Q: I am the chief of staff for a Member of the House with a question about the new law against insider trading by Members and staffers. I used to work in the private sector at a Fortune 500 company, and I remember a big focus on compliance with insider trading laws. We had a company policy, and many employees received frequent training. Now that Members and staffers will be subject to insider trading laws, do Congressional offices need similar policies and training?
A: The Stop Trading on Congressional Knowledge Act, passed by Congress last week, has been described as a new prohibition on insider trading by Members and staffers. President Barack Obama stated, “After I sign this bill into law, Members of Congress will not be able to trade stocks based on nonpublic information they gleaned on Capitol Hill.”
But some have questioned how much the act really changes. Some legal scholars believe that pre-existing federal insider trading laws already applied to Members and staffers. Others have suggested that those laws might have somehow exempted Members and staffers. Whoever is right, passage of the STOCK Act removes any doubt over whether Members and staffers should be concerned about insider trading.
In general, pre-existing federal law prohibited what the Securities and Exchange Commission calls “illegal insider trading.” This, the SEC says, means buying or selling a stock “in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information” about the stock. In short, you may not trade stocks on the basis of material, nonpublic information that you receive from someone to whom you owe a duty of confidentiality.
The federal government spends a great deal of time investigating potential violations of insider trading laws. These investigations often begin after the government learns that a company’s senior employees have bought or sold shares of the company’s own stock shortly before publication of significant news about the company. Such trades can raise the eyebrows of government officials, which can lead to investigations.
This is significant not only because of the stiff penalties for illegal insider trading but because investigations themselves are costly. Even where the timing of trades of company stock in relation to the publication of company news is purely coincidental, employees and companies can still face investigations and are often forced to devote significant funds and resources to responding. Companies under investigation typically must provide the government with all documents relating in any way to the investigation. Identifying responsive documents often requires long hours by expensive attorneys who specialize in such investigations.
To reduce the likelihood of such an investigation, many companies have insider trading policies restricting the extent and timing of employees’ trading of company stock. For example, many companies prohibit employees from trading company stock altogether other than during certain safe “windows” that are established with help from company legal counsel.
The STOCK Act directs the SEC to make a rule prohibiting Members and staffers from buying or selling a company’s stock while in possession of material nonpublic information about prospective legislative action relating to the company obtained by reason of being a Member or staffer. This raises all sorts of tricky compliance questions.
For one, what counts as material information about a company’s stock? To be material, must the information specifically relate to the company? Or, can general information about legislative action affecting a company’s entire industry be sufficient?
Sen. Scott Brown (R-Mass.), one of the act’s sponsors, appears to believe the latter is the case. “A Member of Congress hears during a meeting that a program is going to be cut the next day,” Brown said in Senate testimony last year. “That Member could then sell his or her stock in that sector and score a profit — or avoid losses — when the news breaks.” The act, Brown suggests, would make this illegal.
But, what does it mean for a company to be in a certain sector? And, what about companies that are not in that sector but in a related sector whose businesses might indirectly benefit from the cutting of the program? Would Members and staffers be prevented from trading those companies’ stocks as well? It is not an overstatement to say that every piece of proposed legislative action affects at least some businesses in some way.
Further complicating the materiality issue is how likely legislative action must be for knowledge of that action to qualify as material. Suppose, as chief of staff for a Member, you learn that your Member is considering introducing legislation that, if passed, would negatively affect a company whose stock you own? Would that knowledge alone mean that you should not sell your shares of that company’s stock?
The difficulty of answering questions like these means that compliance with the STOCK Act will not be easy. As you point out, many companies take a proactive approach to compliance by designing and implementing insider trading policies and also training employees. Congressional offices might be wise to do the same.
C. Simon Davidson is a partner with the law firm McGuireWoods. Click here to submit questions. Readers should not treat his column as legal advice. Questions do not create an attorney-client relationship.