The Uncertainty of the STOCK Act

Chairman of the House Financial Services Committee Rep. Spencer Bachus (R-Alabama), who frequently buys stock options while overseeing the nation’s banking and financial service industries, is currently under investigation by the Office of Congressional Ethics for possible violations of insider trading laws.   

Insider trading becomes illegal when there is a breach of fiduciary duty, trust or confidence while in possession of nonpublic trading information about stocks or securities. These acts threaten the reliability and authenticity of the stock market and deprive investors from trading on a level playing field.    

Illegal insider trading has long been a top priority of the U.S. Securities and Exchange Commission (SEC). According to a testimony given on December 1, 2011, by Robert Khuzami, the director of the Division of Enforcement of the SEC, “in the fiscal year of 2010, the SEC brought 53 insider trading cases against 138 individuals and entities, a 43 percent increase in the number of filed cases from the prior fiscal year”. Moreover, according to Mr. Khuzami, the SEC is using aggressive investigative approaches while working closely with the FBI and the Justice Department in bringing charges against perpetrators. Such was the case of Galleon hedge fund founder Raj Rajaratnam who the SEC brought charges against for rampant insider trading, including a $92.8 million civil penalty against him personally.

Insider trading is not only an issue on Wall Street; it is also a big issue on Capitol Hill. This is because of the abundance of financial information available to members of Congress which they take advantage of. A study by Ziobrowski A. L et al., (2011) on abnormal returns from stock investment by House members shows that members of the House beat the market performance by 55 bases point each month, approximately 6% better than market average.

During last month’s State of the Union address President Obama stated, “Send me a bill that bans insider trading by members of Congress, and I will sign it tomorrow.” Then on February 2, 2012, the Stop Trading on Congressional Knowledge (STOCK) Act was passed in the Senate with 96-3 votes and a few days later in the House with 417-2 votes. Thus, it is now prohibited for members and employees of Congress and the Executive Branch to engage in insider trading or use of nonpublic information obtained through their employment for personal benefit.

With such bill in place, members of Congress will no longer be exempt from the federal securities laws. In addition to the Act, the Ethics Manual of the US House of Representative states that, “members and employees should never use any information received confidentially in the performance of governmental duties as a means for making private profit”. Furthermore, the Senate Ethics Manual, under Conflict of Interest Rule 37(4) “prohibits individuals from using their legislative power to advance their personal financial interests”.  Evidently, the STOCK Act is cracking down on members of Congress for insider trading, and mandating the disclosure of financial transactions involving stock and other securities.

However, to date there have been no known arrests or prosecutions for insider trading involving any member of Congress, and the SEC regulation remains ambiguous on whether insider trading by governmental officials is illegal or where the fiduciary duty lies in regards to members of Congress. Moreover, although the regulation is clear that the misappropriate use of information gained from employment to make profit is illegal, there is no clarity as to whether the information used by members of Congress is indeed nonpublic, and whether the members of Congress are considered federal employees.

Regardless of the ambiguity of the regulation, the main purpose of the STOCK Act is to make the SEC regulation apply to Capitol Hill. Furthermore, the Act is attempting to rebuild the notion of ethical conduct and transparency in Washington, making it easier for Congressional members to be investigated.

Nevertheless, there are some dishonest members who will find a way to trade on inside information. Thus, the uncertainty still remains on whether the Act can solve the issue of insider trading in Congress. Moreover, there seems to be an underlying motive in passing the STOCK Act. Is it only to address the issue of Congress using privy information to make personal profit from the very institutions it resides over? Or is it an attempt to address the American people’s outrage by the fact that their trusted representatives are involved in the ponzi scheme of insider trading? Whatever the motive, members of Congress need to stop using privilege information to make personal profit because of the adverse effect it has on the nation’s financial institutions, the market, and the trust of the American people.