10/19/2012

By James Hamilton, Randall Levine, and Stephanie Schuster-Lezell[1]

Introduction

            The long-standing federal insider trading laws do not expressly apply to Members of Congress and their staffs.  The recently passed STOCK Act is intended to close this apparent gap, by amending the insider trading laws to prohibit Members of Congress and their staffs from using insider information acquired in the exercise of their official duties for personal gain.  But will the STOCK Act actually serve its intended function?  The Speech or Debate Clause, a relatively obscure clause of the United States Constitution, may thwart attempts to enforce the STOCK Act against its intended targets on the Hill.  Instead, because the Act likely provides liability for “tippees” (persons that receive and trade based on material non-public information),  the STOCK Act’s impact may fall hardest on private parties who regularly receive information from Members or their staffs.

Brief History of the STOCK Act

            Early attempts to pass the STOCK Act gained little attention or support.  Representative Louise Slaughter (D., N.Y.) first introduced the STOCK Act six years ago,[2] and multiple versions of the Act were submitted and resubmitted to Congress without passing.[3]  In 2011, a “60 Minutes” episode brought national attention to potential insider trading by Members of Congress .[4]  This attention, combined with President Obama’s push for the legislation in his 2012 State of the Union address, inspired renewed efforts to make the STOCK Act law.[5]

            In January 2012, the STOCK Act was introduced in the Senate.  In addition to imposing insider trading liability on Members of Congress, the Senate version required registration of so-called “political intelligence”[6]firms under the Lobbying Disclosure Act.[7]  House Majority Leader Eric Cantor expressed concern that the proposed regulation of “political intelligence” firms was overly broad and would chill constitutionally protected speech between Congressmen and their constituents. [8]  The House-passed version removed the registration requirements.[9]  Rather than attempt to reconcile the House and Senate versions, the Senate consented to and passed the House version on an unusual procedural motion.[10]  President Obama signed the bill on Wednesday, April 4, 2012.[11]

The STOCK Act’s Major Provisions

            The STOCK Act declares that Members of Congress and congressional employees “may not use material nonpublic information derived from such person’s position . . . or gained from the performance of such person’s official responsibilities” to make private profits.[12]  The Act also affirms that Members of Congress and their staff “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.”[13]

            The STOCK Act further “affirm[s] a duty arising from a relationship of trust and confidence owed by each Member of Congress and each employee of Congress.”[14] To that end, the Act amends Section 21A of the Securities Exchange Act of 1934[15] to clarify that:

solely for the purposes of the insider trading prohibitions arising under this [Securities Exchange] Act, including section 10(b) and Rule 10b-5 thereunder, each Member of Congress . . . owes a duty arising from a relationship of trust and confidence to the Congress, the United States Government, and the citizens of United States with respect to material, nonpublic information derived from such person’s position . . . or gained from the performance of such person’s official responsibilities.[16]

            The Act also imposes the same duty and prohibitions on Executive Branch employees, judicial officers, and judicial employees.[17]

            The STOCK Act enacts stringent reporting requirements for Members of Congress, their staff, and Executive employees.  Covered individuals must disclose any trade exceeding $1,000, either 30 days after being notified of the transaction (if made by someone other than those individuals) or 45 days after the transaction.[18]  Trades involving publicly traded, widely-held investment funds are exempt from the reporting requirements, unless the covered individual has control over the fund’s assets. [19]

            The Act also prohibits Members of Congress from participating in Initial Public Offerings (“IPOs”) “in any manner other than is available to members of the public generally.”[20]

            Although Congress enacted the STOCK Act without a provision regulating “political intelligence firms,” the Act tasks the Comptroller General with preparing a report on the activities and effects of “political intelligence” firms within one year.[21]  

Does the STOCK Act Impose Both Tipper and Tippee Liability?

            The STOCK Act clearly is intended to impose criminal penalties on Members of Congress and staffers who use material non-public information obtained in the course of their legislative activities for their own private gain.[22]  But the Act may have other applications.  Does it impose liability on Members of Congress and staffers who disclose material non-public information to private parties?  Does it impose liability on private parties outside Congress, who receive material non-public information leaked from Congress and use it to make trades?  These permutations of insider trading liability are called “tipper” and “tippee” liability -- and they are likely both covered by the STOCK Act.

Tipper and Tippee Liability Under The Insider Trading Laws

            Under section 10(b) of the Securities Exchange Act of 1934, a corporate insider can be held liable for trading on material nonpublic information, or for disclosing that information to an outsider, i.e. “tipping.”[23]  A “tipper” can be liable without executing a single trade, and the “tippee,” also may be liable for insider trading based on the disclosed information.[24]

            Both tipper and tippee liability are premised on the fiduciary duty corporate insiders owe to shareholders, which includes a duty to refrain from acting on material nonpublic information for personal gain.[25]  Insiders are “forbidden by their fiduciary relationship from personally using undisclosed corporate information to their advantage [and] they may not give such information to an outsider for the same improper purpose.”[26]  The tipper need not benefit financially from the tip to be liable, but must benefit in some way, either directly or indirectly.[27]     

            The tippee can also be held liable for insider trading.  Although the tippee does not owe a fiduciary duty to shareholders, “the tippee’s duty to disclose or abstain is derivative of the insider’s duty.”[28]  Thus, a tippee is liable if he trades on information he knew or should have known was disclosed in breach of the tipper’s duty.[29]  The essential element of both tipper and tippee liability is a fiduciary duty to shareholders with respect to the material nonpublic information. 

Tipper and Tippee Liability Under the STOCK Act

            Though not expressly provided, there are strong arguments that Congress intended to impose both tipper and tippee liability in the STOCK Act.  First, the Act affirms that Members 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.”[30]  Tipper and tippee liability arise under section 10(b) and Rule 10b-5.[31]

            Second, the Act amends the Securities Exchange Act of 1934[32] to impose a “duty” upon Members of Congress, “arising from a relationship of trust and confidence . . . with respect to material, nonpublic information derived from [a Congressman’s] position . . . or gained from the performance of [his] official responsibilities.” [33]  This duty is an essential element of tipper and tippee liability.

            Third, legislative history indicates that Congress was at least aware of the potential for tipper and tippee liability in the STOCK Act.  The Securities and Exchange Commission’s statements in support of the Act specifically explain that disclosing inside information in breach of a fiduciary duty renders both the tipper and tippee liable for insider trading.[34]

            Assuming, as seems likely, that the STOCK Act intends to impose both tipper and tippee liability, its bite  will likely be felt mainly outside the halls of Congress.  This is because the Constitution’s Speech or Debate Clause restricts enforcement of certain laws against Members of Congress and their staffs, as discussed below.  However, an outsider who receives material nonpublic information from a Member of Congress may be subject to “tippee” liability if the information is used to trade. 

            Although Congress declined to regulate “political intelligence” firms under the Lobbying Disclosure Act, the STOCK Act may nonetheless apply to such firms through the Act’s potential for “tippee” liability. This regulation may result because the purpose the political intelligence industry is to obtain inside information from Congress to inform client trading strategies.  Before reporting to their clients, political intelligence professionals may now feel the need carefully to scrutinize any information they receive from Hill contacts to ensure they have not obtained material non-public information, and to prevent inadvertent violation of insider trading laws.

The Interplay Between the Speech or Debate Clause and Enforcement of the STOCK Act

            Notably absent from the STOCK Act’s legislative history is an analysis of the Constitution’s Speech or Debate Clause and its potential impact on enforcement efforts. The Clause provides that “for any Speech or Debate in either House, [Members of Congress] shall not be questioned in any other Place.”[35]   The Clause has been interpreted to immunize Members of Congress and their staffs from liability for acts within the scope of legislative activities.[36]  Though the Speech or Debate Clause likely does not totally rule out prosecuting Members of Congress for insider trading, it may provide targets of an investigation under the STOCK Act with powerful defenses to liability and with potential means to stymie an investigation. 

Overview of the Speech or Debate Clause

            The Speech or Debate Clause protects the “independence and integrity of the legislature” and shields the legislature from “prosecution by an unfriendly executive and conviction by a hostile judiciary.”[37]  The Clause “is to be read broadly” to achieve its aims.[38]  When the Clause applies, its protections are “absolute.”[39]

            The Speech or Debate Clause provides both immunity from liability and testimonial privilege.[40]  The Clause thus protects Members of Congress “not only from the consequences of litigation’s results but also from the burden of defending themselves.”[41]  Congressional staff are also protected by the Clause.[42]   Protection under the Clause is not limited to speeches or debates within the four walls of Congress.[43]   For example, committee reports are protected, as are hearings “even if held outside the Chambers [of Congress].”[44]  The Clause also protects the conduct of Congress’ fact-finding investigations.[45]   

            But the Clause’s protections are not limitless.  It protects Members of Congress and staff only from inquiry into, or prosecution for, “legislative acts.”[46]  Legislative acts are those “generally done in Congress in relation to the business before it.”[47]   Accordingly, “the Speech or Debate Clause prohibits inquiry only into those things generally said or done in [Congress] . . . in the performance of official duties and into the motivation for those acts.”[48]  Legislative acts conducted outside of Congress are only protected insofar as they are “an integral part of the deliberative and communicative processes by which Members participate in committee and House proceedings.”[49]

            Matters are not “within the legislative sphere” just because they are related to congressional duties.[50]  Strictly political activities are not considered legislative acts and are not protected by the Speech or Debate Clause.  Such activities include performing errands for constituents, making appointments with government agencies, assisting in securing government contracts, preparing news letters and news releases, and delivering speeches outside of Congress, e.g., on the stump.[51]

The Speech or Debate Clause Does Not Provide

Members with Absolute Protection From Prosecution

            The Speech or Debate Clause does not totally immunize Members of Congress or their staffs from prosecution for insider trading under the STOCK Act.  In United States v. Brewster,[52] a Senator indicted for accepting a bribe in violation of a federal statute asserted that the Speech or Debate Clause shielded him from prosecution.[53]  The Court disagreed and held that the Clause’s protection “does not extend beyond what is necessary to preserve the integrity of the legislative process.”[54]  The Court emphasized that the Clause’s “purpose [was not] to make Members of Congress super-citizens, immune from criminal responsibility.”[55]  The Court held that the Clause did not prevent prosecution of a Senator for acceptance of a bribe because accepting a bribe is not an act within the legitimate legislative sphere.[56]

            In Brewster, the Court recognized the potential for Executive abuse of the federal bribery statute to harass the Legislature.[57]  The Court reasoned that, on balance, the potential for abuse did not weigh heavily, because “our history does not reflect a catalogue of abuses at the hands of the Executive.”[58]   The Court concluded that “[d]epriving the Executive of the power to investigate and prosecute and the Judiciary of the power to punish bribery of members of Congress is unlikely to enhance legislative independence.”[59]

            Similarly, in Hutchinson v. Proxmire,[60] the Court held that the Speech or Debate Clause does not immunize Members of Congress from liability for making defamatory statements outside of Congress.[61]  There, a Member originally made allegedly defamatory statements inside Congress and later republished the allegedly defamatory statements in newsletters and a press release.[62]   In holding that the Speech or Debate clause provided no defense, the Court reasoned that republication of the comments was neither “essential to the deliberations of the Senate . . . [nor] part of the deliberative process.”[63]  The Court distinguished between Congressmen informing themselves through committee hearings, which is protected by the Clause and cannot support civil or criminal liability, and informing constituents, which is not protected.[64]

            Much like accepting a bribe or making defamatory statements outside Congress, a court likely would hold that trading on or disclosing material non-public information for personal gain is not within the “legislative sphere” protected by the Speech or Debate Clause.  Like bribery statutes, the STOCK Act aims to prevent Members of Congress and their staffs from abusing office for financial gain.  Permitting Members of Congress and staff to profit by trading on material nonpublic information will not enhance legislative independence.  

The Speech or Debate Clause May Nevertheless

Inhibit Enforcement of the STOCK Act

            In its submission to Congress in support of the STOCK Act, the SEC vaguely warned that “investigations into potential trading or tipping by Members of Congress or their staff could pose some unique issues, including those that may arise from the Constitutional privilege provided to Congress under the Speech or Debate Clause.”[65]  That warning may prove to be an understatement.  The Speech or Debate Clause precludes prosecution for an unlawful act, if the underlying elements of the offense require inquiry into or proof of conduct within the legislative sphere.[66]  The Clause may pose problems for investigators seeking evidence to establish the STOCK Act’s requirement that material non-public information used for trading must be obtained in connection with a Member’s official duties. 

            The Supreme Court has held that “a Member of Congress may be prosecuted under a criminal statute provided that the Government’s case does not rely on legislative acts or the motivation for legislative acts.”[67]  For example, in Brewster, the Court reasoned that proving the offense of bribery did not require any “inquiry into how [the Congressman] spoke, how he debated, how he voted, or anything he did in chamber.”[68]  The prima facie elements of accepting a bribe are: (a) an offer of some benefit; and (b) a promise, in exchange, to act a certain way.[69]  The prosecution did not need to show that the Congressman actually voted the way he promised in exchange for the bribe.[70]  Thus, the Court held that the Speech or Debate Clause provided no protection.[71]

            Unlike bribery, the STOCK Act may require inquiry into matters within the legislative sphere.  To prove insider trading under § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, the prosecution must show (a) that the insider traded, and (b) that he or she traded on the basis of material nonpublic information.[72]  Proving that the insider traded “on the basis of” inside information requires the prosecution to show that the insider “was ‘aware of the material nonpublic information’ when he made the purchase or sale of the securities.”[73]  Proving insider trading by a Member of Congress or staffer thus requires inquiry into how they became aware of the non-public information. 

            Members of Congress regularly obtain information in the course of legislative fact-finding investigations that may be considered material and nonpublic.  Congressional investigations unquestionably “fall within the ‘legislative sphere,’ and are shielded by the Speech [or] Debate Clause.”[74]  Authorizing an investigation, holding hearings, and preparing reports are all “integral parts of the [Legislature’s] deliberative and communicative processes.”[75]  As a practical matter, the Speech or Debate Clause may bar prosecution of a Member of Congress or staffer for insider trading where it is alleged that the Member or staffer obtained information in the course of an investigation. 

            Similar problems may stymie enforcement of the Act against a Member of Congress or staffer under a “tipper” theory.  To prove tipper liability, prosecutors must prove that the Member of Congress disclosed information in breach of duty.[76]   That duty extends to material non-public information “derived from [the Congressman’s] position . . . or gained from the performance of [his or her] official responsibilities.”[77]  However, a Member’s “performance of [his or her] official responsibilities” is at the heart of what the Speech or Debate Clause protects. 

The Speech or Debate Clause’s Testimonial Privilege

May Present a Roadblock to Investigating Tippee Liability

            The Speech or Debate Clause not only protects Members of Congress and staff from prosecution, it also provides a privilege from discovery about legislative acts in proceedings involving third parties.  Members of Congress and staff may not be compelled to testify about legislative acts or produce documents relating to legislative acts, “even with respect to potential wrongdoing by third parties.”[78]  The Clause’s testimonial privilege “extends to non-disclosure of written legislative materials.”[79]  The D.C. Circuit has held that “[a]s discovery procedures can prove just as intrusive as naming [Members]. . . parties to a suit . . . [A] party is no more entitled to compel congressional testimony – or production of documents – than it is to sue congressmen.”[80]   The Clause’s “bar on compelled disclosure is absolute” and applies equally in civil and criminal matters.[81]  

            In Brown & Williamson Tobacco,[82] a company attempted to subpoena documents related to a private lawsuit from two Congressmen.[83]  The D.C. Circuit refused to enforce the subpoenas because of the Speech or Debate Clause, holding that the Clause prohibits compelled disclosure whether or not the Member of Congress is the target of the investigation.[84]

            The Speech or Debate Clause thus could be used to preclude discovery of evidence needed to establish that a private party is liable as a tippee for trading based on information leaked from Congress.  Proving tippee liability requires proof that the tippee knew or should have known that the tipper disclosed the information in violation of a fiduciary duty.[85]  Thus, to establish tippee liability under the STOCK Act, the prosecution must prove that the tippee knew that a Member or staffer disclosed information either “derived from [the official’s] position . . . or gained from the performance of [his or her] official responsibilities.”[86]  Proof that the tippee knew of a Member’s breach necessarily requires proof that the Member actually breached the STOCK Act’s fiduciary duty -- which in turn could require inquiry into the forbidden legislative sphere. 

            For example, proving that a Congressman learned information through a congressional investigation and then disclosed that information in violation of the STOCK Act’s duty could require testimony or other evidence about the scope and subject matter of the investigation.  Because congressional testimony and other evidence related to legislative acts, e.g., congressional investigations, are privileged by the Speech or Debate Clause, that evidence may be unobtainable.[87]

            There are, of course, potential ways for prosecutors to attempt to circumvent the Speech or Debate Clause to obtain requisite evidence.  Prosecutors may be free to subpoena or interview companies or individuals that have provided information to Members of Congress or their staffs.  For example, the Third Circuit has reasoned that records created and maintained by third parties are likely discoverable even if they contain material arguably privileged by the Speech or Debate Clause, because Members of Congress and their staffs have substantially less interest in maintaining the secrecy of documents possessed by third parties.[88]

Conclusion

            Because efforts by the Executive Branch to prosecute Members of Congress and their staffs for violating the STOCK Act undoubtedly would be complicated by the Speech or Debate Clause, STOCK Act enforcement could miss the statute’s intended targets and fall primarily on private individuals and businesses interacting with Congress.  The Act may have a beneficial in terrorem effect on the conduct of Members and staff, but not much more.  It is likely that any investigation into potential violations of the Act by Members of Congress or staffers of necessity would focus on gathering information from private parties, rather than the congressional targets of the investigation.  Private parties who have regular communications with the Congress, particularly political intelligence professionals, must consider how communications with the Hill could subject them to liability under the STOCK Act’s new restrictions.