The STOCK Act’s Muzzle and How to Fix it in Conference (Update)

My colleagues David Bier and Ryan Radia contributed to this post.

Per the scenario in a previous post, it’s April 2012. You are a conscientious congressional staffer who still takes seriously the need to be a steward of taxpayers’ money. (Yes, I know for a fact, there are more than a few of these folks around on Capitol Hill.) You are watching closely events surrounding an “omnibus” or “minibus” spending bill deemed even by conservative Republican members as “must-pass” because it funds the military as well as other parts of government.

Suddenly, you hear about an outrageous earmark about to be slipped into the bill that would enrich a Fortune 500 company. You decide to alert a network of fiscal watchdogs you’ve met with over the years to wage an instant campaign against this piece of corporate welfare.

You have all the information in the e-mail and are about to hit “send.” But then you remember something from a briefing you attended a couple days ago. The subject was the STOCK (Stop Trading on Congressional Knowledge) Act – aimed at stopping “insider trading” by members and employees of Congress – that your boss and nearly every other member of Congress voted into law in February.

At the time, you didn’t think the law would affect you since the only trading you do is indirect, through your mutual funds and pension. You were surprised to learn, however, that you now have a broad “duty of confidentiality” that encompasses not just trading on “material, nonpublic information,” but disclosing information to those who might.

You sit back and think, “It is indeed possible that someone I send this to could buy stock in the company, or could short the company based on the coming outrage.” You stare at the computer screen wondering how virtually no one noticed how this law could have potentially criminalized an act of whistleblowing as abetting “insider trading.”

Such a scenario is almost certain if House and Senate versions of the STOCK Act are not modified before a final bill is sent to President Obama. The House passed the bill yesterday with a 417-2 vote after a similarly overwhelming 96-3 Senate vote last week.  Both bills must go to “conference” to produce a final identical bill to be voted on by both houses, giving members an opportunity for a fix to help make sure that whistleblowing and routine communication with outside groups from being caught in the law’s web.

The legislation gained steam after a series of revelations in conservative author Peter Schweizer’s best-selling book, Throw Them All Out, that pointed out that many members of Congress regularly trade stocks and options, sometimes after receiving sensitive information. A “60 Minutes” report based on some of Schweizer’s findings propelled the issue into the spotlight, with President Obama calling on Congress in the State of the Union to ban “insider trading” among its members and staff.

But lost in the justifiable outrage about politicians’ perks is discussion about how provisions in the bills would actually work. Among the most important things to know about the STOCK Act is that  by specifically applying “material, nonpublic information” rules that govern officers and directors of a corporation to Congress, the  bill would bar in many instances the disclosure of such information as well as trading on it.

The bills specifically impose a “duty of confidentiality” on members of Congress and their staffs. They state that “each Member of Congress or employee of Congress owes a duty arising from a relationship of trust and confidence [emphasis added] to the Congress, the United States Government, and the citizens of the United States with respect to material, nonpublic information.”

The term “confidence” in the context of securities law does not mean faith in a particular institution — indeed it would be difficult to legislate confidence in Congress or any branch of government — but rather keeping matters in confidence. And under the “duty of confidentiality” imposed with regard to publicly-traded companies, many have been prosecuted for sharing information as well as trading on it.

A so-called “tipper,” wrote attorney Nelson Ebaugh in the Texas Journal of Business Law, “is exposed to insider trading liability for simply communicating material, nonpublic information even if he did not personally use the information to trade in the company’s securities.” Ebaugh added that courts are split on whether a “personal benefit” is even required for guilt.

Ebaugh and other experts have argued that insider trading rules have been applied so broadly to such “tippers” of corporate information that they inhibit disclosure about corporate wrongdoing. If these rules were applied to information about upcoming congressional action, it would have serious, if not more severe, effects in muzzling whistleblowers.

In addition to the e-mail to activists from the beginning of this article, conference calls and off-the-record meetings with ideological activists, such as the famed “Wednesday meeting” created by conservative activist Grover Norquist and similar gatherings organized by liberals, could also be curtailed. In the corporate word, the Securities and Exchange Commission has cracked down on what it calls “selective disclosure” to analysts. As a result, under Regulation Full Disclosure, most public companies put information about conference calls on their web site and/or post the recorded call for all to hear.

Following this precedent, if the STOCK Act is passed, the SEC may require meetings and calls in which Congress members and staffers participate to be open to the public or not occur at all. The result would be less outflow of information from Congress and a less-informed public.

Fortunately, some simple language — a “mens rea” or “guilty mind” requirement — could be added in conference to help ensure the new rules don’t inhibit the free flow of information necessary for accountability in Congress. A clause could be added stating something like:

“Nothing in this subsection shall be construed to impose liability on Members of Congress or employees of Congress for acts of disclosing material, nonpublic information to nonaffiliated third parties, unless the Member of Congress or employee of Congress discloses the information to a nonaffiliated third party:

(A)               As a means for making a private profit;

(B)               With knowledge that the recipient of the information, or persons acting in concert with the recipient of the information, intend to use the information for purposes of making a private profit;”

The First Amendment is also threatened by a measure added to the Senate bill by Sen. Charles Grassley (R-Iowa) that would require so-called political intelligence (an oxymoron if there ever was one!) firms to register as lobbyists.  But these firms do not lobby for legislation, but merely gather information for investors, businesses, and sometimes, as University of Minnesota law professor Richard Painter points out, non-profits such as churches and unions. The work that they do is not that different from the news gathering of high-priced investment magazines and newsletters for wealthy subscribers, which no one doubts have First Amendment protection.

As Sen. Joseph Lieberman (I-Conn.) said on the Senate floor, “We are ultimately dealing with First Amendment rights here, and ought not to legislate until we are prepared to do so in a reasoned way.” Fortunately, the House bill did not contain Grassley’s amendment, but Grassley and Democrats will fight to reinsert the measure in the conference bill.

The exposes of Schweizer and others raise serious issues about power and privilege that need to be addressed. The STOCK Act contains some sensible measures, such as more rapid and specific disclosure of investment holdings. Unfortunately, the “political intelligence” provision of the Senate bill and the “duty of confidence” in both bills would muzzle the communication necessary for sunlight and reform. For the sake of transparency and accountability, this potential muzzle must be lifted.