Strange Bedfellows: Insider Trading And Political Intelligence

The Nervous Dairy Farmer

Imagine the following: The owner of an organic dairy farm is concerned. Every day, the news is filled with reports that a bill to cut crucial funding for dairy farms is in the works. The dairy farmer calls up his Congressman, a member of the House Committee on Agriculture, anxious and eager to learn anything to help put his mind at ease. The Congressman is unavailable, but his aide tells the dairy farmer not to worry, the Congressman will make sure the bill does not make it out of the Committee. Relieved, and feeling a bit greedy, the dairy farmer calls his brother, a hedge fund manager, and asks him whether they can somehow make money on the information he just learned. The next day the brother's fund purchases 100,000 shares of OrgDairy Inc., the nation's largest publicly-traded organic milk producer. Two days later, it is publicly announced that the bill died in Committee. OrgDairy's stock price climbs 10 percent on the news and the brother's fund makes millions.

Has a crime been committed? By whom?

While the above hypothetical reads like a law school exam, it highlights some of the practical difficulties in prosecuting cases based on so-called ''political intelligence.'' This term - used to refer to (i) information about government actions and legislation that could impact an industry or business, or (ii) information about companies learned by government officials through their official responsibilities - has taken center stage in recent months. In April 2013, Senator Chuck Grassley of Iowa launched an investigation relating to Height Securities LLC, an investment-research firm, regarding information it obtained and disseminated about a health insurance funding decision by the federal government. The Federal Bureau of Investigation and the Securities and Exchange Commission reportedly have followed suit.

But is trading on political intelligence really insider trading? The answer is complicated for a couple of reasons. First, insider trading laws do not explicitly prohibit trading on all information obtained from government sources. Nor could they, given our transparent, democratic system of government. Second, the elements of insider trading - shaped by cases involving corporate insiders and their companies' confidential, business information - do not fit neatly with typical political intelligence fact patterns.

'Political Intelligence' and Insider Trading Theories

Courts have developed two theories of insider trading. In its most basic form, under the ''classical'' theory of insider trading, the securities laws are violated where a corporate insider discloses (or trades) on inside information in breach of his fiduciary duty to shareholders of the company.1 The ''misappropriation'' theory, by contrast, targets information improperly used or disseminated by outsiders who disclose or trade on material non-public information in breach of a duty of confidentiality to the source of information, usually but not always their employer, who lawfully provided it to them.2 In other words, merely trading on inside information is not per se illegal; to be liable, the inside information must have been provided in breach of a duty of trust or confidence and in exchange for a benefit to the source of the information.

While considered distinct, the classical and misappropriation theories have substantial similarities. Key among those are the following elements: (1) the information was non-public; (2) the information was material; (3) the information was provided in breach of a duty of trust or confidence, i.e. it was provided in exchange for a personal benefit;3 and (4) the recipient knew the information was provided in breach of a duty.

Courts have not had frequent occasion to apply these elements to cases involving government or legislative actions. Indeed, until recently, serious ambiguity existed as to whether elected officials or their staff could even be prosecuted for trading on material non-public information (''MNPI'') they learned through the course of their jobs. Unlike the classic example of a company insider who owes a duty to his company's shareholders, members of Congress and their staffs owe no direct fiduciary duty to companies about which they learn information through their professional interactions and the scope of their duty of confidence to Congress itself has not been clearly delineated. In response to these ambiguities, in April 2012 Congress passed the Stop Trading on Congressional Knowledge Act (the ''STOCK Act''), in which it sought to ''affirm a duty of trust and confidence owed by each member of Congress and each employee of Congress.''4 This affirmation ''ensures that Members and staff are subject to the same liabilities and remedies as any other person who violates the securities laws.''5 Accordingly, the Act amended 15 U.S.C. § 78u-1 (''Civil Penalties for Insider Trading'') to include the following provision:

Each member of Congress or employee of Congress owes a duty arising from a relationship of trust and confidence to the Congress, the US Government, and the citizens of the US with respect to [MNPI] derived from such person's position . . . or gained from the performance of such person's official responsibilities.6

This provision of the STOCK Act only goes so far, however: on one hand, the legislative history makes clear that Congress was concerned with situations in which its members and staff learned of MNPI through their jobs and traded on that information, and the STOCK Act affirms that they do indeed owe duties of trust and confidence (thus doing through legislation what has traditionally been left to the courts); on the other hand the STOCK Act does not address exactly what information Congresspeople and their staffs must treat as confidential or when they must do so.

This disconnect may be explained by the delicate balancing act Congress undertook in passing this legislation. While Congress wanted to confirm that its members were subject to insider trading laws, it needed to ''legislat[e] in a way that does not undermine the interactions of Members and the general public.''7 In highlighting this conflict, the Senate Committee on Homeland Security and Governmental Affairs identified a fundamental difference between members of Congress and corporate insiders:

Every day, Members and their staff exchange information and views with constituents and numerous other individuals, including representatives of companies, associates, non-profit organizations, and the media. These interactions are vital to the democratic process. Exchanges of information between Congress and the American public allow Members to explain actions that Congress is taking, or is considering. And these exchanges allow the American people to share with Members their views on how actions of the government may help, or hurt, them. In this respect, the role of a Member of...