What You Need to Know About the STOCK Act

by Holland & Knight LLP
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Beginning today, members and senior staff1 of the U.S. House of Representatives and U.S. Senate are required to disclose certain financial transactions no later than 45 days after the transaction has occurred. This new disclosure requirement is a result of the enactment of the Stop Trading on Congressional Knowledge Act (STOCK Act), signed into law on April 4, 2012. In addition to this new disclosure requirement, the STOCK Act:

  • affirms that federal insider trading laws apply to all members, officers and employees of the House and Senate
  • mandates disclosure of certain information regarding mortgages for primary residences and employment negotiations
  • restricts participation in initial public offerings
  • requires a report on “political intelligence” activities, i.e., gathering information from a government source that is then used to make investment decisions

Bottom Line

You must not provide any material, non-public information to Congress and you must scrupulously avoid providing to any third party, or trading on, any material, non-public information received from Congress. In addition, publicly traded companies should be prepared for additional scrutiny if a member or staffer discloses that he or she has traded in the company’s stock. The press, regulators, ethics officials and law enforcement will be scrutinizing these disclosures and cross-referencing them with other public databases and press reports. If it appears that a publicly traded company lobbied a member or staffer, or participated in a fundraiser for a member before a disclosed trade was made, further inquiries into insider trading may occur.

How to Avoid an Investigation

While it is impossible to prevent being a target or witness in a STOCK Act investigation, certain steps can be taken to reduce the likelihood of involvement in such an investigation:

  1. Ensure that no material, non-public information is discussed with Congress.
  2. Amend internal policies to make it clear that passing along material, non-public information to Congress and providing to any third party, or trading on material, non-public information received from Congress is prohibited.
  3. Specify in contracts with outside lobbyists and consultants that passing along material, non-public information to Congress and providing to any third party, or trading on material, non-public information received from Congress is prohibited.
  4. Provide STOCK Act training to personnel who interact with Congress.
  5. Integrate STOCK Act compliance into the organization’s overall compliance program.

What Is Insider Trading?

The STOCK Act explicitly affirms that federal insider trading laws, including Section 10(b) of the Securities Exchange Act of 1934 (the “1934 Act”) and 17 C.F.R § 240.10b-5 (Rule 10b-5), apply to members, officers and employees of the House and Senate. The elements of an insider trading violation are the following:

  • an actual purchase or sale of securities
  • such purchase or sale occurred while the investigation’s target possessed material, non-public information
  • such information was in fact both material and non-public

Thus, if an individual obtains material, non-public information about a public company, economic sector or industry into which the company falls, and then makes trades in that company’s securities based upon that information, he or she may well face charges of violating insider trading laws. The recent passage of the STOCK Act makes it more likely that future insider trading investigations will focus on activity involving Congress.

What Are Periodic Transactions Reports?

A periodic transactions report (PTR) is a new financial disclosure report mandated by the STOCK Act that discloses certain transactions involving stocks, bonds and other securities made by members and senior staff of the House and Senate, as well as certain executive branch employees.2 PTRs must be submitted within 30 days of receiving notice of a covered transaction and no later than 45 days after the transaction. The PTR filing requirement goes into effect on July 3, 2012. Covered transactions include those involving more than $1,000 in stocks, bonds and other securities. A PTR is generally not required for transactions involving widely held investment funds such as mutual funds or exchange traded funds, although these transactions must still be disclosed annually as required by the Ethics in Government Act of 1978 (5 U.S.C. App. 103). The STOCK Act requires that PTRs, as well as annual financial disclosure reports for members and senior staff, be available online.

Other Public Disclosure Databases

Once a PTR is available online, the press, ethics officials, regulators and law enforcement will likely review other public databases to determine whether it is possible that material, non-public information on the stock, bond, or other security was passed along to the member or staffer who submitted the PTR. These other public databases include the Federal Election Commission (FEC) campaign finance database, the Lobbying Disclosure Act (LDA) lobbying database and Forms 3-5 required of insiders pursuant to Section 16(a) of the 1934 Act.

Political Intelligence Activities
The STOCK Act also requires the Government Accountability Office (GAO), with assistance from the Congressional Research Service (CRS), to prepare a report on “political intelligence” activities within 12 months of enactment. The STOCK Act defines political intelligence as information:

(1) Derived by a person from direct communications with an executive branch employee, a Member of Congress, or an employee of Congress; and

(2) Provided in exchange for financial compensation to a client who intends, and who is known to intend, to use the information to inform investment decisions.

Under certain circumstances, political intelligence may be considered material, non-public information. Accordingly, those who gather political intelligence should be mindful of, and conduct themselves in accordance with, insider trading laws.

After the GAO provides Congress with the political intelligence report, additional legislation regulating political intelligence activities may be forthcoming. Although the gathering of political intelligence generally falls outside of the scope of what is required to be disclosed under the LDA, it is possible the LDA will be amended to require disclosure of political intelligence activities.

Does the STOCK Act Apply to Brokers and Firms?

No additional know your customer (KYC) requirements applicable to brokers or broker-dealers appear to be triggered by the STOCK Act. However, because aiding and abetting insider trading activity can constitute a violation of Section 10(b) of the 1934 Act and Rule 10b-5, implementation of certain safeguards should be considered. For example, prior to completing a significant, unsolicited trade for a customer known to be a member, officer, or employee of the House or Senate or a federal lobbyist, a broker could require written certification that the client has no material, non-public information concerning the security to be traded or its sector/industry. In addition, brokers should be careful not to recommend the purchase or sale of securities to other clients based on the knowledge that members or staffers are trading the security, absent a wholly independent basis for recommending the purchase or sale of the security.

Conclusion

The STOCK Act guarantees heightened scrutiny for securities transactions by members, officers and employees of the House and Senate. If you come into contact with Congress, you must carefully avoid providing material, non-public information or trading on material, non-public information received from Congress. After the first PTRs are available online, publicly traded companies should expect additional scrutiny if a member or staffer discloses that he or she has traded in the company’s stock. Accordingly, now is a good opportunity to implement appropriate internal policies and provide STOCK Act training for key personnel.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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