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Congressional Insider Trading: Where Things Stand Now


President Obama calls the STOCK Act "a good first step."

MINYANVILLE ORIGINAL Former Goldman Sachs (GS) director Rajat Gupta's insider trading trial is currently entering its third week, in a case that has already sent Galleon Group founder Raj Rajaratnam to prison and won more than two dozen other convictions.

Back in 2011, when Rajaratnam prepared to stand trial on insider trading charges involving 35 stocks, among them Google (GOOG), Advanced Micro Devices (AMD), IBM (IBM), eBay (EBAY), and Goldman Sachs, I was particularly shocked to find out that if Rajaratnam had been a US Senator rather than a $7 billion hedge fund manager when he made the trades in question, there would have been no criminal proceedings at all.

Believe it. As Craig Holman, government affairs lobbyist at nonprofit watchdog group Public Citizen, explained, the Securities and Exchange Act did not apply to members of Congress.

Holman may be America's foremost expert on the subject; he told me he had been "working on this for years" before the issue gained any traction.

In a 2009 article on The Hill's "Congress Blog," Holman explained the loophole:

The Securities and Exchange Commission (SEC) does not have the authority to hold employees of Congress or the Executive Branch liable for using non-public information gained from official proceedings for insider trading. Under current law, "insider trading" is defined as the buying or selling of securities or commodities based on non-public information in violation of confidentiality -- either to the issuing company or the source of information. Most federal officials and employees do not owe a duty of confidentiality to the federal government and thus are not liable for insider trading.

"Any inside, non-public knowledge they gain can be acted upon," Holman told me in a telephone interview. "Some of the stories are just… breathtaking."

Engaging in "the type of insider trading that would send Martha Stewart to prison" was not illegal for our representatives in Washington, Holman told last June. "They go into hearings and confidential meetings with business interests, understanding new legislation is going to come out next week," and are free to use that information to guide their trades. (According to one widely-cited study, US Senators' stock portfolios annually outperformed the market by 12%. Over the same period, US households annually underperformed the market by 1.4%.)

But legislators' actual returns are really almost beside the point.

"Whether members of Congress are in fact cashing in on insider information, or coincidence just makes it appear so, the damage to the integrity of the federal government is the same," Holman said.

Congresswoman Louise Slaughter (D-NY) first introduced the STOCK Act in 2006, along with Congressmen Tim Walz and Brian Baird. The Act would make it illegal for members of Congress to trade stocks based on inside information, but it continued to languish. Victoria Dillon, Congresswoman Slaughter's press secretary, told me lawmakers were simply not interested.

"The first time this legislation was introduced, 14 people endorsed it," she said. "The last time, it got nine. Congresswoman Slaughter is saying, 'We shouldn't have the opportunity to do this. [Insider trading] shouldn't be legal. This is not one of the more complex pieces of legislation. This is common sense.'"

Then, this past November, Steve Kroft -- with guidance from Craig Holman -- ran with it on 60 Minutes. Kroft called out House Speaker John Boehner (R-Ohio); House Minority Leader Nancy Pelosi (D-Calif.); and Rep. Spencer Bachus (R-Ala.), chair of the House financial services committee. (All the lawmakers denied any insider trading.)

Suddenly, according to Holman, Congress "fell over itself" in getting the STOCK Act passed.

In an email, he explained what happened next:

The Senate picked up the STOCK Act first for a floor vote, and much to my surprise several senators added strengthening provisions. Sen. Grassley added the political intelligence component, which would require private investors who roam the halls of Congress for insider information to register under LDA (Lobbying Disclosure Act) as "political intelligence" operatives and disclose their clients. This would enable us to enforce the insider trading laws against these operatives. Sen. Cornyn added an anti-corruption enforcement provision, which would clarify to the courts that government corruption can consist of just honest services fraud and does not need to proof of quid pro quo. So the Senate strengthened the STOCK Act.

However, there were problems. After the Senate voted 96-3 in favor, the STOCK Act found itself on life support.

Here's Holman again:

I was then pushing for the stronger version to be accepted by the House as well. It was heading that way, as even Baucus signed off on the strong measure and sent it to the House floor. As you can imagine, Wall Street hit the chamber with a lobbying campaign to delete the stronger provisions, and Eric Cantor complied, pulling the bill from the floor.

Holman then sent a letter to Congress, which read:

Public Citizen is writing out of deep concern that the delaying tactics by the House Republican leadership, under the direction of House Majority Leader Eric Cantor (R-Va.), are intended to weaken the original legislation. Stalling is providing lobbyists and others with precious time to deflate the scope and nature of the STOCK Act.

Holman tells me that he then "went back to Sen. Reid in an effort to get him to propose a slightly revised stronger measure for conference, where I believed we would prevail. Reid decided he did not want to fight any further on the STOCK Act and so accepted Cantor's version, which is now law."

In a statement released in February, Holman wrote: "What a sorry -- but telling – display."

So where do things stand now?

According to a White House fact sheet, the STOCK Act "expressly affirms that Members of Congress and staff are not exempt from the insider trading prohibitions of federal securities laws" and "makes clear that Members and staff owe a duty to the citizens of the United States not to misappropriate nonpublic information to make a profit."

It also "requires that Members of Congress and government employees report certain investment transactions within 45 days after a trade," and adds six additional ethics requirements Members and staff must follow.

Holman says the STOCK Act is "now moving into the implementation stage," and explains the logistics:

In order to monitor compliance to the law, Congress and the Office of Government Ethics (OGE) for the executive branch, must set up systems of on-line disclosures of trading activity and personal financial reports. Congress is well on its way to doing so, making use of the LDA system of electronic filing and disclosure that we mandated in HLOGA in 2007.

OGE must build its electronic filing and disclosure system largely from scratch, which it is on its way to doing. I joined several transparency groups and met with the director and senior staff of OGE yesterday, and was pleasantly surprised to learn that the agency has been consulting with their congressional colleagues about how to set up such a system. OGE has 18 months since signing of the Act to comply and develop a centralized on-line reporting system. In the meantime, each individual executive branch agency is supposed to set up their own web-based disclosures for their employees by August 31. I can already tell that most agencies are pursuing this mandate haphazardly, if at all. I am not expecting much on August 31. But the most important task is to get OGE's centralized system set up next year.

Will it work? It's anyone's guess. President Obama calls the STOCK Act "a good first step." Holman says that, while the Cantor measures are weaker than he would have liked, they are "still good measures" and "the most significant ethics achievement of the 112th Congress."

As for why it took the better part of a decade and an expose by the most influential news program in the western world to explicitly prohibit insider trading by our elected officials?

Pointed out Melanie Sloan, executive director of the Center for Responsibility and Ethics in Washington and a former federal prosecutor, "There's rarely support for things that limit lawmakers' behavior."
No positions in stocks mentioned.
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