Are Members of Congress Immune from Insider Trading Laws? Khuzami Says "No"
Susan M. Greenwood | Bloomberg Law
Robert Khuzami, Director of the Division of Enforcement (Division) of the Securities and Exchange Commission (SEC) testified before the Senate Committee on Homeland Security and Governmental Affairs concerning the “Application of Insider Trading Laws to Trading by Members of Congress and Their Staffs.” His testimony highlighted the SEC’s accomplishments in insider trading cases and stressed that any Congressional changes to insider trading laws could be a severe detriment to the agency’s continued success.
Strides Forward in Enforcement Actions
Khuzami first noted that fiscal years 2010 and 2011 saw a marked increase in enforcement actions focused on insider trading. In particular, in 2010 there was a 43 percent increase in such actions. Moreover, Khuzami recounted the increase in judgments, especially in the actions against Galleon Group founder Raj Rajaratnam and those within his insider trading ring. In addition to targeting traditional insider trading, Khuzami also explained that the SEC charged multiple companies, including Merrill Lynch, Pierce, Fenner & Smith, with “the misuse or mishandling of material, non-public information.” According to Khuzami, companies that do not have or enforce policies to protect non-public information easily can use customer information for the company’s benefit or to give certain investors an unfair advantage.
The SEC’s pursuit of insider trading has benefited from multiple “initiatives targeted at ferreting out insider trading.” First, the Division established a Market Abuse Unit (MAU) to focus on “various abusive market strategies and practices, including complex insider trading schemes.” Second, Khuzami continued, MAU has utilized the Automated Bluesheet Analysis Project, a tool that allows staff to electronically search across “a database of more than one billion electronic equities and options trading records . . . to recognize suspicious trading patterns and identify relationships and connections among multiple traders and across multiple securities. . . .” Lastly, Khuzami said that the Division’s cooperation program is “encourag[ing] key fact witnesses to provide valuable information.”
Hands-off Approach to Insider Trading
“There is no express statutory definition to the offense of insider trading in securities,” Khuzami said. Although Congress has authorized the SEC to seek monetary penalties and permitted private causes of action for contemporaneous insider trading, insider trading laws have been developed by the courts, particularly the classical and misappropriation theories of insider trading. Under these theories, Khuzami explained, both corporate insiders and outsiders may be held liable under Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, for trading on material, non-public information and tipping information to others.
Given the well-developed case law governing insider trading, Khuzami cautioned that “any statutory changes in this area should be carefully calibrated to ensure that they do not narrow current law and thereby make it more difficult to bring future insider trading actions against any such persons.”
Insider Trading and Members of Congress
According to Khuzami, there is precedent to apply insider trading laws to federal employees. For example, in March 2011, the SEC brought insider tradingcharges against a Food and Drug Administration chemist who traded on information gleamed through his employment. While no such precedent exists with respect to Members of Congress and their staff, Khuzami noted that “[t]here is no reason why trading by Members of Congress or their staff members would be considered ‘exempt’ from the application of these principles to such trading. . . .”
However, Khuzami did note that charging Members of Congress or their staff with insider trading could raise certain “unique issues.” Insider trading is premised on the breach of a duty. While Congressional staff owe a “duty of trust and confidence” to their employer, “[c]ommentors have differed on whether securities trading by a Member based on information learned in his or her capacity as a Member of Congress violates the fiduciary duty he or she owes to the United States and its citizens, or to the Federal Government as his or her employer.” The analysis of the duty owed by Members of Congress and their staff also may be informed by the Code of Ethics for Government Service, which prohibits using confidential information acquired “‘in the performance of governmental duties as a means for making private profit.’”
The other main questions for insider trading—was the information material and non-public, did the defendants have the requisite intent—depend on the relevant circumstances of each particular case. Khuzami observed that “it is difficult to generalize about the outcome of any particular scenario,” but emphasized that the federal securities laws, including prohibitions against insider trading, apply with full force to Members of Congress and their staff.
Finally, Khuzami addressed an issue specific to insider trading based on tipping information to others. Here, he explained, Members of Congress and their staff may have some protection based on “the Constitutional privilege provided to Congress under the Speech or Debate Clause.” Although the privilege traditionally concerns speech or debate on the floor of Congress, Khuzami noted that it has been extended at times and potentially could apply if the “communication of nonpublic information regarding legislative activity to a third party falls ‘within the ‘sphere of legitimate legislative activity’ . . . .”
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