Regulating Congressional Insider Trading: The Rotten Egg Approach

by Sarah J. Williams*

Volume 45 Issue 5

The full text of this article may be downloaded by clicking on the PDF link.

Introduction

A 2004 study revealed that the stock portfolios of members of Congress were consistently outperforming those of the investing public. The financial success of federal lawmakers was statistically correlated to the use of nonpublic information obtained while performing legislative responsibilities—reasonably characterizable as insider trading. Cries of dismay over such profiteering by lawmakers have been echoing in the public domain since Samuel Chase, Maryland’s representative in the Continental Congress, directed colleagues to corner the flour market in 1778 after learning that copious quantities of it would be purchased by the government to support the Continental Army. Notwithstanding efforts to apply insider trading law to curb this behavior and the enactment of the Stop Trading on Congressional Knowledge (“STOCK”) Act, fortuitous securities transactions by members of Congress continue to occur in connection with headlining national events; it was recently observed with respect to news of the financial collapse of certain regional banks.

While there is scholarly and political support for laws that would effectively ban such rotten egg behavior, this Article proposes that the conduct be regulated under the statute created with rotten eggs in mind—the Securities Act of 1933. The Securities Act creates speedbumps for persons in a control relationship with issuers who want to sell the issuer’s securities in the secondary market. The speedbumps require both public disclosure and broker inquiry. This Article asserts that senators and representatives are in a control relationship with issuers such that they transcend the status of ordinary investor in the securities law regime. As control persons, federal lawmakers must navigate the obligations established under the Securities Act for such persons before selling their securities in the secondary market. This approach eliminates the legal and evidentiary challenges of insider trading theory, provides a disclosure mechanism that is vastly more effective than that provided by the STOCK Act, and deploys broker-dealers as gatekeepers to ensure that such trades do not undermine the maintenance of fair markets.

* Sarah J. Williams is an Assistant Professor of Law at Penn State Dickinson Law with over twenty-five years of experience as a securities regulator. She has served as Deputy Director at the Public Company Accounting Oversight Board, Commissioner’s Counsel and Enforcement Branch Chief at the U.S. Securities and Exchange Commission, and Associate General Counsel at NASD (now FINRA). She previously authored The Alchemy of Effective Auditor Regulation, 25 LEWIS & CLARK L. REV. 1089 (2022), and Regulatory Personhood: The Elixir for Redundancy Between the SEC and the PCAOB, 97 ST. JOHN’S L. REV. (forthcoming 2024). The author thanks Professor Joan MacLeod Heminway and the participants at both the 2023 National Business Law Scholars Conference and the 2023 Southeastern Association of Law Schools Conference for thoughtful and encouraging feedback. The author extends sincere gratitude to Andre George, Class of 2025, and Millie Krnjaja, Class of 2023, for outstanding research assistance in support of the development of this work.