Is Congress exempt from insider trading laws?

Claim: Congress is exempt from insider trading laws

Verdict: Mostly True

:memo: note: I wrote this piece while interning at Politifact. Afaik the problem with congress hasn't gotten any better.

On November 13, 2011, 60 Minutes aired a report that investigated Congressional stock trading practices. Peter Schweizer, research fellow at the Hoover Institute and author of Throw Them All Out, spoke with Steve Kroft of CBS about the forms of “honest graft” that members of Congress regularly take part in:

Schweizer: For example insider trading on the stock market. If you are a member of Congress, those laws are deemed not to apply


Kroft: So congressmen get a pass on insider trading?


Schweizer: They do. The fact is, if you sit on a healthcare committee and you know that Medicare, for example, is-- is considering not reimbursing for a certain drug, that's market moving information. And if you can trade stock on-- off of that information and do so legally, that's a great profit making opportunity. And that sort of behavior goes on.


Kroft: Why does Congress get a pass on this?


Schweizer: It's really the way the rules have been defined. And the people who make the rules are the political class in Washington. And they've conveniently written them in such a way that they don't apply to themselves.

Schweizer’s reference to health care was no accident. In the midst of the 2003 health care debate, Senators John Kerry and John Boehner both purchased significant quantities of healthcare and pharmaceutical stocks which greatly increased in value when the provisions of the new health care law were finalized. Schweizer’s book also mentions an incident in 2008 involving Sen. Spencer Bachus, then ranking member of the House Financial Services Committee. On September 18, 2008, Bachus attended a private briefing from Ben Bernanke and Hank Paulson regarding the possibility of a meltdown in the global financial system. The next day, Bachus bought $7,846 worth of options betting that the market would fall. By September 23^rd, Bachus sold the options for over $13,000 and essentially doubled his money.

Members of Congress appear to consistently make these well-timed decisions. A 2004 study by economist Alan Zibrowski et al. finds that from 1993-1998 the stock portfolios of U.S. Senators outperformed the market by 12.3% annually, a rate nearly double that of corporate insiders and well ahead of the average household which fell short of the market by 1.5%. Zibrowski concludes that “it seems clear that Senators have demonstrated a definite informational advantage over other investors” and that “these results suggest that Senators knew appropriate times to both buy and sell their common stocks.”

Despite the fact that Senators like Kerry and Boehner deny making trades based on non-public information, the 60 Minutes piece reports that under the current law it is actually legal for them to do so and Zibrowski’s paper demonstrates the tantalizing incentives to do so. Is it truly the case that Congressmen are exempt from the insider trading laws that govern the rest of the country?

To answer this question, we begin with the definition of insider trading provided on the Securities and Exchange Commission website. “Illegal insider trading refers generally to buying or selling a security, in breach of a fiduciary duty or other relationship of trust and confidence, while in possession of material, nonpublic information about the security. Insider trading violations may also include "tipping" such information, securities trading by the person "tipped," and securities trading by those who misappropriate such information.”

So in order to convict a person of insider trading, the SEC must prove not only that the individual was in possession of non-public information, but that their use of that information violated a duty of confidentiality towards either the company being traded or the source of the information.

Stephen Bainbridge, law professor at UCLA, believes that there is no interpretation of the current law which establishes this duty of confidentiality for members of Congress. In his most recent paper on the subject, “Insider Trading Inside the Beltway,” Bainbridge concludes that for “members of Congress…current law provides a strong argument that their trading cannot be punished under either the classical ‘disclose or abstain’ or the misappropriation theory.”

This is a sentiment echoed by Thomas Newkirk, a partner with law firm Jenner & Block and a former official with the SEC’s enforcement division. In 2006 Newkirk explained to the Wall Street Journal that “if a congressman learns that his committee is about to do something that would affect a company, he can go trade on that because he is not obligated to keep that information confidential. He is not breaching a duty of confidentiality to anybody and therefore he would not be liable for insider trading.”

A dissenting opinion has been offered by Indiana University law professor Donna Nagy, who believes that Congress and legislative staffers are not immune from current insider trading law. In her paper, Nagy argues that members of Congress are “public fiduciaries who owe duties of trust and confidence to a host parties” including Congress itself and the citizen investors who make up their constituency. She believes that “nonpublic congressional information constitutes property which, like congressional funds and tangible property, rightfully belongs to the federal government and its citizens.” Under Nagy’s interpretation, when a Congressman uses non-public information to make trading decisions, they are violating their duty to the citizen they represent and are illegally using federal property for personal gain.

Although this interpretation may be valid, Nagy herself admits that it is contrary to the conventional wisdom of other academics, journalists and government officials who have commented on the issue. The SEC has done little to challenge this conventional view although its actions shed some light on the issue. In 2005 an investigation of Senate Majority Leader Bill First for insider trading was opened, but charges were never brought. In fact, the SEC has never prosecuted a member of the House or Senate for insider trading. The failure of the investigation suggests that the current law’s ambiguity—not Congressional immunity—prevents prosecutors from building an effective case. The fact that Congress controls the budgetary appropriations for the SEC no doubt also lowers the likelihood of prosecution.

The shortcomings of the current law have not gone unnoticed by members of Congress. In 2006 Reps. Brian Baird and Louise Slaughter introduced the Stop Trading on Congressional Knowledge Act. The STOCK Act aims to prohibit Members and employees of Congress from profiting from nonpublic information they obtain in their official positions. Until the 60 Minutes piece aired, the STOCK Act had been repeatedly allowed to die in committee and never managed to gain more than 10 cosponsors. In the 5 days following the 60 Minutes piece the act received an additional 84 House sponsors.

Verdict: Mostly True

The possibility of alternative interpretations and the fact that the SEC at least investigated Senators in the past suggests that Congress members are not entirely exempt under current insider trading law. However, the difficulty in determining to whom Congress owes its fiduciary and confidential duties has prevented prosecution and opened the door for the types of questionable trading practices covered in the 60 Minutes piece and in Schweizer’s book.

Sources

1. CBS 60 Minutes, “Insiders,” Nov. 13, 2011. http://www.cbsnews.com/video/watch/?id=7388130n 
   Producers: Ira Rosen and Gabrielle Schonder. Correspondent: Steve Croft
2. Alan J Zibrowski, et al. Journal of Financial and Quantitative Analysis, “Abnormal Returns from the Common Stock Investments of the U.S. Senate,” December 2004.
3. Stephen M. Bainbridge. UCLA School of Law, Law-Econ Research Paper No.10-08, “Insider Trading Inside the Beltway,” June 30, 2010.
4. (Thomas Newkirk comments) Peter Lattman, WSJ Law Blog, “Bill Looks to Ban Insider Trading for Lawmakers and Their Aides,” Mar. 28, 2006. http://blogs.wsj.com/law/2006/03/28/bill-looks-to-ban-insider-trading-for-lawmakers-and-their-aides/
5. Donna M. Nagy. Boston University Law Review, “Insider Trading, Congressional Officials, and Duties of Entrustment,” May 5, 2011
6. Paul Davidson. USA Today, “SEC Launches formal investigation of First,” Sept. 9, 2005.