The STOCK Act in the “Post-Newman” Era - Stop Trading on Congressional Knowledge Act
Political Intelligence Firms Grapple with Insider Trading in the Public Arena
On April 4, 2012, Congress enacted the Stop Trading on Congressional Knowledge Act (the STOCK Act), which explicitly applies federal insider trading laws to Congressional members and staffers. These personnel had long been considered exempt from such laws because, theoretically, they had no duty to shareholders or a corporation; the STOCK Act clarifies that there is no such exemption, and also imposed additional financial disclosures from Congress and senior staff.2 Since the passage of the Act, Congresspersons and their staffers who receive material non-public information (MNPI) derived from their official positions and pass it along or trade on it for their personal benefit can be held liable under ordinary insider trading principles.
The application of insider trading concepts to the Congressional sphere raises a number of important issues unique to that realm:
What, exactly, is “non-public” information taken “in breach of a duty of trust or confidence,” in the inherently public (as opposed to private) sphere of elected officials?
What type of “benefit,” exactly, does the recent decision in United States v. Newman require be shown when the currency of trade in Congress differs so markedly from that in the private sphere?
The recent —and so far only —SEC investigation initiated under the Act provides an important case study for application of these principles. Even before Newman, the potential prosecution of insider trading charges against Congresspersons or their staffers was problematic; now, the challenges become even more pointed.
The STOCK Act and Application of Insider Trading of Political Intelligence
The STOCK Act Provisions and Insider Trading Principles
Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, 17 C.F.R. § 240.10b5, prohibit the purchase or sale of a security on the basis of MNPI in breach of a duty of trust or confidence. Liability arises for both the insider who breaches his fiduciary duty by trading on MNPI or disclosing it for his/her personal gain, as well as for any “tippee” who trades on MNPI provided by a tipper knowing that it had been disclosed in exchange for a personal benefit.
The STOCK Act specifically provides that “Members of Congress and employees of Congress are not exempt from the insider trading prohibitions arising under the securities laws, including section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.” Employees of Congress include any “officer or employee of the legislative branch.” The Act also makes clear that covered members and Congressional employees owe “a duty arising from a relationship of trust and confidence to Congress, the United States Government, and the citizens of the United States with respect to MNPI derived from such person’s position … or gained from the performance of such person’s official responsibilities.”2
Courts previously struggled with what exactly was required for a tippee in the private sphere to be liable for insider trading, i.e., does a tippee need to know the information is confidential or need to know the information was exchanged for a benefit — or both? However, in the landmark case United States v. Newman, the Second Circuit provided a simple answer which raised the bar for prosecutors: a tippee would only be liable if he or she knew “the information was confidential and divulged for personal benefit.” More to the point, the tipper must have breached a fiduciary or other duty of trust or confidence by disclosing MNPI in exchange for receiving a personal benefit “of some consequence”: such benefit would include, e.g., evidence “of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.”4 In response to Newman, Congress has introduced several bills which propose to broaden insider trading laws to prohibit almost any trading on confidential information. It remains to be seen whether any has much chance of passing; each, however, contains provisions that would likely create further confusion about what types of trading would violate the law.5
What, Exactly, is “Non-Public” Information in the Halls of Congress?
For both the potential tipper and tippee of government information, it is unclear what, exactly, qualifies as “non-public” information under the STOCK Act. While there are many variations on the theme, in the classic private-sector fact pattern a corporate insider uses confidential information to trade or disclose to others to do so in exchange for a return or other benefit; and often the only real issue is whether the information is “material.” For example, an employee cannot disclose —let alone trade on —a company’s expected quarterly earnings or internal sales data; indeed, most employees are prohibited from doing so under their company’s employee policies or by written contract.
Legislative information, however, is different: very little information is “non-public” in the traditional private industry sense. The “open secret” in Congress is that there are no secrets. In fact, Congressional representatives are expected to make their positions clear (often through staffers) and to inform the public how they intend to vote or whether they oppose certain legislation. Those in Congress are also encouraged to predict important outcomes, such as assuring constituents that a controversial bill will not become law. And, there is a great deal of pressure to get rid of “back-room decision-making” in favor of more transparent governing. Groups like Common Cause and other public advocacy organizations unofficially monitor government decision-making to hold officials accountable for their decisions, and to reveal the actual bases for and factors that influence those decisions.
There may also be a troubling and confusing overlap between the agencies or individuals covered by the STOCK Act and those that are also subject to Freedom of Information Act (FOIA) requests or open meeting laws. While FOIA and the open meeting laws do not apply to the legislative or judicial branches, Congress regularly receives and exchanges information with the executive branch and numerous federal agencies that are subject to FOIA. Theoretically, then, information could be “non-public” in the former world but subject to public disclosure in the latter. Insider trading laws are not easily suited to address such scenarios, where real-time, instantaneous trades could be based on information that will eventually be public but is either not public yet or is technically “public” but as a practical matter not accessible to the public on a real-time basis.6
Unfortunately, the STOCK Act and its legislative history provide little guidance regarding what information disseminated by Congressional personnel qualifies as “non-public.” The U.S. House of Representatives Committee on Ethics defines MNPI as “any information concerning a company, security, industry or economic sector, or real or personal property that is not available to the general public and which an investor would likely consider important in making an investment decision.”7 Senate ethics rules also define “material” as information a “reasonable investor would want to know when making an investment decision” and “non-public information” as “confidential or not widely disseminated to the public.8 Similarly, the Government Accountability Office (GAO) released a report in which it defined “non-public information” as “information that has not been disseminated to the general public or is not authorized to be made public.”9 These definitions, however, do little to shed more light on the topic. They fail, for example, to delineate what qualifies as information “not available to the general public”; what qualifies as “dissemination” – or even ”wide dissemination” for that matter – to the general public; or whether is it possible that information may be “authorized” to be made public but has not in fact been made so.10
The GAO report further noted that the issue gets particularly muddled when “semi-public” information is bundled with political and legal analysis and political strategies and forecasts, such as the type routinely rendered by political intelligence firms to institutional investors. In this regard, the intelligence is, at best, a mosaic of public and non-public information. And, the SEC has already said that financial analysts may act on nonmaterial non-public information even if it helps the analyst complete a “mosaic” of information that, taken together with public information, is material.11 The GAO also observed that in the political realm it may not always be possible to determine precisely when non-public information actually becomes “public.” The SEC has also acknowledged these same issues: at a panel discussion before the American Bar Association in 2013, Stephen Cohen of the SEC’s Division of Enforcement acknowledged that any future investigations under the STOCK Act will have to be very “fact-specific” because it is impossible to draw a bright line articulating only the appropriate uses of this political intelligence.12
Finally, the picture grows even more opaque when one considers the constitutional implications of the Act. From a First Amendment perspective, there are concerns about whether the Act will discourage communications between the general public and elected officials. Zealous enforcement of the Act, with so many unanswered questions surrounding the law’s reach or application, might well limit the information exchanged between these two groups. So, too, could enforcement of the Act threaten the protections afforded under the Constitution’s Speech or Debate clause, which prevents the government from using a Congress Member’s legislative acts to prove an element of a crime or otherwise obtaining documents pertaining to those legislative activities: both legislative activities and the related documents in many cases may provide the best and perhaps only proof of any wrongdoing under the Act.
Questions remain, then, about the impact of the Act on sharing information confidentially (as opposed to publicly) in the hopes of facilitating legislative progress. Do Congressional personnel risk insider trading liability simply by sharing information with others inside or outside of government in order to discharge their official duties? Do political insiders risk legal exposure by sharing information, even if they do so under tacit or explicit agreements to protect that information? Or does an agreement to maintain confidentiality insulate political insiders who share this information? Equally perplexing is how information that would otherwise be considered non-public in the legislative realm would be treated if it were eventually available via a FOIA request or a government meeting open to the public. Is it possible for this information to still be non-public, or can it then be shared for the purposes of trading? Finally, how is an investor to know when an investment tip is based on non-public government information?
What, Exactly, is “Personal Benefit” Under the STOCK Act?
It is also unclear what “benefit” a government tipper must receive to be liable for insider trading under the Act, particularly after Newman. The “mere fact of a friendship, particularly of a casual or social nature” is no longer enough13 in the private sphere, but “favors” in the political world can be an entirely different matter: the prototypical insider trading prosecution (of which there are many) involves some way to connect the trading to some benefit accruing to the tipper. While the “benefit” bar is now theoretically higher, it remains to be seen what type of personal (or political) consideration will be sufficient under the Act to qualify as something “similarly valuable” to money or another consequential benefit. Public servants typically do not get “paid” for disclosing information; they constantly trade in such favors, and may in fact see it as part of their job to exchange supposedly “confidential” information. Rightfully so. Finally, as discussed above, Congress has already proposed legislation in response to Newman that arguably eliminates the “benefit” requirement entirely, with the objective of eliminating confusion surrounding this issue. Instead, an entirely new set of enforcement concerns may arise.
The Humana Investigation
Because of its application to public officials, the STOCK Act poses new twists on insider trading theory which are not typically the focus of such prosecutions. A recent SEC investigation involving a tip by a Congressional staffer to a lobbyist for Humana, Inc. put many of these issues on stark display. In that investigation, the SEC alleged that the Staff Director of the Health Subcommittee for the House Ways and Means Committee tipped an attorney at Greenberg Traurig, LLP and a lobbyist for the insurance firm Humana, Inc., about an unexpected increase in Medicare reimbursements. The lawyer admitted having discussed this Medicaid Rate Announcement by the U.S. Centers for Medicare and Medicaid Services (“CMS”) with the Subcommittee staffer and then alerting an analyst, who in turn forwarded an alert to clients informing them of the increase 20 minutes before the market closed. The SEC maintains that the Congressional staffer’s “tip” constitutes MNPI because 1) it resulted in a sharp rise in share prices for several big insurance companies in the last 15 minutes of market trading after the alert went out, and 2) the “tip” happened before CMS released its final reimbursement rates 20 minutes after the close of trading that day. At the same time, there are myriad reasons why the information might otherwise have been considered “public” at the time the staffer supposedly shared it, such as if, for example, a political blog had already released the information based on other sources. It is also unclear what, if any, benefit the staffer received or expected to receive for sharing this intelligence. Nor so far is there any evidence that any of the potential tippees knew about this benefit or that the information was not yet public (both of which are now required under Newman).14
The passage of the STOCK Act has raised significant new questions that likely will remain unresolved for years. With little to no direction, the Act applies insider trading laws designed for the financial world, to the world of politics and government. In the age of social media, political blogs, and the twenty-four hour news cycle, it will be nearly impossible for anyone to know, with any degree of certainty, what categories or kind of information will be considered “non-public” under the law. Equally difficult will be assessing the difference between duty-based, genuine predictions (“I think this law will pass”) and actionable non-public information (“I know this law will pass”).
The challenges become magnified in the world of political intelligence. Given the way that political intelligence is packaged with industry research and policy data and analysis, it is unclear how the SEC will determine, much less prove, that a single piece of information in the mosaic of political intelligence is material – i.e., such that a reasonable investor could be expected to find the information important in making an investment decision. As discussed above, the Newman decision also has made the SEC’s job more challenging by raising the bar for what qualifies as a personal “benefit” for a government tipster.
Conclusions and Compliance Strategy
The exchange of inside information routinely is considered both a valuable and necessary commodity in the public sector, but those who invest based on political intelligence must now take precautions to avoid the inadvertent disclosure or misuse of MNPI. The safest course is to require that before any disclosure government officials and staff subject to the STOCK Act confirm the information in question is public and that it is being provided in their capacity as public servants, not private individuals who might receive some personal benefit from releasing the information. Any information shared must be independently evaluated based on the risks associated with use of that information, i.e., how valuable is the information and how confident is the trader that the information is not MNPI? Finally, political intelligence firms should consider adopting clear policies for presenting political rumors and legislative predictions, which could be based on MNPI and then recast as brilliant analysis; and financial institutions need to implement policies for how to treat such “rumors” and “predictions.”
1 Jack Maskell, The STOCK ACT, Insider Trading, and Public Financial Reporting by Federal Officials, Congressional Research Service (April 18, 2013), http://fas.org/sgp/crs/misc/R42495.pdf.
2 Pub. L. No. 112-105, 126 Stat. 291 (April 4, 2012).
3 773 F.3d 438, 450 (2d Cir. 2014).
4Id. at 452 (emphasis added).
5 One bill would eliminate the requirement that the tipper receive a personal benefit; a second would make it illegal to trade on any information “not publicly available.” Peter J. Henning, Court Strikes on Insider Trading, and Congress Lobs Back, New York Times (March 16, 2015), http://www.nytimes.com/2015/03/17/business/dealbook/court-strikes-on-insider-trading-and-congress-lobs-back.html?_r=0. A third bill would create a new Section 16A of the Securities Exchange Act, which would make it illegal to trade or communicate MNPI that was “wrongfully obtained.” Third Congressional Proposal to Define Insider Trading, The National Law Review (March 27, 2015), https://www.natlawreview.com/article/third-congressional-proposal-to-define-insider-trading.
6 The same issues arise with open meeting laws, where various public, collegial, or deliberative bodies may be required to disclose information gleaned from Congresspersons and legislative staff.
7Memorandum to All House Members, Officers, and Employees: Rules Regarding Personal Financial Transactions, U.S. House of Representatives, Committee on Ethics (Nov. 29, 2011), https://ethics.house.gov/sites/ethics.house.gov/files/Appendix%20I.pdf.
8Restrictions on Insider Trading Under Securities Laws and Ethics Rules, United States Senate, Committee on Ethics (Dec. 4, 2012), http://www.ethics.senate.gov/public/index.cfm/files/serve?File_id=8c923399-2dc0-4ef6-a0d2-9ef564fc7038.
9 United States Government Accountability Office, “POLITICAL INTELLIGENCE, Financial Market Value of Government Information Hinges on Materiality and Timing,” GAO-13-389 (April 2013), http://www.gao.gov/assets/660/653532.pdf (summarizing various definitions and guidance).
10 At a Senate hearing Before the Committee of Financial Services, it was suggested that, because there was no clear definition or direction, that Congressional committees should individually impose more specific policies and procedures regarding what information must be treated as confidential and when the duty of confidentiality has been violated. The Stop Trading on Congressional Knowledge Act: Hearing Before the Committee of Financial Services, Cong. Rep. No. 112-90, at 100-101 (Dec. 6, 2011) (statement of Robert L. Walker).
11 Selective Disclosure and Insider Trading, Release Nos. 33-7881, 34-43154, 17 C.F.R. §§ 240, 243, and 249 (Oct. 23, 2000), https://www.sec.gov/rules/final/33-7881.htm.
12 The STOCK Act and the Political Intelligence Industry, The Harvard Law School Forum on Corporate Governance and Financial Regulation (July 20, 2013), http://blogs.law.harvard.edu/corpgov/2013/07/20/the-stock-act-and-the-political-intelligence-industry/#more-49318.
13 United States v. Riley, 13-cr-339, 2015 U.S. Dist. LEXIS 26400, at * 10 (S.D.N.Y. March 3, 2015) (explaining the benefit is not enough under Newman unless there is “proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature”).
14 The investigation has currently implicated as many as 44 hedge funds and trading firms. Sutter and the House Ways and Means Committee refused to cooperate and the SEC commenced an action to enforce its subpoenas: SEC v. The Committee on Ways and Means of The U.S. House of Representatives and Brian Sutter, 1:14-mc-00193. The action remains pending in the Southern District of New York.