Fraudulent trading in securities is succinctly defined in title 17 of the Commodity and Securities Exchanges, part 240 of the general rules and regulations of the Securities Exchange Act of 1934, subpart A, which relates to manipulative and deceptive devices and contrivances (17 C.F.R. § 240.10b-5):
“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.”
Notice that this applies to “any person.” Words have meaning. In fact, that’s what words are for, to explain things plainly. Any person means simply that: any person whatsoever. Thus, the broad anti-fraud provisions of 17 C.F.R. § 240.10b-5 do not admit of exceptions. Exceptions are not permitted, for reasons articulated by Chairman Levitt of the United States Securities and Exchange Commission in a 1998 address to the legal and investment community:
“Our markets are a success precisely because they enjoy the world’s highest level of confidence. Investors put their capital to work – and put their fortunes at risk – because they trust that the marketplace is honest. They know that our securities laws require free, fair, and open transactions.”
Though the broad anti-fraud provisions just described don’t mention insider trading expressly, interpretations by the courts have led to the most important developments in insider trading law in the United States (Newkirk & Thompson 1998).
Let’s assume neither you nor I are members of Congress. If either of us runs afoul of insider trading law, we risk severe punishment at the hands of the federal justice system. That risk is more than hypothetical, too, because the SEC uses a number of sophisticated software programs to analyze transactions made at the security exchanges, programs that look for trends in market behavior by security purchasers and sellers. When a trend is sniffed out that smacks of insider trading in the slightest, ears at the SEC perk up, and an investigation is conducted. If that investigation uncovers more evidence, the SEC visits the home and place of work of the potential violator, seizing papers, bank accounts, telephone records, and anything else that might support a criminal case against them.
Case in point: A hedge fund manager was recently sentenced to 11 years in prison after being convicted of insider trading (Mcardle, writing in The Atlantic, 2011). That particular hedge fund manager happened to profit mightily from his insider trades, but it isn’t necessary that one profit in order to be charged with the crime of insider trading. The fellow who passed insider information on to the hedge fund manager has also been indicted on charges of insider trading, and faces a long stint in prison if he is convicted, even though — from all indications — he didn’t make a dime.
True, Mcardle makes it clear in her article that a conviction will not be easy for the prosecution, but the point is that the SEC is pursuing the case with gusto. The lesson? Don’t mess with the SEC by violating their sacred rules against insider trading. Even if you don’t profit from the deal, you are likely to spend huge sums of money defending yourself in court, and if you are convicted, you will have the pleasure of wearing an orange jumpsuit, behind bars, for a plurality of years.
But what if you or I were members of Congress? That’s evidently another story. From all indications, members of Congress have enjoyed an exemption from the SEC rule on insider trading for many a moon, to the point that — according to Jack Abramoff, no stranger to the joys of prison life himself (CNBC, 11 Nov 2011) — they often brag, to each other and to their contacts in the business world, about their insider trading exploits. As further evidence of the “congressional exemption,” Senator Scott Brown (R-Massachusetts) recently filed a bill to prohibit congressional insider trading (CNN wire staff, 15 Nov 2011).
Were the congressional exemption not a genuine, de facto reality, there would be no need for such a bill. Suffice it to say that a number of senior legislators in both houses of Congress have been trading in securities under circumstances that have all the earmarks of insider trading transactions, using confidential information they came by as a result of privileged behind-closed-door discussions. The congressional perpetrators involved hail from both sides of the aisle, too, and include names familiar to all of us.
If true, there seems little doubt that, were a full-scale investigation carried out, many more names — including perhaps a goodly part of that raft of legislators famously known for skirting close to the edge on a number of legal fronts — would likely float to the surface. I use the term float intentionally. It makes my blood boil to think any of our elected officials are engaging in such behavior. And it boils more furiously to realize that the commission charged with ensuring such behavior does not go unpunished has been looking the other way for years.
Which begs this question: if a congressional exemption exists, how did it come into existence? And how strong, enduring, and legal is such an exemption? Some, including perhaps Senator Brown — whose bill aims at bringing such an exemption to a halt — firmly assert that the exemption is not only real, but legal to boot. In fact, Brown’s STOCK bill has the unnerving character of implicitly legitimizing the congressional exemption, by presuming it legal as a means of bringing it to a definite end.
Senator Brown seems to be saying “Whoa, kids, these poor, ignorant, nice members of Congress had no idea it was not in the best interests of the nation for them to be allowed to make insider trades in securities. But, hey, now that they know, tell you what they’re gonna do: they’re gonna give up that right of theirs. Yes, in a gesture of abject magnanimity, they’re gonna refuse to ever, ever, ever do it again.”
How altruistic! Don’t you just love these guys?
Well, maybe not. Let’s look at things another way, shall we? According to one legal scholar (Donna Nagy, 2011) there is no legal basis for the so-called congressional exemption. None whatsoever. If it exists — and apparently, ipso facto, it does — then it does so only because the SEC has chosen not to investigate members of Congress for violations of that kind, even when strong evidence comes to light to indicate that such violations are taking place. You don’t think the SEC computers failed to see those trends in congressional transactions, do you? Let’s get real. Honestly…
Senator Brown’s STOCK bill makes it illegal for members of Congress to engage in insider trading? Balderdash! It’s already illegal! Brown’s bill, therefore, is worse than insulting. If Congress had any spine at all, it would rise up as one and tell him so. But, then, Congress has no spine. The SEC exists, in part, to strengthen that spine, but from all indications the SEC has fallen down on the job.
So, does that makes the SEC guilty of aiding and abetting criminal behavior? It does, though few if any are presently making that point in print. Some might say the SEC isn’t culpable for looking the other way, because the officials involved are not profiting from the transactions that members of Congress are making. Yet, if an executive of a corporation who passes on insider information to a hedge fund manager and doesn’t make a dime on the deal can be indicted for insider trading, then why shouldn’t SEC officials who know — or ought to know — about congressional insider trading and ignore it be treated in a similar fashion?
Maybe a few officials at the SEC need to be indicted and prosecuted for failing to enforce their own laws. Slap some of those officials with fines and a few years in prison, and see how well their successors do at the job of enforcement into the future.
Nagy’s arguments are right on target: Insider trading is criminal, whether the perpetrator is an elected member of Congress or not. In fact, it seems obvious that the level of criminality involved should be elevated if the perpetrator is an elected official, because such behavior is tantamount to accepting a bribe, and to engaging in the worst species of corrupt practices.
Every member of Congress should be held responsible for making sure they, their family members, and every member of their staff and their families, are taking strenuous steps to avoid insider trading. There should be posters on every bulletin board in Washington D.C. extolling the criminality of such practices, and exhorting the reader to report possible violations. When a member of Congress becomes informed that insider trading has occurred by anyone in their families, or by anyone on their staff, they should be held responsible for reporting such activity, immediately, to criminal authorities.
In the face of these serious allegations it is painful to contemplate the possibility that our own legislators are not only failing to report such things when they learn of them, but of actually behaving, themselves, in ways that undermine the integrity of our most sacred markets. The horrible economy of the past several years speaks loudly, not only for reforms, but for restitution and punishment of the offenders.
What part of “Ignorance of the Law is No Excuse” don’t we understand? If that epithet applies to an ordinary Joe and Judy like you and me, it ought to apply to our elected officials in spades. Look, if one of us violates the law, even if we didn’t realize the law existed, we can go to prison for a long, long time. You and me, kiddo. Yes, even you. And Yes, even me. Why should the officials we elect to high office be treated any differently?
My point is this: from all the evidence I’ve seen, the congressional exemption doesn’t exist. Members of Congress may have been given a pass by the SEC in the past, but that doesn’t take them (Congress or the SEC) off the hook. Congressional members and their families who engaged in insider trading should be held accountable, charged, prosecuted, and — if convicted — sent to prison. SEC officials who ignored evidence that congressional insider trading was taking place should likewise be held accountable, charged, and — if convicted — sent to prison as well. After all, none of this would have been possible without the willful refusal on the part of the SEC to impartially enforce their own laws on all of us, not just on you and me.
Short of that, maybe everyone who is not a member of Congress who has ever been charged, convicted, fined, and sentenced for insider trading in the past should have their convictions summarily overturned. Agreed, that makes no sense (I’m all for a strong enforcement of SEC laws because it strengthens the securities market, and boy do we need a strong securities market today), but neither does allowing the SEC and members of Congress to engage in criminal behavior with impunity. And, of course, I could speak here of much more than insider trading, though that’s another story.
Congress is responsible for defending, protecting, and enforcing the law. The SEC operates to make sure the laws relating to our securities exchanges are obeyed by all. These responsibilities are trampled the moment an official in the SEC, or any member of Congress, behaves as though he or she, or anyone within the purview of their sphere of influence is above the law. Allowing members of Congress to break the law turns our entire system of justice on its head, and creates an environment in which lawlessness is enabled to seep into every facet of society. On the contrary, members of the SEC, and members of Congress, must be held to the highest standards of honesty and integrity, and when those standards are violated, each violator must be brought to account by the courts of justice and punished severely.
- CNN Wire Staff. 2011. Bill Filed to Prohibit Congressional Insider Trading. CNN, November 15, 2011.
- Javers, Eamon. 2011.Congress Members Took Part in Insider Trading: Abramoff. CNBC, 11 November 2011.
- Keith, Tamara. 16 April 2013. How Congress Quietly Overhauled Its Insider-Trading Law. NPR It’s All Politics.
- Mcardle, Megan. 2011. Can You be Guilty of Insider Trading without Personal Gain? The Atlantic, October 27, 2011.
- Mullins, Brody. 2011. Momentum Builds for Insider Trading Ban for Congress. WSJ, 17 November 2011.
- Nagy, Donna M. 2011. Insider Trading, Congressional Officials, and Duties of Entrustment. Boston University Law Review, Vol. 91, p. 1105, 2011.
- Newkirk, Thomas C., and Melissa A. Robertson. 1998. Insider Trading — A U.S. Perspective. U.S. Securities and Exchange Commission.