Last year, Congress wrote and President Obama signed into law the Stop Trading on Congressional Knowledge Act of 2012 (the STOCK Act). When the law was enacted, Members of Congress, their staffs, and Executive Branch officials already were thought to be subject to insider trading laws. In addition, the same officials also were subject to ethics rules that prohibit using material, non-public information (MNPI) derived from their official position for private gain. Unfortunately, enactment of the legislation has had and will likely continue to have potentially significant ramifications for seemingly innocent conduct in the private sector. These unintended effects could be further compounded if proposals to amend the law to impose new conditions on the so-called “political intelligence” industry are enacted.
The STOCK Act places at risk anyone receiving MNPI from a Covered Official (a Member of Congress, a congressional staff member, an Executive Branch official, and certain judicial officers and employees) if the person receiving it personally profits from, or provides the information to a third party that profits from, the purchase or sale of securities based on the information. Generally, a person may not engage in securities transactions if he or she possesses MNPI obtained from a source who breaches a duty of trust and confidence. The STOCK Act has statutorily created a duty of trust and confidence held by these Covered Officials that could be breached. In determining whether information received from a Covered Official may implicate potential insider trading issues, you need to know whether the information is non-public (i.e., information that has not been publicly disclosed and widely disseminated). If the information is non-public, then you need to determine whether the information is material (i.e., information a reasonable investor would consider important when deciding to buy, sell, or hold a security). If the information is both non-public and material, then engaging in securities transactions on the basis of that information risks insider trading liability.
To supporters of the legislation, this all seems pretty straightforward. It is anything but. Acting upon so-called “political intelligence,” for example, may result in insider trading liability even though the person receiving the information would have no reason to know that it is non-public, material, and sourced from a Covered Official.
Given the potential implication of the changes in law made by the STOCK Act, best practices suggest using extreme caution when trading in securities or providing advice regarding the purchase or sale of securities on the basis of specific information about a particular company or industry. But where to draw the line? What kinds of questions should you be asking to determine whether the information was obtained directly or indirectly from a Covered Official and whether the information is non-public and material in nature? While there is no precedent to suggest that parties must refrain from trading or providing advice on the basis of information about a company or an industry obtained from a Covered Official in combination with independent analysis of the information (i.e., insights developed after analyzing information from multiple sources, including watching committee hearings on C-SPAN, discussing the issue with congressional staffers in many offices, or reading reports from think tanks that may themselves be based on input from Capitol Hill sources) recipients of information received directly or indirectly from Covered Officials should act carefully even in this situation.
Recent events have thrust investor decisions based in part on political information, including that formulated by political intelligence firms in Washington DC, back into the spotlight. Not surprisingly, news coverage has reignited the debate over the extent to which the political intelligence industry should be more strictly monitored or even regulated. Senator Charles E. Grassley (R-IA) and Congresswoman Louise Slaughter (D-NY) are reportedly drafting legislation that would impose disclosure requirements on political intelligence related activities akin to the requirements of the Lobbying Disclosure Act.
When the Senate version of the STOCK Act was on the Senate floor in 2012, Senator Grassley argued that “[when] a person seeks information from Congress in order to make money, the American people have a right to know the name of that person and who that person is selling that information to.” His amendment was adopted in the Senate, but rejected by the House, with some Members expressing concerns regarding logistical and constitutional issues. As a compromise, Congress charged the Government Accountability Office (GAO) with conducting a study.
On April 4, 2013, the GAO released its report on political intelligence and its role in the financial markets. While declining to make specific recommendations to Congress, GAO’s report notes several concerns with regulating the political intelligence industry, including the need for clarification of key terms in the STOCK Act, the scope and characteristics of any required disclosures, the need for a media exemption, and a potential “chilling effect” or slowing of communication between the government and the public. The report further highlights the difficulties inherent in assessing the role of political intelligence in any investment decisions, emphasizing the near impossibility of determining whether one piece of political intelligence results in a particular investment decision. The GAO noted, for example, that political intelligence often is bundled and with other political analysis, as well as legal and other information sources.
While the ultimate implications for the political intelligence industry are uncertain, nothing in what we know about the legislation will reduce the risks created by the STOCK Act.