The STOCK Act: A Response to Professor Bainbridge
Professor Stephen Bainbridge recently responded to a National Review Online article by my colleagues John Berlau and David Bier in which they argue that the STOCK Act (which recently passed both houses of Congress) would, if enacted, discourage congressional staffers from engaging in “whistleblowing and routine communication with outside groups.” Prof. Bainbridge responds by summarizing the state of insider trading laws vis-à-vis congressional staffers; he concludes that Berlau and Bier’s essay is a “load of codswallop,” a conclusion with which I disagree.
Many of Prof. Bainbridge’s criticisms are well-taken, to be sure, and I’d be remiss to attempt to defend all of Berlau’s arguments. However, Prof. Bainbridge overstates his case in contending that “[t]he STOCK Act doesn’t change the law applicable to Congressional staffers.” Although the STOCK Act would hardly ban whistle blowing, the law would substantially alter — or, at the very least, meaningfully clarify — the degree to which congressional staffers are subject to liability under the insider trading laws.
At issue is Section 4 of the STOCK Act. Here’s the relevant portion:
SEC. 4. PROHIBITION OF INSIDER TRADING.
(a) Affirmation of Nonexemption- 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.
(1) PURPOSE- The purpose of the amendment made by this subsection is to affirm a duty arising from a relationship of trust and confidence owed by each Member of Congress and each employee of Congress.
(2) AMENDMENT- Section 21A of the Securities Exchange Act of 1934 (15 U.S.C. 78u-1) is amended by adding at the end the following:
`(g) Duty of Members and Employees of Congress-
`(1) IN GENERAL- Subject to the rule of construction under section 10 of the STOCK Act and solely for purposes of the insider trading prohibitions arising under this Act, including section 10(b) and Rule 10b-5 thereunder, each Member of Congress or employee of Congress owes a duty arising from a relationship of trust and confidence to the Congress, the United States Government, and the citizens of the United States with respect to material, nonpublic information derived from such person’s position as a Member of Congress or employee of Congress or gained from the performance of such person’s official responsibilities.
The last paragraph explicitly imposes on congressional staffers (and on Members) a “duty arising from a relationship of trust and confidence . . . with respect to material, nonpublic information derived from such person’s position . . . [for purposes of the insider trading laws.]”
Prof. Bainbridge argues in his response to Berlau that this language is redundant as far as congressional staffers are concerned:
As I demonstrated . . . in my article Insider Trading Inside the Beltway, insider trading and tipping by Congressional staffers and executive branch employees is already illegal under current law. It was only Members of Congress who fell through the cracks of current law.
This oversimplifies the profound grey areas surrounding insider trading laws and obfuscates how the STOCK Act might substantially impact staffers’ willingness to disclose material nonpublic information. Although Prof. Bainbridge is correct in stating that insider trading laws already apply to congressional staffers, today, the outer reach of these laws is entirely unclear.
Misappropriation Theory & Congressional Staffers
Prof. Bainbridge’s main argument that congressional staffers already face insider trading liability under the so-called “misappropriation theory.” This theory, the First Circuit explained in S.E.C. v. Rocklage, “creates liability when a tipper or trader misappropriates confidential information from his source of the information. The misappropriator thus breaches a fiduciary duty owed to the source.”
How does this apply to congressional staffers? From Prof. Bainbridge’s article:
Congressional aides and other government employees have duties arising out of both their fiduciary relationship with their employer and their employment contract. . . . [B]oth members of a Congressman’s staff and Committee staffers are employees of their respective houses. In addition, both are subject to an ethical obligation never to ‘use any information received confidentially in the performance of governmental duties as a means for making private profit.’ These employment relationships should suffice for Congressional staffers to be deemed to have an agency or other relationship of trust and confidence with their employing agency. In S.E.C. v. Cherif, for example, the court held that ‘a person violates Rule 10b-5 and Section 10(b) by misappropriating and trading upon material information entrusted to him by virtue of a fiduciary relationship such as employment.’ Put into O’Hagan’s terminology, ‘a [staffer’s] undisclosed, self-serving use of [Congressional] information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the [Congress].’
Do congressional staffers owe a “relationship of trust and confidence” to their Member, or to Congress writ large? It’s entirely unclear, argues Bud Jerke, writing in the University of Pennsylvania Law Review (Cashing in on Capitol Hill: Insider Trading and the Use of Political Intelligence for Profit, 158 U. Pa. L. Rev. 1451 (2010)):
There is no consensus as to whether politicians are ‘employees’ or ‘employers.’ Similar to the disagreement over the question whether members of Congress and their staff are bound by a duty of trust or confidence sufficient to give rise to liability under the misappropriation theory, there is also disagreement over whether members of Congress are ‘employees’ who could satisfy the misappropriation theory.
Bolstering Prof. Bainbridge’s contention that congressional staffers already owe a duty of confidence to Congress is a 2008 Harvard Law & Policy Review essay by Andrew George, Public (Self)-Service: Illegal Trading on Confidential Congressional Information, which elaborates on the nature of the duty owed by congressional staffers for purposes of the insider trading laws:
There are . . . three types of legal duties that can apply to legislators and staffers under the misappropriation theory. The first is a fiduciary duty, which can be predicated upon common law relationships such as ‘attorney and client, executor and heir, guardian and ward, principal and agent, trustee and trust beneficiary, and senior corporate official and shareholder.’ The second and third types of duties are those of similar ‘trust and confidence’ to fiduciary duties. The second is a duty arising out of an agreement to maintain information in confidence. Such an agreement must be express but need not be written . . . . The third type of duty exists where the parties ‘have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality.’
George explains that “even if a superior meant for a staffer to trade or tip. . . . the staffer would inherit his superior’s breach of duty . . . [and] if he knew that the tip had been obtained through a violation of a duty of trust and confidence, would be just as guilty as his superior, if he traded on the information or passed it on to a future trader.” Such a duty, George suggests, may arise from Rule 29(5) of the Standing Rules of the Senate, which states:
Any Senator, officer, or employee of the Senate who shall disclose the secret or confidential business or proceedings of the Senate, including the business and proceedings of the committees, subcommittees, and offices of the Senate, shall be liable, if a Senator, to suffer expulsion from the body; and if an officer or employee, to dismissal from the service of the Senate , and to punishment for contempt.
What do the terms “secret or confidential” mean in this context? According to a 1992 statement by Sen. Mitchell, the rule “refer[s] to all information the Senate treats as confidential, including information received in closed session, information obtained in the confidential phases of investigations, and classified national security information.”
To date, no court has squarely addressed the misappropriation theory of insider trading liability as it pertains to congressional staffers, nor has the academy reached anything resembling a consensus on the issue. Thus, it’s entirely unclear whether, under current law, congressional staffers owe to anyone a blanket duty of confidentiality with respect to all material nonpublic information they learn on the job. Much, if not most, of the nonpublic material information staffers currently tend to share with third parties on a regular basis does not arise out of a “secret or confidential proceeding.” Nor is it subject to an unwritten duty of confidence embodied by “histories . . . of maintaining confidences.” This is particularly true when congressional staffers disclose information with the express or implied consent of the Member for whom they work.
Consider a staffer who discloses draft language of a prospective legislative amendment to a think tank analyst with the implied consent of the Member. Has that staffer breached a duty of confidence? Or how about a staffer who, with the sponsoring Members’ permission, discloses a discussion draft of a bill yet to be introduced? Or a staffer who discloses that a bill’s successful passage out of committee is a “sure thing” based on casual banter with colleagues working in other offices?
Under current law, if the SEC wishes to prosecute the staffer for tipping material nonpublic information in any of these hypothetical situations, it must show that the staffer has breached a legal duty. Meeting this burden may at times be a slam dunk (for instance, when national security information is involved). In most cases, however, prosecuting a staffer under the misappropriation theory will require the SEC to articulate specific facts showing that the disclosure breached a duty based on an unwritten relationship of confidence between the staffer and another party.
The STOCK Act would absolve the SEC of this burden by imposing on congressional staffers a universal duty of trust with respect to all “material, nonpublic information derived from such person’s position . . . or gained from the performance of such person’s official responsibilities.”
Personal Benefit Test
Imposing a blanket duty of confidentiality with respect to material nonpublic information may well make sense in the context of staffers who trade upon such information, or who share it with political intelligence firms or other third parties who intend to capitalize on the information. But what about staffers who disclose material, nonpublic information for less nefarious purposes?
Prof. Bainbridge, citing the leading treatise on insider trading, points out that a staffer who “tips” is unlikely to face insider trading liability under the misappropriation theory if the staffer receives no personal benefit.
Fair enough—but what constitutes a “personal benefit” as far as insider trading laws are concerned? As the Supreme Court held in Dirks v. SEC, the “desire to expose fraud” is not a personal benefit, so whistle blowers who disclose inside information for the purpose of shining light on illegal activities aren’t liable as tippers. Under Dirks, therefore, congressional staffers who disclose material nonpublic information to expose wrongdoing by their colleagues or bosses have nothing to worry about, even if the STOCK Act is enacted.
But what about congressional staffers who disclose material nonpublic information to advance their careers as legislative aides, to make their Member look good in the press, or to further efforts to defeat a bill opposed by party leadership? Such disclosures are commonplace in Washington; in my capacity as a think tank analyst, I and my colleagues often receive nonpublic information from staffers, some of which might rise to the level of materiality. Would a court conclude that a staffer who disclosed material nonpublic information for political purposes intended to personally benefit from the disclosure?
It’s entirely possible. As Prof. Donna Nagy has explained, “[t]he Dirks court . . . made clear that courts should broadly construe the requirement of a personal benefit for tipper-tippee liability, and cited examples, such as a ‘relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient’ and ‘when an insider makes a gift of confidential information to a trading relative or friend.’” 94 Iowa L. Rev. 1315, 1329 (2009).
The Dirks court held that an insider may be liable if he “receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings.” Building on Dirks, a district court held in SEC v. Downe (S.D.N.Y. 1997) that a tipper could be liable for insider trading merely because he “enjoyed the benefits of being viewed as a successful investor in the eyes of his peers—including [the tippee]—as well as the gratification of bestowing the ‘gift’ of his investment expertise.” (emphasis added) And in 2007, the Seventh Circuit noted in US v. Evans that “the concept of gain [in Dirks] is a broad one, which can include a ‘gift of confidential information to a trading relative or friend.’”
Congressional staffers are routinely promoted—and given attendant pay raises—based in large part on their ability to advance their Member’s political and legislative agenda. Selectively disclosing information to key third parties – including think tankers, journalists, law professors, and lobbyists – is often a helpful means of advancing or obstructing a particular bill. While the overwhelming majority of nonpublic information disclosed by staffers to third parties for political reasons is likely never used to make trades, a staffer-tipper may be liable for trades made by third party tippees even if the staffer is unaware of the tippee’s intent to trade, assuming the staffer intended to directly or indirectly benefit from the tip. S.E.C. v. Yun (11th Cir. 2003) (“To establish liability . . . the SEC need not show that the tippee actually traded for the tipper and gave him the profits of the trades; all the SEC needs to show is that the tipper received a ‘benefit,’ directly or indirectly, from his disclosure.”).
A congressional staffer facing insider trading charges for disclosing material nonpublic information to a third party might argue that the disclosure was intended not to benefit the staffer personally, but the congressional office. (Prof. Bainbridge cites in his article at n.59 a “SEC release acknowledging that selective disclosures to analysts was viewed as protected from insider trader liability because the tipper received no personal benefit but rather provided the tip so as to benefit corporation.”)
Under the STOCK Act, however, a congressional staffer owes a duty not to their Member, or to their political party, but to “the Congress, the United States Government, and the citizens of the United States.” Thus, if a staffer discloses information in a manner intended to serve the interests of her Member – but not the interests of the “citizens of the United States” – it seems unlikely that the staffer could mount a successful defense on the notion that tippers aren’t liable for disclosures designed to benefit their corporation.
Congress could address this concern in reconciliation by simply clarifying that the STOCK Act is not intended to impose insider trading liability on staffers who disclose material nonpublic information for legitimate political purposes unrelated to direct pecuniary gain. The STOCK Act’s expansion of insider trading liability should apply solely to staffers who disclose material nonpublic information and know (or should know) that the information is likely to be used in making trading decisions.
Otherwise, staffers and Members might become reluctant to share information with journalists, think tankers, and professors, causing the legislative process to suffer. A high-profile SEC prosecution of a staffer would only amplify this concern. As Bud Jerke warns:
The insider trading approach will potentially make criminals out of those who write their elected representatives. Although falling into the trap is more complicated than merely writing Congress, this is the public perception that will prevail. The perception of members giving political inside information to constituents is enough to chill vital discourse. Members of Congress will be reluctant to exchange ideas with constituent groups, and constituents will hesitate to monitor their elected officials. The result will be an isolated legislative body, scared to bounce ideas off of others, and an American public that views political knowledge as incriminating.
The misuse of nonpublic legislative information for private gain is a real problem, but Congress should think twice before granting the SEC broad and ill-defined new powers that might chill legislative transparency and political discourse.