Politics & Policy

The STOCK Act and the SEC

The STOCK Act must be amended to protect government whistleblowers.

I have long admired Stephen Bainbridge’s writings on corporate governance and securities regulation. Usually, he casts a skeptical eye on the Securities and Exchange Commission as well as the “good governance” trends of the moment in the government and corporate worlds. We’ve had some friendly conversations via email through the years, and he has praised my work several times, as I have his.

So I was a bit taken aback to read his blistering attack on the recent NRO article I wrote with my colleague David Bier outlining how the STOCK Act could inhibit the disclosure of information by whistleblowers on congressional staffs, even if they would not profit from a trade made on the basis of that information. Implying that he doesn’t know me from Adam (he refers to me as a “guy from the Competitive Enterprise Institute . . . named John Berlau”), Bainbridge accuses Bier and me of peddling a “load of codswallop” (glad to learn this new word!) and of making “so many mistakes . . . that it’s hard to know where to start.”

#ad#My sentiments exactly on his so-called rebuttal. Bainbridge distorts our main premise, and then suspends his longtime skepticism of the SEC in favor of a blind faith that it will enforce the legislation fairly. And he doesn’t even bother to address our proposed solution of inserting a “mens rea” or “guilty mind” clause into the final bill — which has passed both chambers of Congress but with differences that still need to be ironed out by a conference committee. The clause would simply state that disclosures of information are illegal only if they are made for the purpose of making a profit, or with knowledge that the information would be used by the recipient (or others acting with the recipient) to make a profit.

Bainbridge starts out by saying that we “claim that the STOCK Act bans whistle blowing.” We do nothing of the sort. Obviously, a bill that expressly banned whistleblowing would go nowhere.

What we do say is that the STOCK Act would make whistleblowing less likely because the disclosure of “nonpublic” and “material” political information by a member of Congress or a staffer could now be punished even if the member or staffer did not trade on this information. This is because the law takes the “duty of confidence,” meaning confidentiality, that the SEC has applied to corporate information and applies it in a vague way to information about government operations.

Since insider trading has mostly been prosecuted as theft or “misappropriation” of information — with the victim being the corporation rather than, as is often assumed, the investor on the other side of the trade — those who disclosed tradable corporate information (called “tippers”) have often been subject to the same liability as those who traded on it (called “tippees”). “A person can . . . be held liable for ‘tipping’ material, nonpublic information to others who trade,” explained SEC enforcement director Robert Khuzami in congressional testimony in December. Because the STOCK Act does not contain a clause protecting those who unknowingly “tip,” we argue that it thus creates the likelihood that whistleblowers could be busted for the “misappropriation” of information from the government they now owe a “duty of confidence” to.

This was a danger that Representative Louise Slaughter (D., N.Y.), one of the first proponents of expanding insider-trading laws to government information, at least initially recognized. In a 2006 “fact check” on her original STOCK bill, Slaughter argued that because “the work of Congress depends on open lines of communication between Members and constituents and organizations,” trading on congressional information must be policed through a “prohibition that does not require a duty of confidentiality.” Yet the current House and Senate bills fail to incorporate this protection; instead, they state that “each Member of Congress or employee of Congress owes a duty arising from a relationship of trust and confidence [emphasis added] to the Congress, the United States Government, and the citizens of the United States with respect to material, nonpublic information.”

None of the facts that Bainbridge presents — when he finally gets to the facts after his overheated rhetoric — diminish the threat of the current bills to whistleblowers and those communicating with the grass roots. In fact, he acknowledges that whistleblowing by staffers could come into conflict with insider-trading bans, but opines that this is the case under current law regarding market-sensitive information about both corporate and government operations. “If whistle blowing constitutes an illegal tip, accordingly, it’s illegal under current law,” he writes.

#page#Needless to say, it is a minority opinion that current insider-trading laws reach government information, or else there wouldn’t have been this much of a push for the STOCK Act in the first place. Slaughter summed up the consensus view of scholars in her fact sheet: “Just as anyone else, Members of Congress and staffers are subject to current insider trading laws. However, current insider trading laws do not apply to nonpublic information about current or upcoming congressional activities.”

Bainbridge then makes much of the fact that many courts require that the tipper cannot be found guilty unless he has received a personal “benefit.” Our article acknowledged that courts were split on this matter.

#ad#More important, however, is that prosecutors and courts have broadened the “benefit” requirement to include even nonfinancial reputational gains. In SEC v. Downe, 969 F.Supp. 149, the Second Circuit ruled that a tipper was guilty of insider trading merely because he “enjoyed the benefits of being viewed as a successful investor in the eyes of his peers.” Similarly in SEC v. Yun, 327 F.3d 1263, the 11th Circuit found that a “benefit” of disclosure could include “maintaining a good relationship between a friend and frequent partner in real estate deals.”

As applied to the disclosure of government information, these precedents could make it relatively easy to find a “benefit” for prosecution of a whistleblower. Presumably, if a congressional staffer helps his or her boss win a major legislative battle, that staffer’s reputation would rise — and, quite possibly, so would his or her future earnings. Thus, if a congressional staffer discloses, say, a nonpublic draft bill to a think-tanker or activist for the purpose of aiding the recipient’s efforts to support or defeat the legislation, it is certainly plausible that a court might find that the disclosure was for personal benefit.

But none of this seems to matter to Bainbridge, because he believes the SEC can be trusted to be reasonable and prudent when it deals with Congress, even if it has shown no such restraint in dealing with the private sector. “I admit that I’ve long suspected that the SEC thinks there is an invisible footnote to the First Amendment that exempts it from the prohibition on interfering with the right of free speech,” Bainbridge writes. But in this case, he argues, we don’t have to worry because “surely not even the SEC would argue that it can police political speech in the same manner it polices corporate speech.”

Besides, even if the SEC did so, Bainbridge reminds us, there are always the courts. “Have Berlau and Bier never heard of the courts?” he asks. He then offers the “best bottle of wine” in his cellar for a bet that “if the SEC tried to apply insider trading laws to whistleblowers . . . the courts would invalidate [the action] in a heartbeat.”

We have indeed “heard of the courts.” We’ve also heard something to the effect that it takes quite a long time, even if a constitutional challenge is eventually successful, to find a plaintiff, gain standing, and go through several rounds of appeals. So if the law passes, and Bainbridge agrees to a definition of “heartbeat” that encompasses a time period of any length less than one year after such an adverse action occurs, it’s a safe bet that I will become the new owner of his bottle of 1982 Château Montrose. Game on!

But it is still my desire to see simple changes to the final bill that will ensure that such a bet can never be made, and that government whistleblowers can never be threatened — even temporarily — with prosecution for insider trading. Members of Congress have a duty to never pass laws with provisions that violate or give agencies latitude to violate the Constitution under the rationale that the courts will come to the rescue. The members of all branches of government swear an oath to the Constitution, and all must do their best to uphold it.

And to uphold the First Amendment and other precious liberties, the final STOCK Act must not include the awful amendment introduced by Senator Charles Grassley (R., Iowa) that, as NR publisher Jack Fowler has noted, would force a wide variety of groups who communicate with Congress to register as “political intelligence” firms. And it must include a clause protecting disclosure of information unless it is done deliberately for private profit. This clause could read:

“Nothing in this subsection shall be construed to impose liability on Members of Congress or employees of Congress for acts of disclosing material, nonpublic information to nonaffiliated third parties, unless the Member of Congress or employee of Congress discloses the information to a nonaffiliated third party: (a) as a means for making a private profit; or (b) with knowledge that the recipient of the information, or persons acting in concert with the recipient of the information, intend to use the information for purposes of making a private profit.”

What’s your objection, Professor Bainbridge, to this extra layer of protection for those who try to ensure that our government remains transparent and accountable?

— John Berlau is senior fellow for finance and access to capital at the Competitive Enterprise Institute. Ryan Radia, CEI’s associate director of technology studies, contributed to this article.

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