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PH COVID-19 Client Alert Series: Novel Legal Issues Arise from U.S. Lawmakers’ Potential “Insider” Trades Based on Information Regarding COVID-19 Threat
By Kenneth M. Breen, Phara A. Guberman & Scott Glicksman
According to media reports, at least four U.S. Senators allegedly sold millions of dollars’ worth of stock shortly before the nearly unprecedented market declines triggered by the COVID-19 pandemic. The U.S. Department of Justice (“DOJ”), in conjunction with the U.S. Securities and Exchange Commission (“SEC”), is investigating whether these members of Congress traded based on confidential information ahead of the market turmoil caused by the COVID-19 crisis.
A novel question remains as to the legality of these actions under various insider trading laws and any potential downstream charges stemming from these trades. Where an issue like the COVID-19 pandemic has been covered so extensively by the media, it will likely be difficult to establish what information was material nonpublic information and what information was part of the public domain.
There is also a more general question about whether regulatory information is considered “property” for purposes of insider trading law. The government is not a business and it may either carry out or deviate from its planned adoption of regulations or action. Pre-decision regulatory information may or may not be considered the government’s “stock in trade” and, therefore, may or may not be considered “property” for purposes of a Title 18 criminal violation.
Regardless of the potential defenses and novel theories of prosecution, DOJ and SEC investigations of this trading activity have already begun. There will likely also be shareholder actions against the members of Congress and the downstream tippees, some of which have already started.
Previous Insider Trading Cases Against Members of Congress
There is at least some precedent for insider trading investigations involving members of Congress. This year, former Rep. Christopher Collins (R. N.Y.) was sentenced to more than two years in prison after pleading guilty to charges
In the Collins case, Cameron Collins was sentenced to five years of probation, including six months of home confinement, and a $150,000 fine.
In another example, former Senate majority leader Bill Frist was investigated by the DOJ and SEC when in 2005, he sold all of his stock in the $25 billion international company called Hospital Corporation of America (“HCA”), which was founded by his father and brother—and at which his brother was a director at the time. Frist sold a large sum of shares in the company just days before HCA’s stock price fell by nine percent in a single day. After an 18-month investigation, the DOJ and SEC jointly decided to not file charges in 2007. Ultimately, documents indicated that he began the process of selling the stock in late April 2005, months before he knew of HCA’s troubles. According to records Frist produced during the investigation, he had consulted with a staff attorney at that time when he said he was unaware of HCA’s problems collecting payments from uninsured patients.
Senator Frist was also at the center of another trading controversy later in 2005, when he announced that the Senate would vote on a bill which would make $140 billion of public funds available to pay off asbestos liability claims.
Insider Trading Investigations Involving Leaks of Media Embargoed Content
There is also at least some precedent for government enforcement of insider trading laws relating to leaks of media embargoed content. In 2003, John M. Youngdahl, a former senior economist at an investment bank, pleaded guilty to criminal charges, including insider trading, theft of government property, wire fraud, and conspiracy, brought by the DOJ in connection with the purchase of millions of dollars of 30-year bonds and bond futures minutes ahead of a Treasury Department’s announcement that it was ending the sale of such bonds.
Specific Insider Trading Prohibitions and Protections for Members of Congress
There is no “loophole” for members of Congress to avoid insider trading investigations. The Stop Trading on Congressional Knowledge (“STOCK”) Act,
Section 4 explains that this prohibition derives from a duty owed by members of Congress “arising from a relationship of trust and confidence to the Congress, the United States Government, and the citizens of the United States.” STOCK Act, § 4. In recognition of, and in furtherance of that duty, the Act explicitly states that “Members of Congress and employees of Congress are not exempt from the insider trading prohibitions arising under the securities laws, including section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.” STOCK Act, § 4.
Even with the STOCK Act in place, the DOJ and/or SEC might face difficult burdens to establish insider trading liability as to a Senator or House Representative. In the case of the recent conduct related to COVID-19, this would mean showing much more than that a member of Congress received a briefing on the potential impact of COVID-19 and then purchased or sold securities. For example, challenges would include whether much of the information relied upon was likely already in the public domain, and whether any confidential information obtained was not specific to a particular issuer or industry.
Further complicating an investigation is the existence of the Speech or Debate Clause of the U.S. Constitution, which protects members of Congress from prosecution for legislative activities.
Conclusion and Recommendations
These insider trading investigations into members of Congress may continue to expand how insider trading can be charged, including for downstream tippees as the prosecution risk is not limited to members of Congress. There is already precedent for criminal and civil charges against entities for trading on pre-decision government information.
The most well-known way to avoid prosecution, as set forth in Rule 10b5-1, is for members of Congress to invest personal holdings through a third-party that has set up a predetermined investment plan at a time prior to the receipt of material nonpublic information, or to set up a “blind trust,” with professional advisers who are solely and independently responsible for all investment decisions. Under a blind trust, the trustees and beneficiaries generally communicate only to discuss asset distributions, general investment goals, or summary trust information required for tax purposes.
Further, robust compliance procedures and internal controls are always critical for broker-dealers, investment advisers, and other regulated entities. It is important for investment advisers and hedge funds to continue to exercise caution to prevent the receipt of any illicit confidential information. Investment advisory firms may want to reevaluate their internal policies regarding confidential information. Such policies should cover “government decisions” and pre-decision information including, but not limited to, approvals, funding, and policy decisions. Relationships with and information from paid consultants who are former government officials should also be closely evaluated.
These entities should also evaluate relationships they have with members of Congress and government agencies and implement special procedures for the treatment of any information obtained from discussions with any government employee. As part of internal compliance procedures, the best practice may be to require all employees to disclose to the internal compliance team any such relationships with any government employee, recently departed government employee, and/or his or her immediate family members.
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