule 10b-5 only because a "relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation." (39) As Justice Powell reasoned, trading by an insider in this situation, without first disclosing the material, nonpublic information, is fraudulent because at common law, "one who fails to disclose material information prior to the consummation of a transaction commits fraud ... when he is under a duty to [disclose the information]." (40) And, at common law, a duty to disclose arose "when one party ha[d] information 'that the other [party] [was] entitled to know because of a fiduciary or other similar relation of trust and confidence between them.'" (41) Thus, because corporate insiders owe both fiduciary duties and duties of trust and confidence to shareholders of their corporation, a duty to disclose material, nonpublic information to these shareholders or abstain from trading with them arises. (42)

   Officers and directors of a corporation are the typical "corporate insiders." (43) However, under certain circumstances, "outsiders" such as underwriters, accountants, or lawyers may become fiduciaries of a corporation's shareholders. (44) These types of people are commonly referred to as "constructive insiders." (45) The grounds for recognizing the fiduciary duty which renders someone a constructive insider is that "they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes." (46) Indeed, the Court has stated that for such a duty to be imposed "the corporation must expect the outsider to keep the disclosed nonpublic information confidential, and the relationship at least must imply such a duty." (47)

   2. The Misappropriation Theory

   Under the misappropriation theory, a person commits fraud in connection with the purchase or sale of securities, in violation of [section] 10(b) and Rule 10b-5, when "he misappropriates [material] confidential information for securities trading purposes, in breach of a duty owed to the source of the information." (48) The misappropriation theory reasons 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." (49) Thus, in dicta in United States v. O 'Hagan...