COVID-19 and Congressional Trading on Nonpublic Information
Reprinted with permission from the March 26, 2020, edition of the New York Law Journal. © 2020 ALM Media Properties, LLC. All rights reserved.
With recent headlines focused on allegations of insider trading in the Senate, this article analyzes insider trading law with respect to the senators’ stock sales and discusses the challenges prosecutors might have in proving certain elements of an insider trading offense.
As federal, state, and local governments have ramped up public safety measures in response to the coronavirus outbreak, the Department of Justice (DOJ) and U.S. attorney’s offices across the country have been warning citizens to be vigilant for fraudulent disaster-related schemes. The DOJ has announced that addressing coronavirus-related fraud schemes is a major priority, and many federal and state prosecutors’ offices and law enforcement agencies have formed joint task forces to coordinate the investigation and prosecution of these crimes. With recent headlines focused on allegations of insider trading in the Senate, this article will analyze insider trading law with respect to the senators’ stock sales and discuss the challenges prosecutors might have in proving certain elements of an insider trading offense.
Public Disaster Fraud
Public disasters create massive government relief programs and financial aid, which history has shown invariably spawn opportunities for fraud. In recent years, U.S. attorney’s offices across the country have devoted significant resources to prosecuting schemes designed to take advantage of government assistance programs and sympathetic citizens during challenging times.
Disaster-related crimes have often involved fraudulent applications for government relief funds. In the aftermath of natural and manmade disasters, certain individuals and businesses charged with these crimes have allegedly lied about the nature of the property that sustained damage, the existence or extent of the damages sustained, the purpose for which the relief funds would be used, and the true identity of the applicant.
In addition, public works contracts in the wake of disasters have been a frequent target of fraudulent billing and bid rigging. Some fraudsters have even targeted funds designated to assist first responders. Others have opportunistically solicited contributions to fraudulent charities. And some technologically savvy offenders have opted to dispense with fraudulent pretenses and instead perpetrate elaborate heists, such as hacking into financial institutions to access funds designated for disaster relief victim.
Questionable Trading Preceding the Coronavirus Crisis
As a general matter, most disaster-related fraudulent schemes are investigated and prosecuted months and even years after the disaster has been contained. During the week of March 16, however, the media widely reported on potential coronavirus-related wrongdoing that occurred before the disease prompted crisis-level public safety protection measures in the United States. Two U.S. Senators—Senate Intelligence Committee Chairman Richard Burr (R-NC) and Senator Kelley Loeffler (R-GA)—sold millions of dollars in stock holdings after they participated in private Senate briefings about the coronavirus.
Sen. Burr’s Stock Sales. According to news reports, Burr and his wife sold 33 different stocks on February 13, 2020 that were collectively worth between $628,000 and $1.7 million. The sales included shares in two major hotel chains whose stock prices declined significantly in recent weeks. During this time, Burr reportedly received daily briefings by intelligence officials on threats to the United States, including the worldwide spread of the coronavirus. Days before his stock sales, on February 7, Burr co-authored an opinion article for Fox News asserting that “the United States today is better prepared than ever before to face emerging public health threats, like the coronavirus.”
Two weeks after his stock sales, however, on February 27, Burr reportedly warned a small group of well-connected constituents to prepare for dire economic and societal effects of the coronavirus. Yet, only a week later, on March 5, Burr told the public, in language similar to the February 7 op-ed he wrote, that the United States has “a framework in place that has put us in a better position than any other country to respond to a public health threat, like the coronavirus.” Burr has denied trading on confidential, non-public information, and said he made his decision to sell his stocks based on his review of public news reports concerning the coronavirus.
Sen. Loeffler’s Stock Sales. According to news reports, Loeffler and her husband, Jeffrey Sprecher, who is chairman of the New York Stock Exchange, sold stock worth between $1,275,000 and $3.1 million in 27 separate transactions between January 24, 2020 and February 14, 2020. Loeffler’s stock sales began the very day her committee, the Senate Health Committee (of which Burr is also a member), hosted a private, all-senators briefing from administration officials on the coronavirus. While the stocks Loeffler sold have plummeted in value in recent weeks, one stock which she purchased during the same time period, Citrix, a technology company that offers teleworking software, has seen its price rise.
In the weeks after her stock sales, Loeffler downplayed the public health and economic threats posed by the U.S. coronavirus outbreak. “Democrats have dangerously and intentionally misled the American people on #Coronavirus readiness,” she tweeted on February 28. On March 10, Loeffler tweeted, “Concerned about #coronavirus? Remember this: The consumer is strong, the economy is strong & jobs are growing, which puts us in the best economic position to tackle #COVID19 & keep Americans safe.” Loeffler has denied that her stock sales were in any way influenced by the information she received in congressional briefings. Rather, she asserts that investment decisions for her portfolio are made by multiple third-party advisers “without my or my husband’s involvement.”
Of course, Burr and Loeffler have not been charged with any crimes, and any prosecutor or regulator would bear the burden of establishing the falsity of their assertions that they did not trade on nonpublic government information. For the purposes of this article, as a hypothetical exercise, we will analyze insider trading law with respect to the senators’ stock sales and discuss the challenges the prosecutors might have in proving certain elements of an insider trading offense.
Relevant Legal Framework. The DOJ has traditionally prosecuted insider trading offenses under Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. §78j), which prohibits “manipulative or deceptive device[s]” in connection with the “purchase or sale of any security,” and the accompanying SEC Rule 10b-5, which prohibits “any device, scheme, or artifice to defraud.” More recently, the DOJ has also brought insider trading charges under the general securities fraud statute enacted in 2002 as part of Sarbanes-Oxley (18 U.S.C. §1348), which makes it a crime to “knowingly execute, or attempt to execute, a scheme or artifice…to defraud any person in connection with …any security.”
The conduct that constitutes insider trading is not defined by either statute, but has been defined by decisional law addressing the contours of insider trading. Judicial decisions have established two principal theories underlying the insider trader offense. First, the “classical theory,” which prohibits a corporate insider from trading securities based on material, nonpublic information where he or she is an insider of the corporation whose securities are being traded, and thus the trader breaches a fiduciary duty to the corporation’s shareholders. Second, the “misappropriation theory,” which prohibits an individual from trading on confidential information he or she misappropriated from the source of the information, and thus breaches a fiduciary duty owed to the source.
In Dirks v. SEC, 463 U.S. 646 (1983), the Supreme Court held that insider trading liability also applies to a “tipper,” who discloses material, nonpublic information to a “tippee” in violation of the tipper’s fiduciary duty to the source, and the tippee then trades on that information. The tippee’s liability is derivative of that of the tipper where the tippee knows or has reason to know of the breach of duty. While a detailed discussion of tipper/tippee liability is beyond the scope of this article, the Second Circuit recently held in United States v. Blaszczak, 947 F.3d 19 (2d Cir. 2019), that proof of a “personal benefit” to the tipper is not required in insider trading prosecutions under 18 U.S.C. §1348, as opposed to prosecutions under Section 10(b). Thus, under the present state of Second Circuit case law, the elements of civil liability for insider trading, which can only be pursued by the SEC under Section 10(b), are more onerous than the elements of a criminal prosecution for the same conduct under Title 18.
Applicability of Insider Trading Law to Members of Congress. Until the passage of the Stop Trading On Congressional Knowledge Act (the STOCK Act) on April 4, 2012, legal scholars were divided as to whether members of Congress could be prosecuted for insider trading if their securities purchases or sales were made on the basis of material, nonpublic information that they obtained in the course of their legislative duties. Specifically, the principal issue of ambiguity was whether a congressperson owed a fiduciary duty to anyone to refrain from trading on nonpublic information that he or she obtained in private briefings or closed committee sessions.
The STOCK Act resolved that ambiguity by explicitly imputing a fiduciary duty to members of Congress and government employees: “[E]ach member of Congress or employee of Congress owes a duty arising from a relationship of trust and confidence to the Congress, the Government, and the citizens of the United States with respect to material, nonpublic information derived from such person’s position as a Member of Congress or employee of Congress or gained from the performance of such person’s official responsibilities.” 15 U.S.C. §78u-1(g). The STOCK Act provides similar language for judicial and executive branch employees. 15 U.S.C. §78u-1(h).
With respect to Burr and Loeffler, one critical challenge for a prosecutor would be proving that the stock sales were made on the basis of material, nonpublic information. Burr asserts that his stock sales were informed by public news reports at the time, and not by the content of the private briefings by administration officials and others. A prosecutor would need to obtain evidence of what information was conveyed during the briefings and compare that information to publicly available information. The Second Circuit has defined material, nonpublic information in analogous circumstances as “information that is either not publicly available or is sufficiently more detailed and/or reliable than publicly available information to be deemed significant, in and of itself, by reasonable investors.” United States v. Contorinis, 692 F.3d 136, 144 (2d Cir. 2012).
Loeffler disclaims any responsibility for the stock sales, asserting that the decision to sell the stock was made by third-party advisers without any input by her or her husband. A prosecutor would therefore investigate whether Loeffler provided the information she learned in her briefings to any of those third-party advisers, directly or indirectly.
To convict a defendant of securities fraud under Title 18, a prosecutor also may need to prove that the confidential information provided during the Senate briefing sessions was “property” in the hands of the government. In the recent Blaszczak decision, the Second Circuit affirmed insider trading convictions under 18 U.S.C. §1348(2), rejecting the defendants’ argument that a government agency’s confidential information on which the defendants traded was not “property” belonging to that agency. Blaszczak, 947 F.3d at 33-34.
In Blaszczak, an employee of the Centers for Medicare & Medicaid Services (“CMS”) disclosed confidential nonpublic information concerning potential reimbursement rate changes for certain procedures. Although the defendants argued that CMS’s interest in the information at issue was solely regulatory in nature, the Second Circuit concluded that “CMS’s right to exclude the public from accessing its confidential predecisional information squarely implicates the government’s role as property holder, not as a sovereign.” In addition, the court noted that the government presented evidence that CMS has an economic interest in its confidential predecisional information, including “that CMS invests time and resources into generating and maintaining the confidentiality of” the information. The court therefore held that “in general, confidential government information may constitute government ‘property’ for purposes of” 18 U.S.C. §1348(2).
Here, with respect to Burr, the briefings by intelligence officers to the Senate Intelligence Committee, and for Burr and Loeffler, the briefings by administration officials to the Senate Health Committee, constitute information that those committees chose to keep confidential and nonpublic for the purposes of making policy decisions. Under the holding in Blaszczak, such information would likely be considered “property” in the hands of those committees.
The STOCK Act was passed after several media outlets, including 60 Minutes, called attention to evidence that members of Congress were using classified information they received from briefings to profit from securities trading. Nevertheless, few members of Congress have been criminally prosecuted for insider trading since its enactment, and it appears that none of those prosecutions were based on the misappropriation of nonpublic, government information. Legal experts have suggested that the reasons for the dearth of STOCK Act prosecutions include the difficulty of proving that a member of Congress relied on nonpublic—as opposed to publicly available—information, and potential legal challenges to subpoenas and other discovery devices seeking information about legislative deliberations and congressional sources of information, which may be privileged under the Speech or Debate Clause of the Constitution. Faced with such obstacles, prosecutors may have been daunted considering the inevitable publicity resulting from investigating and prosecuting a member of Congress.
The appetite for insider trading prosecutions of lawmakers, however, has undoubtedly grown in the wake of the coronavirus disaster, with the economy shut down, families confined to their homes, and loved ones becoming gravely ill. Evidence of profitable securities trading by members of Congress in advance of this unprecedented public health crisis—even as those same politicians downplayed concerns about the coronavirus and assured constituents that the government was adequately prepared to address it—has stoked public outrage. It seems more likely than ever before that prosecutors and securities regulators will undertake investigations of government insider trading and will rely on the STOCK Act in building their cases.