Coronavirus, Congress, and Insider Trading

There were reports last week of potential insider trading by members of Congress. Several of them sold millions of dollars in stocks as the coronavirus crisis was just beginning to unfold, before the major stock market decline. At the time, they were receiving regular, confidential briefings on the dangers of the virus. Some were publicly downplaying the severity of the problem while they privately unloaded their stock holdings. But although some of these stock trades may have been deplorable, proving they were criminal would likely be an uphill battle.

The Law of Insider Trading

Insider trading is the purchase or sale of securities based on material, nonpublic information, in violation of a duty of trust and confidence. Classic insider trading involves corporate executives or other company insiders trading their own company’s stock based on nonpublic information, in violation of the duty they owe to their shareholders not to exploit company information for their own private gain. A simple example would be a CEO who knows her company is about to be acquired and purchases large amounts of stock in the company before that information becomes public.

Under the much broader misappropriation theory, an individual is liable for insider trading if he trades stock based on material nonpublic information in violation of a duty owed to the source of that information. In the leading Supreme Court misappropriation theory case, United States v. O’Hagan, the defendant was an attorney whose firm represented the acquiring company in an unannounced takeover bid. He bought large quantities of stock and options in the company that was going to be acquired, and made several million dollars once the deal became public. As an outsider, O’Hagan didn’t owe any duty to the shareholders of that company. But he did owe a duty to his own firm and its client not to misappropriate the client’s confidential information for his personal gain. His trades in violation of that duty thus constituted insider trading.

A key in any insider trading case, therefore, is identifying the relevant duty. Trading on material nonpublic information is only insider trading if using that information for a personal benefit violates a duty the trader owes to someone. If you acquire material, nonpublic information through diligent research and hard work, or even by overhearing two corporate insiders talking on an airplane, it’s not insider trading for you to trade based on that information. There must be a violation of a duty.

The Impact of the STOCK Act

Members of Congress, by the nature of their work, necessarily learn a great deal of information that could impact the stock market. In 2012, in response to concerns about Members profiting off such information, Congress passed the Stop Trading on Congressional Knowledge, or STOCK Act. The Act prohibits Members of Congress and their employees from using information learned during the course of their duties for private profit. It directs the Ethics Committees of both Houses of Congress to issue guidance concerning this prohibition. The Act also states that “Members of Congress and employees of Congress are not exempt from the insider trading prohibitions arising under the securities laws.” The Act specifies that Members and Congressional employees owe a duty “arising from a relationship of trust and confidence” to the Congress and to the American people.

This legislative recognition of a duty is significant for insider trading purposes. As just noted, the existence of such a duty is a prerequisite for insider trading liability. The STOCK Act makes it clear that Members of Congress owe a duty of trust and confidence to Congress and the American people not to personally profit from information they learn in the course of their duties. If Members trade stock in a company based on material, nonpublic information learned through their work, they may be liable for insider trading for breaching that duty.

Senator Richard Burr
Senator Richard Burr

The Congressional Trades and Insider Trading

The allegation concerning several Members of Congress is that they received nonpublic information during briefings about the Coronavirus and traded stocks based on that information in anticipation of the coming market crash. Not all such transactions involved stock sales; for example, Senator Kelly Loeffler bought stock in a company that specializes in software that allows people to work from home, and other congressional aides reportedly bought stock in companies such as Clorox, Inc.

To prove insider trading, prosecutors would have to establish that these purchases and sales were based on material, nonpublic information learned during the course of Congressional duties. If they were, then the STOCK act makes clear that such transactions for private gain would violate a duty owed to Congress and the American people and therefore would potentially be insider trading. But there are several factors that suggest establishing insider trading could be challenging.

1) Was the Information Truly Nonpublic?

To evaluate any claims of possible insider trading, it is critical to know exactly what information was relayed at the Congressional briefings. Prosecutors would need to show the briefings included information that was not yet public and that would likely lead those who received the information to conclude the stock market is going to decline. Any investigation into these Congressional trades, criminal or civil, therefore would have to explore what exactly the Members were told in these briefings.

There was a lot of public information already floating around about the coronavirus at the time of the briefings in January and February. Were Members really given information that was not otherwise publicly available? Or did the briefings simply serve to educate the Members and try to get them to focus on the problem, without necessarily relying on material nonpublic information?

The answer may vary depending on the briefing. At least some of the briefings reportedly were classified, which suggests a greater likelihood that they contained information not otherwise publicly available. But as to a more routine, unclassified briefing, it may be that any diligent researcher could have readily come up with the same information that was being given to the Members. And if that’s the case, then acting on that information would not be insider trading.

2) Was the Information Material?

Even if the briefings contained nonpublic information, that information must have been material. Information is material if it is likely to be deemed important to a person deciding whether to buy or sell the stock. One issue here would be that even if some of the information in the briefings was nonpublic, was it so different from what was already available that it would materially influence anyone’s decision to buy or sell? In other words, there was already so much information available that any additional information received in the briefings, even if not otherwise public, may not have made a material difference to a potential trader. Was there actually something disclosed in the briefings that was both nonpublic and so dramatically different from the other available information that it would have tipped the scales on whether to buy or sell?

Another wrinkle when it comes to materiality is that this information likely did not relate to any particular company, or even any particular industry, but to the risks to the country and economy as a whole. Insider trading cases usually involve nonpublic information that relates directly to the stock that was traded. Charging insider trading based on information suggesting that the overall economy in general is going to decline would be unusual. Even if there is information suggesting that the economy as a whole might suffer, how does one prove that information was material to the stock price of any one company? You could try to argue that certain industries seemed more likely to suffer or to profit, and focus on trades based on those industries (such as sales of hotel or airline stocks), but it still could be challenging to prove materiality as to any particular trade.

Once again, what was said at the briefings could be key; for example, if a briefing focused specifically on likely damage to the airline industry, that might support allegations of subsequent insider trading in airline stocks. But if a briefing was focused more on the overall health risks to the country and less on the economic impact, then proving the materiality link to trading stock in any particular company could be much more challenging.

3) Were the Trades Actually Based on the Information Received?

Another possible defense would be that even if there was nonpublic information provided during the briefings, the trades were not based on that information. In the wake of the insider trading allegations, Senator Richard Burr put out a statement claiming his trades were based only on public information, such as reports on CNBC. Burr is claiming, in other words, that even if he received nonpublic information, his trades were based not on that information but on other information that was widely available to the general public.

If there was material, nonpublic information provided at the briefings, then it likely will not be enough for Burr just to claim he relied on other, public information when making the trades. Under SEC Rule 10b5-1, if a person possesses material, nonpublic information at the time of a purchase or sale of a security, there is a presumption that the trade was based on that information. The purchaser can rebut that presumption, but only by showing that there was a pre-existing, written plan or order to sell the stocks that predates the receipt of the nonpublic information. Absent such a pre-existing order, a Member or staffer will be presumed to have relied upon any material nonpublic information received when making a trade.

A related issue will be whether the Member or other individual who received the information actually ordered the trades in question. Senator Kelly Loeffler, for example, has claimed on Twitter that she does not make decisions about her stock trades and that those decisions are made by third-party advisors without her input. Senator Diane Feinstein has claimed that her stocks are held in a blind trust and that this particular trade was made in her husband’s account, and so any trades were made without her knowledge or participation. If trues, these would be defenses to any claim of insider trading.

One question raised by Senator Loeffler’s defense is whether she had any communications with those “third party advisors” where she shared information learned during the briefings. She may not make the decisions herself, but if she passed along material, nonpublic information and her advisors traded on that information then she could still be liable for insider trading as a “tipper” or for aiding and abetting. The same would be true if she passed the information to her husband, who happens to be Chairman of the New York Stock Exchange, and he then relied on that information to trade or to direct others to trade on their behalf.

Representative Chris Collins

The Case of Representative Chris Collins

These allegations have led some to compare these Members of Congress to Representative Chris Collins, who was recently sentenced to 26 months in prison for insider trading. But the cases have almost nothing in common. Collins served on the board of a pharmaceutical company and sold stock in that company after receiving confidential information from the board chairman that a major drug trial had failed. The Collins case differs from these current allegations in two important respects. First, the inside information Collins gained was not as a result of his work on Capitol Hill. His status as a Congressman was irrelevant to his insider trading case, as was the STOCK Act. Collins could have been just any board member, trading on confidential information received from the chairman. And second, the information Collins received was specific to the one company in whose stock he subsequently traded – it wasn’t information about a potential overall market decline.

The Appropriate Remedy

These stock trades deserve to be investigated. Some certainly seem to violate the spirit of the STOCK Act. But given the issues described above, it seems unlikely that any will result in a criminal case. And a criminal remedy is not necessarily the answer; there are many possible consequences for these actions besides a criminal prosecution. The SEC may pursue civil insider trading charges, where the penalties may include fines and disgorging of profits. Other shareholders in companies that were dumped may sue for civil stock fraud. The Ethics Committees can explore the allegations and impose sanctions as well; Senator Burr, for example, has already requested an Ethic Committee investigation of his own stock trades. Members of Congress could face calls to resign, as some already have. And of course, voters have the ultimate political sanction at the ballot box for any offenders who run for re-election.

One good outcome would be for this scandal to lead to reforms that include a requirement that every Member of Congress hold their stocks and other assets in blind trust, with absolutely no control over investment decisions. Until that is the norm, allegations like this will continue to arise and there will always be suspicions that some Members are using the power of their office unfairly to line their own pockets. Such conduct may not always be criminal, but it’s always wrong.

The Rush to Criminal Remedies

A series of recent prosecutions has me thinking about the proper role of criminal remedies. There seems to be a trend in recent years for the public – and some prosecutors – to leap to criminal prosecution as the first option in response to various kinds of misconduct.  Don’t get me wrong — as a former prosecutor I have no problem with criminal remedies when appropriate. But as I tell my students on the first day of class: there’s a lot of conduct that is immoral, unethical, or just downright sleazy, but isn’t criminal and doesn’t need to be. I think we may be losing our sense of when prosecution is the right response and when some alternative, less severe sanction might be appropriate.

The Gray Areas

 In my white collar crime class we routinely discuss the availability of other remedies for conduct that potentially could be prosecuted. This is particularly important in white collar criminal law. After all, if you have a violent crime like a homicide or robbery, there’s little question that criminal prosecution is the appropriate response. We’re not going to respond to a homicide by saying, “Well, let’s just let the victim’s family file a civil suit.”

White collar cases, by contrast, often involve misconduct that falls into a gray area. The cases involve fuzzier criminal concepts like fraud and corruption, where criminality may be less clear-cut. There generally is no victim of physical violence; most harms are economic. For such misconduct there is usually a wide range of alternative remedies available: civil penalties and fines, private civil lawsuits, administrative sanctions, professional discipline (loss of professional licenses or loss of a job or career), even just the sanction of public disgrace and humiliation. In cases involving political misconduct, voters can respond at the ballot box by throwing the offender out of office.

Non-criminal remedies and sanctions almost always are much more efficient. Criminal sanctions are cumbersome and difficult to impose. Grand jury investigations and trials are time consuming and resource-intensive. They require the government to meet the highest burden of proof in the law: guilt beyond a reasonable doubt, found by a unanimous jury. By using civil proceedings the government may obtain many of the same remedies faster and with a lower burden of proof. Society as a whole often may be better served by resolving much misconduct with non-criminal sanctions.

Criminal prosecution should be reserved for the most extreme misconduct, the most severe violations of society’s rules. Criminal convictions may result in the harshest sanctions society can impose: the loss of liberty. Many other types of penalties are available in both civil and criminal proceedings, but only in a criminal case can the offender be sent to jail. The hammer of criminal penalties therefore should be reserved for those cases that truly deserve it.

There is a lot of play in the joints with concepts like fraud and corruption, and white collar statutes are notoriously broad. It is far easier to stretch those statutes to argue they should apply to particular misconduct that, unlike a homicide or burglary, on its face may not be obviously criminal. That’s why prosecutorial discretion plays such a crucial role in white collar crime. In a white collar case it’s often unclear whether criminal sanctions are necessary and appropriate. Making that decision requires good judgment and the sound exercise of discretion.

A number of recent cases and investigations have me questioning whether at least some prosecutors are losing sight of these principles. In some cases, I don’t think the conduct was criminal at all. With others, even if it’s possible to come up with a creative criminal theory, I think the misconduct would have been better addressed through non-criminal remedies.

The NCAA Corruption Case

Exhibit one is the NCAA corruption case, which I’ve written about several times (on the blog here and here, and in the Washington Post here). The defendants are aspiring sport agents and representatives of the sportswear company Adidas. They engaged in a scheme to pay the families of star high school athletes $100,000 or more in exchange for an agreement to attend and play basketball at particular universities whose athletic programs were sponsored by Adidas. They were convicted of fraud in New York and are currently appealing to the Second Circuit Court of Appeals.

The remarkable thing about this prosecution is that in the absence of the NCAA rules, there would be no fraud theory at all. There was nothing illegal about the payments; it’s not a crime to pay someone to induce them to attend a particular school. The defendants did not want to harm the universities – just the opposite. They would only succeed and profit if the universities did as well. And the evidence indicated that the coaches at the universities knew this scheme was going on, or at the very least willingly looked the other way.

But the payments violated NCAA rules, which prohibit college athletes from receiving any kind of compensation. Having ineligible athletes on their rosters exposed the universities to potential sanctions from the NCAA – a private organization that the universities voluntarily joined. Prosecutors charged that the defendants defrauded the universities by secretly paying the athletes, thus exposing the universities to those potential sanctions.

It’s a very odd fraud case where the defendant has no intent to harm the victim and the senior representatives of the supposed victim are in on the scheme. It’s even more odd when violating the rules of a private, voluntary association through otherwise lawful behavior can be leveraged into a criminal fraud theory.

This did not need to be a criminal case. The NCAA needs to clean house, but federal prosecutors don’t need to do it for them. People shouldn’t go to jail for violating the rules of a private organization by behavior that was otherwise lawful.

Appropriate sanctions for violating the NCAA rules: the Adidas representatives lose their jobs. The universities get fined or otherwise disciplined by the NCAA. The coaches who participated get fired. Maybe Adidas loses the right to sponsor some athletic programs. And players who took part in the scheme are declared ineligible for NCAA play – and probably go on to play in the NBA and make a fortune.

The Varsity Blues Case

 The college admissions scandal known as “Varsity Blues” is more complicated, because the dozens of different defendants are culpable to different degrees. I’ve written about this case on the blog here and here and in the Post here. The case features two different kinds of schemes involving parents cheating to help their students gain admission to elite universities. The mastermind at the center of both schemes was college counselor Rick Singer.

In the entrance exam scheme, parents paid to have someone correct their child’s answers on admissions tests like the ACT, or take the test for them, to improve their score. In the sports recruiting scheme, parents made much larger “donations” to the university to have their students admitted as recruited athletes. Sometimes this money went to bribe the coaches, who agreed to admit students even though they didn’t play the sport in question. Sometimes some or all of the money went to the athletic programs at the schools. Some of the cases also involved the parents and Singer creating phony athletic profiles falsely indicating that the student was a star athlete in the relevant sport.

As with the NCAA case, in the Varsity Blues investigation there often was no discernible harm to the supposed “victims.” The universities received tuition dollars from the students who were admitted. In many cases the athletic programs received substantial sums of money as well.  In fact, in a recent ruling related to sentencing (where the dollar amount of the loss is important to calculating the sentencing guidelines), the judge recently found there was no loss to the universities. If there is no discernible financial harm to the “victims,” it should at least make you stop and question whether you have an appropriate criminal fraud case.

But what about the truly deserving students who were not admitted – aren’t they the true victims here? Well, yes, but not for criminal purposes. These defendants had no relationship to any such unidentified applicants and owed them no duty. The criminal charges are structured as a fraud against the universities and the testing companies, not against other students. The non-admitted students are victims of the defendants’ cheating in a societal sense, but not in a criminal one.

As I mentioned, the facts of these cases vary widely. For Singer and for the coaches who accepted hundreds of thousands of dollars in bribes to admit unqualified students in violation of the duties they owed to their university employer, I’ve got no problem with criminal sanctions. But for many of the parents, the picture is more complicated. It’s not clear all of them had the kind of intent we normally would require for a criminal conviction.

Consider one example: actress Felicity Huffman, who pleaded guilty and was recently sentenced to fourteen days in prison. Her case is relatively simple. She was not involved in the sports recruiting scheme. She simply paid $15,000 (a relatively modest amount, in this investigation) to have someone help her daughter cheat on the ACT.

That conduct is deplorable. But if you boil it down, it means Huffman was prosecuted and sent to jail for cheating on a test. It’s expensive and sophisticated cheating, to be sure, but that’s still all it is. If a future student manages to sneak in some unauthorized notes to the testing center and cheats on the ACT, are we now going to prosecute that student for fraud when she applies to college? What about a student who “embellishes” his entrance application – claiming he was captain of the debate team, for example, when in fact he was only a minor participant. How about a student who, once admitted, cheats on a calculus test? Are all of these now “fraud” and subject to criminal prosecution?

The conduct in the Varsity Blues case is reprehensible. It rightly caused widespread outrage based on the sense of privilege and entitlement demonstrated by the wealthy parents. But it’s not at all clear that a federal criminal prosecution is the appropriate response in all the cases.

Appropriate sanctions for cheating on your child’s college admissions test: your child gets kicked out of school. You forfeit any tuition dollars that you paid. The school gets to keep any other “donations” you made in connection with the cheating. You are publicly humiliated and disgraced, and your career suffers as you lose your acting gigs. And – perhaps the most severe sanction — you have to spend a lifetime trying to explain to your child why you did what you did and trying to remedy that breach of trust.


 The “Bridgegate” prosecution is another example of the expansive and inappropriate use of criminal remedies. (See my blog post here and Post article here.) The defendants engaged in a scheme to close inbound lanes on the George Washington Bridge, causing four days of massive traffic gridlock in Ft. Lee, NJ.  They falsely claimed they did it to conduct a traffic study, but in fact they did it to punish the mayor of Ft. Lee for refusing to endorse governor Chris Christie for re-election.

There was tremendous public outrage over this political stunt. Ultimately the defendants, who were Christie appointees, were prosecuted and convicted for fraud. The government’s theory is that the defendants defrauded the Port Authority of the salaries of the employees who were ordered to carry out the sham traffic study and the lane closures.

The Supreme Court recently agreed to review those convictions, and I expect the Court will throw them out. This “fraud” theory has no limiting principle, because almost every case of political misbehavior will result in some public employee time being expended. The defendants were not lining their own pockets. There was no law or regulation that mandated a certain lane configuration, and they had the authority to order the change. There was nothing inherently improper about the work they ordered the other employees to do – the only thing improper was their motive. They essentially were prosecuted for engaging in New Jersey hardball politics and lying about their true reason – the kind of thing that politicians, for better or worse, do all the time. This did not need to be a criminal case.

Appropriate sanctions for political mischief that is otherwise lawful: The career of the politician involved suffers from the public backlash. (This actually happened — Christie’s political career took a major hit from the scandal. He left office in disgrace and his presidential ambitions quickly withered.) The employees involved should be fired. (This also happened.) There could be possible civil suits if anyone was injured as a result of the traffic gridlock. And all involved are publicly disgraced and humiliated.

The Curse of Binary Thinking

 Part of what I think is going on with many scandals these days is a kind of binary thinking when it comes to misconduct: either something is criminal or it’s basically OK. Consider, for example, the Mueller report.

On the Russian “collusion” question, Mueller did not find evidence of a criminal conspiracy between the Russians seeking to influence the election and members of the Trump campaign. There were lots of contacts with the Russians, and the Russians were eager to help, but there was insufficient evidence of an actual criminal agreement to work together.

Many on the left reacted to this conclusion with something close to outrage. Look at all the contacts between the campaign and Russians! How could there not be a crime? But again, behavior can be reprehensible without being criminal. The Trump campaign knew that Russia was trying to help them win by using, among other things, emails stolen from their opponent. They welcomed and encouraged that help and did not report the various outreach efforts from the Russians. Even if not criminal, this is not OK.

The Trump administration’s response to the Mueller report has exhibited the same binary approach: “no crime – so nothing to see here.  Let’s move on.” But just because something isn’t criminal doesn’t mean it’s not a problem. Our standards for our elected officials should be higher than simply that they managed to avoid indictment. And it doesn’t mean there should not be some other kind of serious non-criminal consequences — whether that’s impeachment or just the results of the next election.

The same thing applies to these other scandals. Saying it’s not criminal doesn’t mean that the conduct of the defendants in those cases was okay. It just means that criminal sanctions are not necessarily the right response to the misconduct.

The Loss of Social Control

 I had a professor in law school who defined law as organized social control. His thesis was basically that the more other connections, norms, and informal means of responding to misbehavior you have in a society, the less law you need – and vice versa. If your neighbor is playing their music too loud and you know your neighbors and have ties within your community, you go talk to them and ask them to turn it down, maybe enlisting other neighbors to help. If you don’t know them, you call the cops – relying on the law to impose some social control.

Maybe that’s part of what is going on here. We see fewer alternative means of effective social control and so turn to criminal law for a solution. Many of the norms and informal controls that used to govern social and political behavior seem to be disregarded or shattered more and more routinely, with no apparent consequences. The super-wealthy and privileged seem to cheat, whether on taxes, college admissions, or elsewhere, and get away with it. Politicians lie repeatedly and pay no apparent political price. The Trump administration defies subpoenas and resists traditional congressional oversight, with few apparent consequences. The president himself calls for the investigation and jailing of his political opponents, and chants of “lock her up” are still a feature at his rallies. If people feel like nothing else is working, they may reach for criminal sanctions as a first resort rather than a last resort, looking for the law to impose some order in our lives.

I don’t know what the solution is, but we need a societal re-set on the appropriate use of criminal remedies. We can’t prosecute our way out of the current chaos.

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