Congressional Securities Trading

Gregory H. Shill is an Associate Professor of Law at the University of Iowa College of Law. This post is based on his recent paper, forthcoming in the Indiana Law Journal. Related research from the Program on Corporate Governance includes Insider Trading Via the Corporation by Jesse Fried (discussed on the Forum here).

In March 2020, as millions of Americans—a record number of them newly jobless—locked themselves indoors to help fight an accelerating pandemic, they learned that two U.S. Senators had been warned about COVID-19 in a secret briefing and then proceeded to cash in their shares in the nick of time. The stocks Sens. Richard Burr and Kelly Loeffler traded included companies, like hotel chains, that were especially sensitive to the coronavirus. This scandal sparked renewed interest in congressional insider trading—and exposed gaps in current law and leading reform proposals alike. In a new Essay, Congressional Securities Trading, I use the occasion of the pandemic trades to offer a fresh perspective on this evergreen topic.

The Essay addresses a basic tension: Members of Congress are perpetually in possession of material nonpublic information (“MNPI”), yet for various reasons need to trade securities from time to time. This framing, which reflects a securities regulation orientation rather than litigation and enforcement, is new to scholarship on the issue and works in tandem with adversarial measures. It borrows from a related context—public company regulation—which has largely been overlooked. And it offers a way to both prevent dubious trades in general and disgorge the profits that result from those that slip through.

Like Members of Congress, corporate insiders such as CEOs engage in securities trading despite possessing MNPI. Both groups also create MNPI as a byproduct of their work. This combination is not intrinsically malign, but it creates the potential for legal exposure. The system designed to manage trades by corporate insiders provides a model. Specifically, Rule 10b5-1 plans (which disclose trades ex ante) and the short-swing profits rule of Section 16(b) (which disgorges illicit profits ex post) should be adapted to the congressional context. Both devices emphasize the management of legitimate trades rather than the punishment of criminal ones (which is already achieved by other rules).

These rules should be streamlined and enhanced in their application to Members of Congress and staff. Unlike its corporate counterpart, a congressional Rule 10b5-1 plan should be both mandatory and publicly disclosed. Disgorgement of short-swing profits under a congressional Section 16(b) should be automated rather than awarded as a private recovery, as it is in the corporate context. Additionally, the reporting window for congressional trades—currently, a 45 day period following a trade—should be reduced to two days, the equivalent period for a Form 4 filing in the corporate context.

These rules would help reduce the risk of policy distortion and unjust self-enrichment by Members of Congress. To reduce those dangers further, lawmakers should also be restricted from owning any securities other than U.S. index funds and Treasuries. But ownership restrictions like these, which form the basis of leading reform proposals, are inadequate by themselves.

To illustrate the limitations of ownership restrictions, consider the leading proposals. The plan Sen. Elizabeth Warren pursued in her presidential campaign would ban ownership of individual stocks by Members of Congress, while a bill proposed by Sens. Sherrod Brown and Jeff Merkley would only permit such ownership through a blind trust. These reforms would presumably have foreclosed the trades of individual stocks executed by Sen. Burr. However, in the weeks that followed his trading activity, the market as a whole lost trillions of dollars in value.

Had Sen. Burr been restricted to owning mutual funds, he could just as easily have cashed in those holdings to monetize any MNPI he received in the briefing. In such a case, doctrinal uncertainty concerning the distinction between trading while in possession of MNPI and on the basis of MNPI would create major proof problems, which attach in some circuits whenever the trader can claim a plausible public source of information on which he traded (something Sen. Burr quickly claimed). The STOCK Act of 2012 explicitly extended the Rule 10b-5 insider trading prohibition to Members of Congress, but proving the charge remains difficult.

Sen. Loeffler, whose shares were traded the same day as the briefing, claims that her portfolio is managed by a blind trust, but it is unclear at this time whether it met the necessary requirements. That uncertainty and the blind trust model in general do not provide much transparency in a situation that demands a maximum quantum of it. A court may well determine in the future that her arrangement satisfied the standard, but the public trust has been damaged.

The pandemic trades would have been far less likely under the reforms I propose. First, neither Senator would have been able to own individual stocks. Second, both Senators would have been required to disclose their trading plans in Rule 10b5-1 plans publicly and ex ante. As in the public company context, they would have been free to modify or cancel their plans, but doing so would tend to increase regulatory and shareholder scrutiny. Here, it might also create a political cost at two points in time: the announcement of a plan change and the filing of a transaction report akin to a Form 4. Next, that transaction report, which is already required, would have to be disclosed more than 20 times faster than currently (in two days rather than 45). The constellation of these requirements likely would have caused the Senators to weigh carefully any trading decisions, just as corporate insiders are very careful about trades that require a change to a 10b5-1 plan or trigger a Form 4 filing.

A congressional analogue to the Section 16(b) short-swing profits rule would provide some additional security on the back end. If the Senators did end up going through with a trade, and it resulted in a profit within a six-month window, it would (under my proposal) be automatically disgorged. The short-swing profits rule simply presumes profits in that window to be based on MNPI, even if the resulting profit is inadvertent. It does not require any showing of intent. The advantage of this strict liability approach is amply illustrated by the case of Sen. Burr, whose explanations may complicate any insider trading case against him. A Section 16(b) disgorgement does not by itself imply, much less require proof of, the commission of any crime.

And finally, the rich disclosures generated by this system would broaden their impact. The securities fraud case that resulted from trades by insiders on the Equifax data breach provides an illustration: a Form 4 filing by one insider triggered a larger investigation that later resulted in insider trading charges against another executive (a senior manager, but one who was not senior enough to have a Form 4 filing obligation). One could imagine disclosures in the congressional context generating similarly useful ripples.

The reforms proposed here would formalize congressional securities trading, make abuses less likely, disgorge illicit gains, and increase the regulatory and political cost of improper trades. In a polarized era, they also have a practical virtue: none of these proposed rules would require new legislation or regulation. They can all be adopted by chamber rule as a matter of self-regulation in each house of Congress.

The complete paper is available for download here.

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