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Cornell’s Legal Information Institute defines insider trading as “the trading of a company’s securities by individuals with access to confidential or material nonpublic information about the company.” Insider trading is identified and prosecuted under the Securities Exchange Act of 1934, Rule 10b-5 and U.S. v. O’Hagan, 512 U.S. 642 (1997), which establishes the concepts of the classical theory of insider trading and the misappropriation theory of insider trading. While these rules evidently applied to the general public, there were questions as to whether or not and to what extent these provisions applied to members of Congress, their staff, and their families.
After years of insider trading allegations against congressional members, and in an effort to make congressional stock trading more transparent, the STOCK Act, or the Stop Trading on Congressional Knowledge Act of 2012 was passed. The STOCK Act formally established that congressional members and employees are bound by laws regarding insider trading along with the Securities Exchange Act of 1934 and Rule 10b-5 which establishes that “it shall be unlawful for any person . . . (a) [t]o employ any device, scheme, or artifice to defraud, (b) [t]o make any untrue statement of a material fact or to omit to state a material fact . . . 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.” Additionally, the STOCK Act strikingly amended the Securities Exchange Act of 1934 explicitly stating that congressional members and employees “owe a duty arising from a relationship of trust and confidence to Congress, the U.S. government, and U.S. citizens with respect to material nonpublic information derived from their positions as Members or congressional employees or gained from performance of the individual’s official responsibilities.” Section 6 of the act establishes specific provisions which include that after being notified of an exchange of securities exceeding the amount of $1,000, the individual is given 35 to 40 days to report it.
The STOCK Act was intended to help restore the public’s belief in Congress, particularly during a time in which the vast majority of the public held a strong distrust for Congress. In addition, a problem seen with both regular insider trading and congressional insider trading was that the legitimacy and confidence in the stock market were at risk. Distrust in the stock market causes fewer ordinary people to invest, leading to less corporate funding and contributing to a decay in market efficiency.
Despite the passage of the STOCK Act, there have been several instances of congressional insider trading, notably and more recently occurring with the onset of the COVID-19 pandemic. Several congressional members had been briefed or received information about the COVID-19 pandemic before the severity of the situation had reached the rest of the general public. Many members took this opportunity to adjust and sell their financial securities prior to the stock market crash in 2020. Several other congressional representatives have been reported to engage in insider trading since then. However, no member of congress has been formally prosecuted or disciplined under the STOCK Act. In the past, if a congressional member was caught violating this act they were only required to pay a small fee, but more often than not these fees were waived. For these reasons, the STOCK Act and its effectiveness have been under scrutiny, and questions about its enforceability have been raised.
One of the many reasons that no member of Congress has been prosecuted under the STOCK Act is due to the roadblocks encountered in proving the occurrence of a violation. This requires the prosecution to prove “that the nonpublic information acted upon was derived from the member’s position, much of which can be shielded from investigators.” Efforts to demonstrate this are limited due to the nature of the information and the protections granted to legislators by the U.S. Constitution.
The first of these protections is the Speech or Debate Clause found in Article 1, Section 6 of the U.S. Constitution, and the second is the Confidential Information Procedures Act. The Speech or Debate Clause protects legislators from being implicated in lawsuits relating to specific legislative activities. The extent of these legislative activities has been narrowed down by the courts throughout the years, however, the applicability of it in the case of insider trading is more encompassing. Since insider information that is obtained by congressmen is produced in formal committee briefings, these typically fall under the jurisdiction of the Speech or Debate Clause and are protected from being used against them. Therefore, the evidence that could be used by prosecutors to either proceed in the case or indict the person is likely not viable, thus, impeding prosecutors from getting the case off the ground.
The second obstruction is the Confidential Information Procedures Act which establishes protocols for cases involving confidential information. Since the information involved in insider trading is often confidential, it is not available for public discernment. This poses two different problems. Not only is the information that the prosecution must provide as evidence classified, but the information that the defendant provides to put that evidence into context may be classified as well. If this is the case, the CIPA necessitates that prior to being able to bring the case to trial, there would have to be a pretrial to determine the admissibility of evidence. If the evidence is not admissible or the court will not allow an unclassified summary of the confidential information, the government must weigh the impact of disclosing this classified information with their ability to prosecute the defendant. In either case, this slows the proceedings and forces prosecutors to reconsider the merits of the case.
Due to the notable challenges of prosecuting under the STOCK Act and recurring incidents of insider trading in Congress, there has been a bipartisan effort to pass the Ban Congressional Stock Trading Act. This act seeks to prohibit members of Congress and their staff from trading securities while in office and for a period of time after they have left their position. However, members and their staff would be allowed to invest in instruments like diversified mutual funds which are widely held, as well as other blind trusts. These blind trusts include funds in which the investor gives another party control over the trust. There is quite a bit of support for this act, however, there were over a dozen representatives who voted against the bill in the House and argued that there are better solutions and that the act would discourage people from running for office.
On either side of this argument, the detriment that insider trading has on the legitimacy and validity of the stock market, as well as on Congress is made clear. Without proper provisions that effectively target insider trading, the public’s trust in Congress will diminish and its legitimacy will wane. In terms of the stock market, if the public limits its investment in securities, corporations that receive much of its capital will incur losses and the market’s function will be greatly inhibited. Ultimately, these institutions are successful because of the power the people give them, and without it, they would become obsolete.