04.04.2012

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Updates

Introduction

On April 4, 2012, President Obama signed into law the Stop Trading on Congressional Knowledge Act (the “STOCK Act” or “Act”).  This new law amends existing securities laws to forbid Congressional Members and other federal government officials and employees from trading on material non-public information they obtain based on their position or responsibilities.  For purposes of the federal securities laws, the STOCK Act specifically creates a fiduciary duty between Congress, the U.S. government and its citizens.

In his January 2012 State of the Union Address, President Obama challenged Congress to: “send me a law that bans insider trading by members of Congress, and I will sign it tomorrow.”  In response, the U.S. Senate initially passed a version of the Act on February 2nd.  The House of Representatives followed suit by passing similar legislation on February 9th.  Then, on March 22nd, the Senate voted to approve the House version of the legislation.  Following through on his State of the Union challenge, President Obama has now signed the STOCK Act into law.

Background

Prior to the STOCK Act’s implementation, securities law experts debated whether prohibitions on insider trading applied to Members of Congress.  Some even asserted that Members of Congress—people with unique access to material, non-public financial information—did not fit within any of the existing theories of insider trading liability.  For instance, under the “classical theory” of insider trading, it is illegal for insiders to trade while in possession of material non-public (inside) information.  But unlike a traditional employee, a Member of Congress is not an “insider” of any stock issuer.  In fact, Congressional ethics rules prohibit Members of Congress from serving as a paid officer or board member of a corporation.  And while the “misappropriation theory” extends liability for insider trading to outsiders who trade while in possession of material non-public information, the trading must be done in violation of a relationship of trust or confidence, otherwise known as a “fiduciary duty.”  Because Members of Congress are independent representatives of the people, it was unclear whether they had a fiduciary duty for purposes of the securities laws and, if so, to whom it was owed.

The STOCK Act Establishes a Fiduciary Duty for Members of Congress

The STOCK Act expressly creates the previously missing fiduciary duty required for insider trading liability under the misappropriation theory, providing in Section 3 that “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, non-public 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 Act also specifies 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.”  The Act further directs ethics committees in all three branches of government to clarify that insider trading violates their internal ethics rules.

Going forward, the fiduciary duty imposed by the Act may be used by the SEC and other regulatory agencies as the basis for insider trading enforcement actions against Members of Congress and elected officials who trade on material non-public information derived from their position.  Though the Act clearly applies to federal employees as well, some have speculated that these individuals probably already had a duty to their employer, the federal government, to keep non-public information confidential.

New Reporting Requirements

The STOCK Act also amends the Ethics in Government Act by imposing new reporting requirements for certain securities transactions performed by Members of Congress, the Executive Branch and judicial officials.  Under these amendments, covered persons must disclose trades over $1,000, with an exception for certain mutual fund-type trades, within 30 days after receiving notification of the transaction, and in no case later than 45 days after transaction was performed.  These disclosures must be filed electronically and will be available on a public website.

Pension Restrictions for Felons

The STOCK Act contains provisions applicable to the Federal Employees’ Retirement System and the Civil Service Retirement System, which will now deny pension benefits to elected officials convicted of certain felonies.  Some of the applicable crimes include: insider trading; racketeering; money laundering; tax evasion; and perjury, among others.

Political Intelligence Firms Subject to Further Review

The final version of the STOCK Act did not contain certain reforms targeted at “political intelligence” firms.  Under the Senate’s version of the STOCK Act, political intelligence firms would have been regulated in the same way as lobbying firms, with the accompanying registration requirements.  The purpose of registration would have been to advise Congressional members of whose interests were being represented by the political intelligence firms gathering information to pass along to the financial industry.  Rather than regulating the political intelligence industry, the final version of the STOCK Act requires a study of the industry by the Comptroller General.  The Act specifies that the study must include an analysis of political intelligence firms, including the extent to which investors rely on such firms; the effect of political intelligence firms on the market; and the implications of imposing disclosure requirements on the political intelligence industry.

Conclusion

It remains to be seen how the STOCK Act will change Congressional trading.  The Act’s disclosure requirements provide an additional incentive to covered officials to self monitor their trades and ensure that their financial transactions comply with federal securities laws.  The Act may also have a lasting impact on the way politicians communicate with lobbyists and other corporate representatives, as well as traditional notions of “publicly available information.”

© 2012 Perkins Coie LLP