The Director of the SEC’s Division of Enforcement appeared before two Congressional Committees in the last week to testify about the Commission’s recent work in the area of insider trading. The testimony raised two interesting topics: (1) a review of the "new initiatives" instituted by the SEC to combat insider trading; and (2) information on how the current law of insider trading applies to securities trading by members of Congress and their staffs.
Mr. Khuzami’s testimony on December 1, 2011 (available here) was before the Senate Committee on Homeland Security and Governmental Affairs who were conducting hearings on "Insider Trading and Congressional Accountability." His testimony on December 6, 2011 (available here) was before the House Committee on Financial Services regarding H.R. 1148, the "Stop Trading on Congressional Knowledge Act," (and is very similar to his Senate testimony).
Mr. Khuzami told both Committees that "the detection and prosecution of those who engage in insider trading remains one of the Division of Enforcement’s highest priorities," making up approximately 8% of the cases brought by the Commission over the last of the decade (with that number increasing in 2010 and 2011). Mr. Khuzami cited numerous examples of these efforts, including the $92.8 million civil penalty against Raj Rajaratnam (previously discussed here).
Mr. Khuzami also highlighted "several new initiatives," including the establishment of a Market Abuse Unit, which focuses on various abusive market strategies and practices, including complex insider trading schemes." One investigative tool used by this Unit has been the Automated Bluesheet Analysis Project, which allows Enforcement staff "to search across this database to recognize suspicious trading patterns and identify relationships and connections among multiple traders and across multiple securities, generating significant enforcement leads and investigative entry points." The project has already led to "significant insider trading actions" that were not generated by one of the traditional external sources.
Mr. Khuzami also pointed to a newly-established cooperation program which is used to encourage key fact witnesses to provide information, and thereby preserve resources. He also testified that early coordination with the FBI, Department of Justice and others had helped with the Commission’s aggressive approach.
Trading by Members of Congress
Mr. Khuzami’s testified at a time when Congress was considering what, if anything, to do about the prospect of Senators, Representatives and staffers trading while in possession of information they obtained due to the positions they held. As Joseph Lieberman, the Chairman of the Senate Committee stated in his opening remarks: "[a] recent book by Peter Schweizer and a story based on it on ’60 Minutes’ have raised the very serious question of whether members of Congress have been using ‘insider information’ to make investments that enable them to make money they could not have made if they were not members of Congress." The book by Mr. Schweizer, "Throw Them All Out," is described here, while the "60 Minutes" piece is discussed here.
In his testimony before the Committee, Senator Scott Brown testified:
Consider this: A Member of Congress hears during a meeting that a program is going to be cut the next day. That member could then sell his or her stock in that sector and score a profit – or avoid losses – when the news breaks. Under current law, the congressman would likely walk away with a fatter investment account. For everyone else, it could mean you go to jail.
Mr. Khuzami did not specifically address Senator Brown’s hypothetical, but stated that "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." However, he pointed out that the issue – especially in the case of Senators and representatives – "is without direct precedent and may present some unique issues." He pointed out that " there are several fact-intensive questions – including the existence and nature of the duty being breached and both the materiality and nonpublic nature of the information – that would drive the analysis" of whether illegal insider trading has occurred. With respect to the fiduciary duty – a key element of any insider trading claim – Mr. Khuzami pointed out courts have held that a public official owes a fiduciary duty to the United States and that Code of Ethics for Government Service specifically addresses the issue by stating that a Government official should "never use any information coming to him confidentially in the performance of government duties."
According to Senator Brown, while some scholars see no need for such legislation, others disagree. He noted that "[t]he mere existence of this debate is enough to show that we must clearly define a blanket affirmative duty on members of Congress to the American public pertaining to confidential nonpublic information." Senator Brown’s solution is the Stop Trading on Congressional Knowledge (or "STOCK") Act of 2011 (S. 1871), which "would prohibit members or employees of Congress, as well as Executive Branch employees, from using nonpublic information obtained through their public service for the purposes of investing or otherwise making a personal financial gain." A similar bill has been introduced in the House (H.R. 1148).
Mr. Khuzami concluded his written testimony with a cautionary note: "[a]ny 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 individuals outside of Congress."