S. 2038 (112^th): STOCK Act

GovTrack’s Bill Summary

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Library of Congress Summary

The summary below was written by the Congressional Research Service, which is a nonpartisan division of the Library of Congress.

House Republican Conference Summary

The summary below was written by the House Republican Conference, which is the caucus of Republicans in the House of Representatives.

This summary can be found at http://www.gop.gov/bill/112/2/s2038.

Background

While insider trading is already prohibited under House rules, in December 2011 the House Committee on Financial Services held a hearing on this issue and heard testimony from, among others, Robert Khuzami, the Director of the Enforcement Division for the U.S. Securities and Exchange Commission (SEC).

Mr. Khuzami testified that, “There is no express statutory definition of the offense of insider trading in securities.  The SEC prosecutes insider trading under the general antifraud provisions of the Federal securities laws, most commonly Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5, a broad anti-fraud rule promulgated by the SEC under Section 10(b).  Section 10(b) declares it unlawful ‘[t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.’  Rule 10b-5 broadly prohibits fraud and deception in connection with the purchase and sale of securities.  As the Supreme Court has stated, ‘Section 10(b) and Rule 10b-5 prohibit all fraudulent schemes in connection with the purchase or sale of securities, whether the artifices employed involve a garden type variety of fraud, or present a unique form of deception,’ because ‘[n]ovel or atypical methods should not provide immunity from the securities laws.’”

Mr. Khuzami went on to explain: “There are two principal theories under which the SEC prosecutes insider trading cases under Section 10(b) and Rule 10b-5.  The ‘classical theory’ applies to corporate insiders – officers, directors, and employees of a corporation, as well as ‘temporary’ insiders, such as attorneys, accountants, and consultants to the corporation.  Under the ‘classical theory’ of insider trading liability, a corporate insider violates Section 10(b) and Rule 10b-5 when he or she trades in the securities of the corporation on the basis of material, nonpublic information.  Trading on such information qualifies as a ‘deceptive device’ under Section 10(b), because ‘a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation.’  That relationship ‘gives rise to a duty to disclose [or to abstain from trading] because of the ‘necessity of preventing a corporate insider from . . . tak[ing] unfair advantage of . . . uninformed . . . stockholders.’”

“The Supreme Court has recognized that corporate ‘outsiders’ can also be liable for insider trading under the ‘misappropriation theory.’  Under this theory, a person commits fraud ‘in connection with’ a securities transaction, and thereby violates Section 10(b) and Rule 10b–5, when he or she misappropriates confidential and material information for securities trading purposes, in breach of a duty owed to the source of the information.  This is because ‘a fiduciary’s undisclosed, self-serving use of a principal’s information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information.’  The misappropriation theory thus ‘premises liability on a fiduciary-turned-trader’s deception of those who entrusted him with access to confidential information.’  Under either the classical or misappropriation theory, a person can also be held liable for ‘tipping’ material, nonpublic information to others who trade, and a ‘tippee’ can be held liable for trading on such information. 

“A common law principle is that employees owe a fiduciary duty of loyalty and confidence to their employers.  In addition, employees often take on contractual duties of trust or confidence as a condition of their employment or by agreeing to comply with a corporate policy.  Accordingly, employees have frequently been held liable under the misappropriation theory for trading or tipping on the basis of material non-public information obtained during the course of their employment.  This includes prosecution of federal employees who, in breach of a duty to their employer, the federal government, trade or tip on the basis of information they obtained in the course of their employment.”

Most notably, Mr. Khuzami pointed out, “The general legal principles described above apply to all trading within the scope of Section 10(b) and Rule 10b-5.  There is no reason why trading by Members of Congress or their staff members would be considered ‘exempt’ from the federal securities laws, including the insider trading prohibitions, though the application of these principles to such trading, particularly in the case of Members of Congress, is without direct precedent and may present some unique issues.”  This legislation attempts to clarify some of the practical questions raised by Mr. Khuzami’s testimony.

Summary

The House amendment strengthens the Senate’s STOCK Act, expands the scope of the bill to require more financial disclosures by government employees, and ensures that the law is workable and meets the goal of preventing those who hold public office (and their staff) from profiting from insider information.   

The following are the major elements of the “STOCK” Act, including the changes to the Senate-passed version: 

The bill would amend the Congressional Accountability Act of 1995 and the Ethics in Government Act to make clear that Members of Congress and congressional employees are prohibited from using nonpublic information for private profit.  In addition, the legislation would require the congressional Committees on Ethics to implement rules to that effect.

The bill would also affirm that Members and employees are not exempt from the insider trading prohibitions of regulations derived under the Securities Exchange Act of 1934 and Rule 10b-5 (see explanation in “Background” section below).

The bill would amend the Commodity Exchange Act to apply to Members, congressional employees, judicial officers, and judicial employees its prohibitions against certain transactions involving the purchase or sale of any commodity in interstate commerce, or for future delivery, or any swap.  (Note: the Senate bill only extended this prohibition to Members and congressional employees.)

The bill would also amend the Ethics in Government Act to require Members, congressional officers, and legislative and executive branch employees not subject to any waivers or exclusions to file reports on certain financial transactions.  Such transaction filings by federal government officials who already submit publicly available annual financial disclosure forms would be required within 30 days after the filer receives notification of any reportable transaction, but in no case later than 45 days after the transaction itself. 

This reporting window is intended to allow filers who receive a brokerage or other report at the end of the month time to accurately report transactions that may have occurred at the beginning of the month.  (Note: the Senate bill specified only a 30-day reporting requirement and also had conflicting provisions regarding which executive branch employees would be covered.)

The bill would also direct the Comptroller General to report on the role of political intelligence in the financial markets.  For the bill’s purposes, “political intelligence” is defined as information that is: 1) derived by a person from direct communications with an executive branch employee, a Member of Congress, or an employee of Congress; and 2) provided in exchange for financial compensation to a client who intends, and who is known to intend, to use the information to inform investment decisions.

The bill would also require the Senate and the House of Representatives to implement an electronic filing system for financial disclosure forms (not later than August 31, 2012, or within 90 days of enactment of this Act) and provide the public with on-line access to that information in a searchable database (not later than 18 months after the date of enactment of this Act).  Additionally, the bill would conform the public reporting requirements of the executive branch to this same timeline of the legislative branch.  (Note: the Senate bill allowed the Executive two years for the information to be put online and to become publicly searchable.)

Section 9 of the bill would require the Judicial Conference of the United States issue interpretive guidance to judicial officers and judicial employees clarifying the prohibition against the use of nonpublic information derived as a result of their position for private profit.  This section would also clarify that the amendment to the Securities Exchange Act affirming the duty of executive and judicial branch officers and employees arising from a relationship of trust and confidence is subject to the rules of construction in Section 10 of the bill and limited to prohibitions against insider trading.  (Note: the Senate bill only addressed these provisions to judicial officers.)

The bill would also include a rule of construction to clarify that nothing in the STOCK Act, or any amendments made by the Act, or any interpretive guidance issued pursuant to the Act shall be construed to prevent Members of Congress, congressional employees, or judicial and executive branch employees from performing any activities or requirements arising from the person’s official position, nor allow them to deviate from any existing legal or ethical requirements therein.

The bill would also prohibit individuals who are required to file financial disclosures from receiving preferential treatment in any initial public offering, if such treatment is not available to the public generally.  (Note: the Pelosi Provision was not addressed in the Senate bill.)

The bill would exempt from reporting requirements certain funds (e.g. mutual funds) if the fund is publicly traded, the assets of the funds are widely diversified, and the reporting individual neither exercises control over nor has the ability to exercise control over the financial interests held by the fund.

The bill would also ensure that a Member of Congress or other elected official who commits a crime does not receive a pension and expands the restriction to cover insider trading.

The bill would also limit bonuses paid to executives of Fannie Mae and Freddie Mac during any period of those entities’ conservatorship.

The bill would extend a restriction on post-employment negotiation to executive and judicial branch employees.  The requirement to disclose any negotiations to an individual’s supervising ethics office already applied to Congressional employees, but would be expanded to apply to all those who are required to file annual financial disclosures.  Additionally, the bill would require individuals who have filed such a notice of negotiations to recuse themselves from any related matter that may present a conflict of interest.  (Note: the Senate bill did not address this issue.)

The bill would also amend the criminal prohibition created in the Honest Leadership and Open Government Act of 2007 against Members of Congress and congressional employees attempting to influence the hiring decisions of a private entity on the basis of partisan affiliation to include officers and employees of the executive branch.  (Note: the Senate bill did not address this issue.)

Lastly, the bill would repeal the requirement that congressional candidate financial disclosures be transmitted to certain state officials, once those disclosures are all available online pursuant to section 8(b) of this Act, as well as conforming the retention requirement for Member financial disclosures to the requirements of this Act.  (Note: the Senate bill did not address this issue.)

Cost

According to the Congressional Budget Office (CBO), implementing this legislation would cost $4 million over the 2012-2013 period primarily for new computer hardware and software and additional labor to support the financial disclosure system required under the bill.  In addition, maintaining the new system would cost $1 million annually, CBO estimates.  In total, CBO estimates that implementing the legislation would cost about $9 million over the 2012-2017 period, assuming appropriation of the necessary amounts.

CBO also states that enacting S. 2038 could increase revenues from civil and criminal fines imposed on federal employees who use nonpublic information for personal financial benefit or who fail to file financial disclosure forms; therefore, pay-as-you-go procedures apply. Civil fines are recorded in the budget as revenues and deposited into the general fund of the Treasury. Criminal fines are recorded as revenues, deposited in the Crime Victims Fund, and spent in subsequent years. CBO expects that any net effect associated with collecting and spending such penalties would not be significant in any year.

House Democratic Caucus Summary

The House Democratic Caucus does not provide summaries of bills.

So, yes, we display the House Republican Conference’s summaries when available even if we do not have a Democratic summary available. That’s because we feel it is better to give you as much information as possible, even if we cannot provide every viewpoint.

We’ll be looking for a source of summaries from the other side in the meanwhile.