[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
PREVENTING UNFAIR TRADING
BY GOVERNMENT OFFICIALS
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
OVERSIGHT AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
JULY 13, 2009
__________
Printed for the use of the Committee on Financial Services
Serial No. 111-56
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53-236 PDF WASHINGTON : 2009
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HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama
MAXINE WATERS, California MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina RON PAUL, Texas
GARY L. ACKERMAN, New York DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California WALTER B. JONES, Jr., North
GREGORY W. MEEKS, New York Carolina
DENNIS MOORE, Kansas JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts GARY G. MILLER, California
RUBEN HINOJOSA, Texas SHELLEY MOORE CAPITO, West
WM. LACY CLAY, Missouri Virginia
CAROLYN McCARTHY, New York JEB HENSARLING, Texas
JOE BACA, California SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia RANDY NEUGEBAUER, Texas
AL GREEN, Texas TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois JOHN CAMPBELL, California
GWEN MOORE, Wisconsin ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota KENNY MARCHANT, Texas
RON KLEIN, Florida THADDEUS G. McCOTTER, Michigan
CHARLES WILSON, Ohio KEVIN McCARTHY, California
ED PERLMUTTER, Colorado BILL POSEY, Florida
JOE DONNELLY, Indiana LYNN JENKINS, Kansas
BILL FOSTER, Illinois CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana ERIK PAULSEN, Minnesota
JACKIE SPEIER, California LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York
Jeanne M. Roslanowick, Staff Director and Chief Counsel
Subcommittee on Oversight and Investigations
DENNIS MOORE, Kansas, Chairman
STEPHEN F. LYNCH, Massachusetts JUDY BIGGERT, Illinois
RON KLEIN, Florida PATRICK T. McHENRY, North Carolina
JACKIE SPEIER, California RON PAUL, Texas
GWEN MOORE, Wisconsin MICHELE BACHMANN, Minnesota
JOHN ADLER, New Jersey CHRISTOPHER LEE, New York
MARY JO KILROY, Ohio ERIK PAULSEN, Minnesota
STEVE DRIEHAUS, Ohio
ALAN GRAYSON, Florida
C O N T E N T S
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Page
Hearing held on:
July 13, 2009................................................ 1
Appendix:
July 13, 2009................................................ 25
WITNESSES
Monday, July 13, 2009
Baird, Hon. Brian, a Representative in Congress from the State of
Washington..................................................... 7
Henning, Peter J., Professor of Law, Wayne State University Law
School......................................................... 15
Kotz, H. David, Inspector General, U.S. Securities and Exchange
Commission..................................................... 10
Slaughter, Hon. Louise, a Representative in Congress from the
State of New York.............................................. 3
Verret, J.W., Assistant Professor of Law, George Mason University
School of Law, and Senior Scholar, Mercatus Center Financial
Markets Working Group.......................................... 16
Ziobrowski, Alan J., Ph.D., Associate Professor, J. Mack Robinson
College of Business, Georgia State University.................. 13
APPENDIX
Prepared statements:
Moore, Hon. Dennis........................................... 26
Henning, Peter J............................................. 28
Kotz, H. David............................................... 38
Verret, J.W.................................................. 48
Ziobrowski, Alan J........................................... 51
Additional Material Submitted for the Record
Moore, Hon. Dennis:
Written statement of the U.S. Securities and Exchange
Commission................................................. 76
Baird, Hon. Brian:
Letter from Common Cause, Democracy 21, League of Women
Voters, Public Citizen, and U.S. PIRG, dated March 4, 2009. 80
Written statement of U.S. PIRG............................... 82
Letter from U.S. PIRG........................................ 83
PREVENTING UNFAIR TRADING
BY GOVERNMENT OFFICIALS
----------
Monday, July 13, 2009
U.S. House of Representatives,
Subcommittee on Oversight
and Investigations,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 2 p.m., in
room 2128, Rayburn House Office Building, Hon. Dennis Moore,
[chairman of the subcommittee] presiding.
Members present: Representatives Moore and Biggert.
Chairman Moore of Kansas. This hearing of the Subcommittee
on Oversight and Investigations of the House Financial Services
Committee will come to order. Our hearing this afternoon is
entitled, ``Preventing Unfair Trading by Government
Officials.''
Normally, we begin our subcommittee hearings with members'
opening statements, up to 10 minutes per side, and then we hear
testimony from our first panel of witnesses. I understand one
of our witnesses, the chairwoman of the House Rules Committee,
Congresswoman Slaughter, has her own hearing that she will be
chairing that she needs to leave for in a few minutes.
So I ask unanimous consent that we go slightly out of
order. I will give my opening statement, followed by Ranking
Member Biggert, and then we will hear from Congresswoman
Slaughter, so she can provide her testimony and be excused.
Is that okay with you?
Ms. Slaughter. Thank you.
Chairman Moore of Kansas. I will then recognize any other
subcommittee member who wants to give a brief statement within
the remaining time for opening statements, if more members show
up, and then invite Congressman Baird, the chief sponsor of
H.R. 682, to give his testimony and see if there are any
questions before I invite our second panel of witnesses to
testify.
Members will each have up to 5 minutes to question our
witnesses. Without objection, all members' opening statements
will be made a part of the record.
Without objection, I ask that written testimony from the
Securities and Exchange Commission be made a part of the
record.
I now recognize myself for up to 5 minutes for an opening
statement.
In May, we learned from the Wall Street Journal that
Federal prosecutors are investigating whether two SEC
Enforcement lawyers had violated insider trading laws. The
newspaper obtained a redacted copy of a report from the
inspector general of the SEC, Mr. David Kotz, who will testify
on this report and his role as independent watchdog of the
Commission.
His report concluded that the lawyers violated the Agency's
internal rules, although the employees have denied any
wrongdoing. In addition to 11 recommendations the IG made to
the SEC, the IG also recommended that the SEC take disciplinary
action against the two employees.
In a written statement provided by the SEC for this hearing
they have, ``deferred consideration of an appropriate response
to this recommendation based on what we understand to be a
pending criminal inquiry by the United States Attorney's
Office.''
As a former district attorney, I fully respect that
everyone is presumed innocent until proven guilty. While we let
Federal law enforcement do their jobs, I did not want to wait
to discuss the larger public policy questions that this case
invokes: Should government officials trade on information that
they have access to that the general public does not? If not,
what additional rules, regulations or laws are required to
address this concern?
Our Nation's Federal Government was founded on the
principle of separation of powers as well as checks and
balances. How do we maintain those important principles while
ensuring there is a level playing field in the marketplace with
respect to the investments by any government official,
including Members of Congress? And while this is not true for
most government officials, we should acknowledge that a few
individuals, like the Federal Reserve Chairman or President of
the United States, will move the market simply by the words
they use in a speech.
No one is proposing this, but should their speechwriters be
banned from investing in all individual stocks out of fear that
they may unfairly profit from their jobs, or is that going too
far? What about reporters who compete to break news of a
pending announcement by the government, or a lobbyist who is
pushing for legislation that will provide tax relief for a
certain industry; how will we guard against unfair trading
practices of those individuals as well?
This debate raises a lot of tough questions, but I hope we
can examine all sides of this issue to better understand what
the problem is and how responsible solutions may prevent unfair
trading by government officials. There will always be a few bad
apples unfortunately, but no government official should believe
that they are above the law. Most government employees are
public servants with the best intentions, working hard every
day to serve the American people.
I do want to commend our first two witnesses and
colleagues, Congresswoman Slaughter and Congressman Baird, for
proposing a response to these questions by drafting H.R. 682,
the Stop Trading on Congressional Knowledge Act. I look forward
to hearing from them why they drafted the bill and how they see
it addressing these important concerns.
In addition to the SEC's Inspector General, who will focus
on his investigation in the second panel, I am interested to
know what our three professors testifying have learned through
their research and experiences and what recommendations, if
any, they may have for this committee and for Congress on these
issues.
I now recognize for 5 minutes our distinguished ranking
member of the subcommittee, my colleague and friend from
Illinois, Ranking Member Judy Biggert.
Mrs. Biggert. Thank you, Mr. Chairman, for holding today's
hearing. It is great to see our colleagues on the other side of
the witness table. I have been there myself, and it is rather
odd sometimes.
But welcome. In the interest of time, and to accommodate
Chairman Slaughter's schedule, I will be brief. And I would
like to thank you both for being here and also thank today's
witnesses for joining us today.
Today's topic, ``Preventing Unfair Trading by Government
Officials,'' I think is critical to this committee, which has
oversight over so many issues, and this certainly is one that
we need to look at. We have to make sure that we can preserve
the integrity of all branches and levels of government and to
preserve the integrity of our financial market.
So I look forward to hearing from the witnesses, what they
know about the extent of insider trading within and beyond the
Federal Government. I think this evidence will be important for
us to determine what actions--such as those that are being
undertaken by the SEC--must be taken to make sure that we don't
have insider trading.
So with that, I yield back and I look forward to hearing
from the witnesses.
Chairman Moore of Kansas. Thank you very much. And I am
pleased to introduce our first panel of witnesses for this
afternoon's hearing.
First, we will hear from our colleague, Congresswoman
Louise Slaughter, who is serving her 12th term representing the
28th District of New York. A microbiologist with a masters
degree in public health, Congresswoman Slaughter is the first
woman to serve as chairwoman of the powerful House Rules
Committee.
After any additional opening statements from subcommittee
members are given, if additional members arrive, Congressman
Brian Baird will testify. He, like me, was elected in 1998 and
also represents the Third District of his State. Congressman
Baird represents his Washington constituents and chairs the
Energy and Environment Subcommittee of the Science and
Technology Committee.
Without objection, any written statements you have will be
made a part of the record. You will each be recognized for a 5-
minute statement.
Congresswoman Slaughter, you are recognized, please for 5
minutes.
STATEMENT OF THE HONORABLE LOUISE SLAUGHTER, A REPRESENTATIVE
IN CONGRESS FROM THE STATE OF NEW YORK
Ms. Slaughter. Thank you, Mr. Chairman, and Mrs. Biggert. I
am delighted to appear here along with Mr. Baird. I consider I
am with three of the brightest lights of Congress.
Thank you so much for holding this important hearing and
giving me the opportunity to testify. I hope our discussion
will lead to the timely and decisive passage of this
legislation to close the insider trading loophole and bring
transparency to a rapidly expanding political intelligence
industry.
Mr. Baird and I first introduced the Stock Act in 2006
after increasing reports of Members of Congress or their staffs
abusing their official status in access to information for
private gain first surfaced. Indeed, a 2004 study by Professor
Alan Ziobrowski of Georgia State University, whom I am pleased
is testifying here today, confirmed that United States Senators
received returns on their investments that were approximately
25 percent higher than typical Americans were able to achieve.
While various reports of Members and staff using
information improperly for financial gain, and hard data
showing that Senators were realizing significantly higher
returns on investment than the average investor do not prove
the existence of a widespread abuse of power and trust, they do
reveal serious loopholes and a potential for abuse that require
immediate action and preventive measures.
Furthermore, political intelligence firms that provide
investors with inside information about a pending legislative
action, information that can be used to inform investment
decisions, had been operating largely in secret and without
controls. Only a handful of political intelligence firms
existed in the 1970's, but in the past few decades, the
industry has bloomed. By 2006, the industry brought in an
estimated $40 million a year.
Mr. Chairman, there was more than enough reason to
introduce the legislation in 2006 to crack down on insider
trading by Members and staff and to bring accountability to the
political intelligence industry.
Since then, we have entered into the worst economic crisis
since the Great Depression and the implications of failing to
act immediately are great. Congress and the Federal Government
are now so enmeshed in the operations of our financial markets
that the potential for abuse by Members of Congress,
congressional staff, and Federal employees is staggering.
A liquidity crunch that began in August 2007 helped to set
off a chain of events leading to the near collapse of the
entire global financial system in September of 2008 and marked
the beginning of an unprecedented involvement of the Federal
Government in our financial system. This has created an
unprecedented opportunity for lawmakers and Federal Government
employees to use the knowledge obtained from their official
status for private financial gain. Between the Federal
Reserve's massive injections of liquidity into the markets and
its role in bailing out, or choosing not to bail out, Bear
Stearns and Lehman Brothers. For instance, the Treasury's role
in implementing the $700 billion Troubled Asset Relief Program
(TARP) and Congress' role in legislating TARP, Congress and
Federal employees have had early access to so much sensitive
information that can seriously affect the stock market that we
must not wait any longer to close these loopholes.
Moreover, the upcoming financial market regulatory reform
will bring with it greater opportunity for those with early
access to information to profit on an immense scale.
Throughout our current economic crisis, and indeed since
their creation in the 1970's, so-called political intelligence
firms have operated quietly in the background with no
regulation or oversight. They focus not on influencing
Congress, but rather gathering information from Members or
staff on forthcoming legislative action in order to give their
clients an advantage over other investors.
With leading experts noting that political intelligence
businesses have quadrupled since 2003, these businesses are now
merging as a key factor in the lobby industry and should be
regulated accordingly. Such an important and increasingly
relevant business should certainly be required to make its
activities known to the public.
Members of Congress, congressional staff, and Federal
employees have the unique opportunity and means to make
profound changes in our economy, in the country, and in the
world. But with this historical opportunity comes a serious
potential for abuse of power and the public trust.
I sincerely believe that the vast majority of Members of
Congress, congressional staff, and Federal employees are here
to serve the best interests of their constituents and the
public, not to line their pockets. But by explicitly
prohibiting the improper use of sensitive information for
personal gain, we will be taking an enormous step in providing
transparency while preserving and strengthening public faith in
our government and a democratic process.
Mr. Chairman and Mrs. Biggert, once again let me thank you
for holding this hearing to shed light on what I consider a
most important issue. I look forward to working with you and
all the members of this committee, as well as any other
interested parties, to enact this critical legislation, and I
yield back the balance of my time.
Chairman Moore of Kansas. Thank you, Congresswoman
Slaughter.
And if you have questions--I am going to forgo mine, but I
understand Congresswoman Slaughter has a few minutes to take
questions if you have questions.
Mrs. Biggert. Congresswoman Slaughter, how would we define
nonpublic information? For example, for a Member of Congress,
what would be something that under this bill would be illegal?
Ms. Slaughter. We have heard stories, and many have printed
in the press about Members of Congress and their staffs using
their own computers, the government's computers, in their
working offices in order to play the stock market day after
day.
There is a story about asbestos. When, shortly before an
asbestos law was to be passed or not passed, as crazy as it
turned out to be, that information was leaked and within days
the stock on asbestos rose precipitously. These are things we
come into contact with, information like this, frequently,
particularly those who work for certain committees.
It is critically important that they understand that part
of their job--just as we all know that we do not put what our
constituents tell us out in general knowledge--is that this is
information that should be held closely because of the effect
that it can have on the market.
We have had other instances, as I pointed out before, of
people who are making money as they work for Congress in
particular offices--leadership offices or others--where they
would be recipients of such information.
Mrs. Biggert. Well, those people who would have every day
to go on the stock market, I think probably their office isn't
busy enough. It seems like we have not enough time to even get
rid of some of our e-mails.
Ms. Slaughter. Isn't that the truth?
I guess they have first things first. Using that
information, for some, I suspect, was more important.
Mrs. Biggert. Do you think that would lead then just to
everyone having to have a blind trust.
Ms. Slaughter. No, I don't think so at all. The fact is
that we have never discussed this issue. I think this is
something that really needs to be part of the Code of Ethics of
the House and the Senate. I would like to see it there,
something that is written, and make it explicit to everybody
who works for us, including interns, that they may not trade on
any information that they get in their congressional office
that would affect the markets in any way or benefit them
personally.
I find it hard, and I am sure most people in our age
brackets do, that you have to go that far, but I think it is
well worth it to do that. But I do think that there should be a
law against it because of nonregulation of these intelligence
lobbying firms has really grown so large.
And the idea that they might take an intern or someone out
to dinner--I know they are not going to take us because we
passed that law, but that they might be doing that in return
for information is also a pretty scary thing.
So we need to regulate them more and tell them--frankly, I
don't like the whole idea of people making $40 million a year
off information that is obtained from Congress for their
clients.
Mrs. Biggert. I think that most offices have a policy that
what is said in that office stays in that office. But obviously
that is not enough.
Ms. Slaughter. If we have it as regulation or as law, as I
point out, it is far more important to me that we regulate
these outside firms. But if we have that, that gives us as
Members of Congress who put so much of our trust into people
who work for us in our office, a chance to understand that is a
basis for firing and maybe other kinds of action.
In the first place, I think all of us know that nobody
should be using the Federal computers for such work, but that
is minor in comparison to what they get for it.
Mrs. Biggert. Thank you. I yield back.
Ms. Slaughter. You are welcome.
Chairman Moore of Kansas. Thank you for your testimony,
Congresswoman Slaughter. You are excused. And at this time, I
would like to--can you make it in time to your next hearing?
Ms. Slaughter. I can. And it is on the overuse of
antibiotics so that we can fight MRSA. Thank you.
Chairman Moore of Kansas. Congressman Baird, you are now
recognized for 5 minutes for your testimony, sir.
STATEMENT OF THE HONORABLE BRIAN BAIRD, A REPRESENTATIVE IN
CONGRESS FROM THE STATE OF WASHINGTON
Mr. Baird. Thank you, Chairman Moore, and Ranking Member
Biggert. And thank you, colleagues on the subcommittee. I also
want to thank our witnesses today. I have had the privilege of
reading their testimony and find it very insightful.
I also want to acknowledge Tim Walz, our colleague, who has
been very active in this issue and has been a great help. And I
want to introduce into the record letters from Public Citizen
and U.S. PIRG, and acknowledge that in addition to those
organizations, Common Cause, Democracy 21, and The League of
Women Voters have expressed support for this legislation.
The reason we are here today really is, to some extent,
people have lost faith in us, in the political system and in
the financial institutions. And this bill is about trying to
restore at least a modicum of that faith back.
It goes with our jobs as legislators that we will have
access to information that others do not; classified briefings,
participation in late night committee hearings, meetings in
closed conference reports, personal conversations with
Administration officials or others all can give us information
that is not yet public. Some of that information will have
significant value. And because we have access to information
that is potentially of such great value, we have, I think, a
dual responsibility.
I should also note we not only access information, we
create information. When we are in a conference report or
conference committee and we decide that something will make it
to the Floor, that is potentially very consequential from a
financial perspective. And because of that dual responsibility
of access to and the creation of information we must not betray
the trust the people put in us and must not betray our own
integrity.
The essence of our bill is simple. It would make it
explicit in law and in our ethical codes that Members of
Congress and their staffs could not make financial transactions
on the basis of information that they know or have reason to
believe is not available to the general public.
Further, Members of Congress or their staffs should not
share nonpublic information with others if there is reason to
believe that the recipient of the information will use that
information for financial transactions. So too, recipients who
receive from Members of Congress or staff information known or
reasonably believed to be nonpublic should not make financial
transactions based on that knowledge.
To help ensure that such actions do not occur or can be
identified if they do take place, greater transparency and
immediacy of reporting should be required of Members of
Congress, key staff, and entities such as lobbying firms or so-
called political intelligence firms.
Finally, we would recommend very strongly to Congress that
we follow the example of every major corporation, Federal
agency, and many law firms by establishing explicit ethical
prohibitions and consequences for violation of these principles
and creating information dissemination and training measures to
ensure that all staff are informed about the ethical standards
and applicable laws and affirm in writing at the time of
employment that they will comply.
I should note that most major corporations do this, many
law firms do it, but I have yet to meet a single Member of
Congress or their staff who was informed explicitly about the
issue of insider trading, the consequences or legal
ramifications thereof; and certainly I don't remember having
seen my staff sign a document about that as they would have to
if they worked for a corporation.
I am not an attorney, but I do have a nose and I know when
things smell bad. Here is something that smells bad.
Imagine a Member of Congress involved in final conference
negotiations on a major piece of legislation. During closed
discussion it is agreed upon that certain language which would
substantially favor a particular investment will be included in
the conference report that is scheduled to be released the
following day and will be voted on shortly thereafter. Based on
that knowledge of nonpublic information, the Member of Congress
instructs his or her broker to make specific market trades to
take advantage of that nonpublic information.
Consider a second example: A senior staffer in charge of
drafting a manager's amendment for a bill scheduled for a Floor
vote the next afternoon, the staff member discusses provisions
of the bill with a fellow staffer and says, this is not yet
public, but fill in the blank with the information. The
recipient of the information then goes out and makes
investments on that.
I spent a substantial amount of time reviewing relevant
laws and precedents that apply to insider trading. It is my
understanding that neither Federal law nor House rules
specifically and sufficiently explicitly address this issue as
it applies to Members of Congress and staff.
Now, I am sometimes asked, well, how do we know this is a
problem, how do we know somebody is engaging in it? Suppose you
were the manager of a bank. You come into your bank one evening
and you discover that the back door of the bank has been left
open. The next day, you take this up with your security people
and you say, it troubles me a little bit that the back door was
left open. And your security people say, no, sir, as far as we
know, nobody has come in through that back door yet and taken
any money. And you say, well, how do you know they haven't? And
they say, well, we really haven't checked to be perfectly
honest. And you say, well, what if they did? And the answer is,
well, we are not even sure that would be illegal.
You would be negligent as the manager of that bank if you
didn't fix all three of those problems. And as managers of this
institution, I would suggest we need to fix all three.
We don't believe the bill is perfect. We think the
information from the witnesses can improve it. We are grateful
for their insights and we look forward to the wisdom of the
committee members in improving this.
The one thing Ms. Slaughter and I are absolutely certain of
is, this is a significant problem that needs to be addressed;
the sooner we address it, the better--better for us as an
institution and better for the financial markets.
And I thank you for the time.
Chairman Moore of Kansas. Congressman Baird, thank you for
your testimony.
I am going to ask Congresswoman Biggert if you have any
questions. You have 5 minutes for questions.
Mrs. Biggert. I understand what you are getting at. It is
just--I guess it is tying it down. You know, when you talked
about classified information, I mean, that is easy for us. We
know that we go in and we have to put our beepers aside, our
phones, everything, when we go into a classified briefing and
know that we are not going to talk about that--although it
seems sometimes, we come out and it is on CNN. But besides
that, it is still, we don't talk about it and don't bring it
up.
But this ``nonpublic,'' I think is hard. Where you draw the
line, I think, is something that is very important to be
spelled out there, because it is a little bit different. You
don't always know that you know something.
Mr. Baird. Right.
Mrs. Biggert. Is that true?
Mr. Baird. It is a legitimate question. The challenge right
now is, because there is no consequence right now, it is
somewhat irrelevant whether something is nonpublic or public.
Our reading of the law, in consultation with experts,
Congresswoman, is that right now, sort of anything goes; and
you can basically say the key issues--and I will let our legal
experts talk more about this--are questions of duty and
misappropriation of information. Right now our duty is not
necessarily clearly enough spelled out in our ethical
standards, so it is not even clear that if you specifically add
something labeled ``nonpublic''--I mean, literally stamped on
it ``nonpublic''--it is not 100 percent clear in our ethical
standards that it is constrained from release.
The issue really is for a legal proceeding to establish--
the way the SEC works oftentimes is sort of going backwards and
saying, okay, so-and-so made an enormous trade or an unexpected
level of trade right before something did become public; why
did they make that trade before something did become public?
The same kind of procedure can apply to our staff members.
And then you work backwards and say, well, you were in this
meeting with the Administration; show us where the
Administration had made that information public, show us where
the conference report had been published prior to the time you
made the trade.
Let's suppose the conference committee is meeting, it is
agreed upon, it is a closed meeting or there is a closed
conversation. Nothing is released publicly until a certain
time. The trade happened before that time. At some point you
can say, how could you possibly have known that if you hadn't
been in the meeting? You were in the meeting, you hadn't seen
it made public; it is presumptive therefore.
By informing people of that risk--and by the way, these are
serious legal consequences and civil consequences--we help
prepare people for avoiding that and create conditions, if they
willfully and intentionally violate that standard, there are
consequences for them.
Mrs. Biggert. Thank you. I yield back.
Chairman Moore of Kansas. Thank you. I thank our colleagues
for their testimony.
Our first panel is now excused, and I will invite the
second panel to take their seats.
As is our committee's custom when we have other members
testify, I ask unanimous consent that Congressman Baird be
invited to join us on the dais if he is able to do so and
wishes to. Any objection?
Without objection, I am pleased to introduce our second
panel of witnesses for this afternoon's hearing. For this
panel, we will first hear from the Inspector General of the
Securities and Exchange Commission, David Kotz. Mr. Kotz has
been asked to focus on his recent investigation of the SEC
employees.
On the broader policy issues we will hear from Professor
Alan Ziobrowski, who is an associate professor at J. Mack
Robinson College of Business at Georgia State University.
Third on our panel is Professor Peter Henning from Wayne
State University Law School.
Finally, we will hear testimony from Professor J.W. Verret,
an assistant professor of law at George Mason University School
of Law and a Senior Scholar for the Mercatus Center Financial
Markets Working Group.
Thanks to all of you for being here. Without objection,
your written statements will be made a part of the record. You
will each be recognized for a 5-minute statement summarizing
your written testimony.
Mr. Kotz, you are recognized, sir, for 5 minutes.
STATEMENT OF H. DAVID KOTZ, INSPECTOR GENERAL, U.S. SECURITIES
AND EXCHANGE COMMISSION
Mr. Kotz. Good afternoon. Thank you for the opportunity to
testify today before this subcommittee on the subject of
preventing unfair trading by government officials as the
Inspector General of the Securities and Exchange Commission. In
my testimony today, I am representing the Office of Inspector
General, and the views that I express are those of my office
and do not necessarily reflect the views of the Commission.
The mission of the Office of Inspector General is to
promote the integrity, efficiency, and effectiveness of the
critical programs and operations of the SEC. The SEC and Office
of Inspector General has staff in two major areas: audits and
investigations. The Office of Audits conducts, coordinates, and
supervises independent audits and evaluations related to the
Commission's internal programs and operation. Over the past
year, we have issued numerous audit reports involving issues
critical to SEC operations and the investing public, including
a comprehensive report analyzing the Commission's oversight of
the SEC's consolidated supervised entity program, which
included Bear Stearns, Goldman Sachs, Morgan Stanley, Merrill
Lynch, and Lehman Brothers.
Our Office of Investigations examines allegations of
violations of statutes, rules, and regulations and other
misconduct by Commission staff and contractors. Over the past
year-and-a-half, we have issued investigative reports
regarding, among other things, claims of improper preferential
treatment given to prominent persons, retaliatory termination,
perjury by supervisory Commission attorneys, lack of
impartiality, and the performance of official duties and the
unauthorized disclosure of information.
In addition to the work I just described, we are conducting
a wide-ranging investigation and evaluation of matters related
to Bernard Madoff and affiliated entities. We have made
substantial progress on our investigation and plan to issue
shortly a comprehensive investigative report detailing all the
examinations and investigations that the SEC conducted of
Madoff from 1992 until the present.
It is with this background in mind that I wish to discuss
an investigation that we recently concluded relating to the
securities transactions of two SEC Enforcement attorneys over a
2-year period. Our Office received information from the SEC
Ethics Office that a particular Enforcement attorney was
trading securities very frequently. As we began investigating
this Enforcement attorney's trading activity, we identified
another Enforcement attorney who was a friend of this
individual and with whom the first attorney often discussed
securities transactions and open enforcement investigations
during regular weekly lunches and via e-mail. We conducted a
year-long investigation of these Enforcement attorneys, which
encompassed a comprehensive review and analysis of more than 2
years of brokerage records, ethics filings, security
transaction filings, and e-mail records.
On March 3, 2009, we issued our report of investigation to
the Agency. Our investigation revealed suspicious conduct,
appearances of improprieties, and evidence of possible trading
based upon nonpublic information on the part of the two SEC
Enforcement attorneys. Because of the seriousness of the
information that our investigation uncovered, we referred the
matter to the United States Attorney's Office of the District
of Columbia's Fraud and Public Corruption Section, which,
together with the FBI, is currently conducting an investigation
of possible criminal and civil violations. Because of this
joint U.S. attorney-FBI investigation, I am somewhat limited in
my ability to discuss the details of this matter.
In addition to suspicions of insider trading, our
investigation found that the Enforcement attorneys committed
numerous violations of the SEC's securities reporting
requirements. For example, although SEC rules require employees
to file a notification form within 5 business days of the
purchase or sale of securities, these Enforcement lawyers
failed to file these forms for certain transactions. Moreover,
although the Office of Government Ethics Form 450 requires the
reporting of an employee's security holdings with a value
greater than $1,000 at the end of each calendar year, or the
generated income of more than $200 per year, the Enforcement
attorneys failed to report such transactions or earnings that
were over these limits. They also found that one of the
Enforcement attorneys failed to clear numerous stock
transactions through an agency database prior to purchasing
stocks.
Our investigation further found that generally, although
the SEC is charged with prosecuting cases of violations of the
Federal securities laws, including the investigation and
prosecution of insider trading on the part of individuals and
companies in the private sector, the SEC had essentially no
compliance system in place to ensure that its own employees,
with tremendous amounts of nonpublic information at their
disposal, did not engage in insider trading themselves. The
existing disclosure requirements and compliance system were
based on the honor system, and there was no way to determine if
an employee failed to report a securities transaction as
required.
No spot checks were conducted, and the SEC did not obtain
duplicate brokerage account statements. In addition, there was
little to no oversight or checking of the reports that
employees filed to determine their accuracy or even whether an
employee had reported it at all. Moreover, different offices in
the SEC received the various types of reports and did not
routinely share that information with each other.
We also found a poor understanding and lax enforcement of
the securities transactions reporting requirements. For
example, most of the Enforcement attorneys who traded and we
investigated testified that no one had ever questioned their
reported securities holdings or transactions in the decades
they worked at the SEC. Moreover, both managers who were
responsible for reviewing the OGE Form 450 testified they did
not recall ever questioning any SEC employees with respect to
their reported securities holdings.
Our investigation also found that the Enforcement attorneys
we investigated routinely discussed stocks and investment
strategies in e-mails and in public. They maintained separate
folders entitled ``Stocks'' in their SEC e-mail accounts.
Chairman Moore of Kansas. Mr. Kotz, your time is up. I
would ask, with the consent of the other members of the panel
here, that you have an additional 2 minutes. Is that
satisfactory?
Without objection, you have an additional 2 minutes, and
your full testimony will be received in the record, sir.
Mr. Kotz. On most days, they sent e-mails from those
accounts about stocks and their own stock transactions.
We discovered that one of the Enforcement attorneys traded
often and even testified that the financial markets were her
main hobby and passion. We found that this attorney spent much
of her work day e-mailing her co-workers about various stock
transactions.
Our investigation also disclosed that one of the
Enforcement attorneys sent e-mails to his brother and sister-
in-law from his SEC e-mail account during the workday,
recommending particular stocks.
Our report recommended that the SEC take disciplinary
action against the two Enforcement attorneys who, we found,
violated the rules. We also provided the Commission with 11
specific recommendations to ensure adequate monitoring of
employees' securities transactions. These recommendations
included establishing one primary office to monitor employees'
securities transactions, instituting an integrated computerized
system for tracking and reporting purposes, obtaining duplicate
copies of brokerage record confirmations for each security
transaction, requiring employees to certify in writing that
they do not have nonpublic information, ensuring that the forms
SEC employees are required to file are checked with the
existing database, requiring SEC employee supervisors to review
a list of pending cases to compare with a list of the
securities reported, conducting regular and thorough spot
checks for compliance purposes, developing a clear, written
policy on the confidentiality of enforcement investigations,
and establishing comprehensive and more frequent training.
Our investigation underscored the need for the SEC to
revamp completely its current process for monitoring SEC
employees' securities transactions. In response to our report
on May 22, 2009, SEC Chairman Mary Schapiro announced that the
SEC would be taking measures to address the problems we
identified. These measures include drafting a new set of
internal rules governing securities transactions for all SEC
employees that will require preclearance of all trades and, for
the first time, prohibit staff from trading in the securities
of a company under SEC investigation.
Chairman Schapiro also announced that the SEC was
contracting with an outside firm to develop a computer
compliance system to track, audit, and oversee employees'
securities transactions. Chairman Schapiro further stated that
she signed an order consolidating responsibility for oversight
of employees' securities transactions and authorized the hiring
of a chief compliance officer.
We are pleased that the SEC is planning to take concrete
steps to address the issues identified in our investigation.
These steps, if implemented, would satisfy the concerns raised
in our report and even, in a few instances, go beyond our
recommended actions.
Chairman Moore of Kansas. Excuse me. I am going to have to
ask you to submit--
Mr. Kotz. I am done.
[The prepared statement of Mr. Kotz can be found on page 38
of the appendix.]
Chairman Moore of Kansas. You are done. Very well, sir. I
then have a couple of questions or at least a question for you.
I am sorry; we will take the other witnesses first.
Professor Ziobrowski, if you would please, sir.
STATEMENT OF ALAN J. ZIOBROWSKI, Ph.D., ASSOCIATE PROFESSOR, J.
MACK ROBINSON COLLEGE OF BUSINESS, GEORGIA STATE UNIVERSITY
Mr. Ziobrowski. Thank you, Mr. Chairman, and the other
members of this subcommittee, for the opportunity to present my
views on the subject of congressional conflict of interest.
In 1995, my colleagues and I began a 10-year project to
examine the common stock transactions of U.S. Senators and
Members of the U.S. House of Representatives. The object of the
study was to measure the abnormal returns earned by legislators
on their common stock investments.
The concept of abnormal returns is fundamental to the
science of finance. Despite claims by stockbrokers, financial
analysts, and all types of financial pundits, many years of
financial research have shown that the ability of investors to
consistently beat the market when armed only with information
available in the public domain is virtually nonexistent. The
evidence is, in fact, so strong that academics generally regard
any individual or group of individuals who possess that ability
to be inside traders or, at the very least, people trading with
an informational advantage, that is, they are assumed to be
trading on the basis of information not available to other
market participants. We do not necessarily know the source or
the nature of the information they possess, however, we are
quite certain that they know things the rest of us do not know.
Using standard methodology, we included nearly 6,000
transactions over 6 years for Senators and over 8,000
transactions for Members of the House during a 17-year period.
In both cases, we found conclusive evidence that legislators
possess an informational advantage, and trade based on that
information. Collectively, Senators beat the market by
approximately 1 percent per month or 12 percent a year. Members
of the House beat the market by half-a-percent a month or 6
percent per year.
To put these numbers in their proper perspective, it has
been reported that corporate insiders who trade common stock in
their own respective companies earned abnormal returns roughly
equal to those of the House and much less than those of the
U.S. Senate.
Although not an objective of this study, our research also
gave me the opportunity to examine financial disclosure and its
efficacy at discouraging conflicts of interest. I found that
access to congressional financial disclosure reports can be
difficult, personally intimidating, and even expensive.
Furthermore, the reports are often missing, difficult to read
or understand, and erroneous.
But all these shortcomings aside, the most obvious problem
with the current system is that it fails to link financial
disclosure to legislative behavior. Without an intimate
knowledge of a legislator's voting record and the bills under
consideration, it is impossible for an American to draw a
meaningful conclusion regarding the conflict of interest.
With respect to H.R. 682, I am generally supportive of
including Members of Congress and their staffs under the
insider trading statutes. In my opinion, it will likely reduce
trading on confidential information. However, it is naive to
assume that the practice will be totally eliminated. After all,
corporate insiders are still able to earn significant abnormal
returns, despite being bound by such laws for many years.
With that in mind, I would therefore recommend one
significant change to the bill. Consistent with the corporate
insider reporting requirements, Members of Congress should be
required to report common stock transactions within days not
months.
Furthermore, the report should be filed with the SEC for
rapid dissemination to the public. This would not eliminate the
insider trades, but it would partially level the playing field
for other market participants. By following the day-to-day
trading activities of Congress, market participants could use
this information in formulating their own investment
strategies.
I realize that there were other questions which were asked
of me by the Chair when inviting me to this hearing. However,
my 5 minutes are up and I have tried to address these other
questions in my written testimony.
But I will be glad to discuss them further during the
question-and-answer session. Thank you.
[The prepared statement of Professor Ziobrowski can be
found on page 51 of the appendix.]
Chairman Moore of Kansas. Thank you, Professor Ziobrowski.
And, Professor Henning, you are next, sir, if you would.
STATEMENT OF PETER J. HENNING, PROFESSOR OF LAW, WAYNE STATE
UNIVERSITY LAW SCHOOL
Mr. Henning. Thank you, Chairman Moore, Representative
Biggert, and Representative Baird for giving me this
opportunity. Before I began teaching at Wayne State University
Law School in Detroit, I was a staff attorney with the SEC for
4 years in the Division of Enforcement, and then worked for 3
years in the United States Department of Justice. I would like
to just talk briefly about two issues here today with regard to
what has been discussed before.
Inspector General Kotz discussed the status of the
investigation that showed certainly troublesome trading by
members of the Enforcement Division staff. When I first read
about his report my reaction was, how could a member of
Enforcement do anything that stupid?
Now my response is, in listening to his description of
measures that would be taken, I would recommend something much
simpler. Rather than the current rules, it should simply be
to--and Congress or the Commission could do this--prohibit
anyone at the SEC, from the commissioners on down, from buying
or selling the shares of publicly traded companies or any
entity subject to SEC regulation while they are employed there.
A simple bright-line rule would be the best way to go.
Now, there is the possibility someone would be hired or
become a Commissioner in a situation in which they already had
shares of stock. The rules are in place there for disposing of
those shares. However, as long as someone is working at the
SEC, that person should not be buying and selling shares of
public companies or companies that are directly regulated by
the SEC. No ifs, ands, or buts about it; a bright-line rule
would handle this problem much better.
It also would not cost the SEC, I suspect, any of its
employees or the people who wanted to work there or who were
working there at the time. If your goal is to play the market
by investing in individual company stocks, then you can pursue
that avocation, but you can't work at the SEC. That would be a
much better and simpler way to handle that issue.
Now, with regard to H.R. 682, I would just like to
highlight two points here with regard to the statute. One
potential gap in the statute is that in extending the ban to
nonemployees, those who would be, in the parlance of the
securities laws, ``tippees,'' there is no clear prohibition on
tipping by these particular people. For example, say an
interest group representative received nonpublic information
about pending legislation that would have a particular impact
on a company or industry, and that person tells a friend so
that he or she can profitably trade on it. The bill or the
legislative history should make it clear that a person who
received that type of information about a legislative action
would be prohibited from disclosing the information to another
person so that person could trade on the shares. So it is not
just Members of Congress and their staffs who would be covered,
and those who might receive that information, but those who, in
turn, might receive the information.
Also, I would point out that in H.R. 682, the reference to
that ``tippee'' is if that person knows the information came
from a Member of Congress or a member of the staff.
Now, in the leading U.S. Supreme Court case on tipping/
tippee liability, the Supreme Court said that person is liable
if he or she knows or should know. And using the terminology
``should know'' is broader; that is an objective test saying,
do you know or should you know that you are receiving it? That
would, in fact, expand the prohibition and would cut off a
defense of, for example, lack of knowledge or mistake. So that
certainly would be one thing to consider.
Another caution that I would raise just briefly--and I
discuss this more extensively in the prepared testimony--is
that if the statute were to be passed, it would authorize the
SEC and the Commodity Futures Trading Commission to initiate
investigations. Also, too, you understand that any violation of
SEC or CFTC rules can also trigger a criminal investigation
that would be by the United States Department of Justice--and
based on my experience, those investigations are quite
thorough--that could involve testimony or interviews with
Members of Congress and staff.
And I would simply point out that this could raise issues
with regard to the protections of the Speech or Debate clause,
and that, in fact, could be a rather substantial issue.
There was an opinion issued just this past Thursday by the
District of Columbia Court of Appeals in re grand jury
subpoenas in which the Department of Justice tried to get
Ethics Committee documents, and you are talking about, in
Speech or Debate, a nightmare. So just to note that in your
consideration.
Thank you very much.
[The prepared statement of Professor Henning can be found
on page 28 of the appendix.]
Chairman Moore of Kansas. Thank you, Professor Henning.
And I now recognize for 5 minutes Professor Verret, if you
would, sir.
STATEMENT OF J.W. VERRET, ASSISTANT PROFESSOR OF LAW, GEORGE
MASON UNIVERSITY SCHOOL OF LAW, AND SENIOR SCHOLAR, MERCATUS
CENTER FINANCIAL MARKETS WORKING GROUP
Mr. Verret. Chairman Moore, Ranking Member Biggert, and
distinguished members of the panel, I want to thank you for the
opportunity to testify today. My name is J.W. Verret. I am a
senior scholar at the Mercatus Center at George Mason
University, and I am also a law professor there, where I teach
securities regulation. I also direct the Corporate Federalism
Initiative, a network of scholars dedicated to studying the
intersection of State and local authority in corporate
governance.
I commend this committee's interest in the conflicts faced
by legislators trading in the market. I also appreciate
concerns that have been raised today about trading by
individuals serving in executive agencies. However, changes to
congressional ethics rules and agency policies can address
those concerns far more efficiently and effectively than the
sweeping changes to the Securities Exchange Act included in
section 2 of today's bill, which limits a private investor from
trading on information obtained through government sources.
Today, I will highlight some of the risks posed by section
2 of today's bill. I will also bring to your attention a
special immunity provision in the Securities Exchange Act that
currently protects insider trading by the Treasury Department,
something this bill does not address.
When considering the SEC's mission to protect capital
markets, it is important to remember that capital markets have
winners and they have losers as part of the rules of the game.
If that were not the case, then no investor would have an
incentive to expend the time and resources to become informed
about investments, and the efficiency of capital markets so
important to our standard of living would disappear.
By targeting investors who seek information about how
pending regulation may affect the companies they are invested
in, section 2 of this bill penalizes resourceful investors and
hinders investment managers and pension fund trustees from
fulfilling their duties to their investors to maximize returns.
The prospect of sweeping financial regulatory reform and
the Federal Government's controlling ownership in over 200
companies has introduced a level of political risk never before
seen in American capital markets. The SEC's mandate to protect
capital formation is not implicated when investors stay
informed about this political risk. Quite the opposite;
informed trades actually enhance the efficiency of capital
markets.
I am also concerned that using insider trading as a vehicle
to address this concern would have the unintended effect of
actually harming the effectiveness and legitimacy of current
insider trading law and investigations. This bill would expand
the definition of ``insider trading'' in a way that would
abandon its original foundation in fiduciary duty principles.
Now that I have addressed some concerns with what this bill
does, I would like to highlight a danger to capital markets
that this bill does not address.
The Treasury Department enjoins immunity from insider
trading liability. Section 3(c) of the Securities Exchange Act
reads in part, ``No provision of this title shall apply to any
executive department or employee of any such department acting
in the course of his official duty as such, unless such
provision makes specific reference to such department.'' As
today's bill does not specifically mention the Department of
Treasury or the Federal Reserve, it would not amend section 3
to cover transactions in TARP securities by government
agencies.
Through TARP, the Treasury Department obtained a
controlling interest in most of the automotive and financial
sectors. The goal was to help increase the stock price of TARP
firms and help them raise private capital eventually. I am
concerned that the prospect of insider trading by Treasury
officials acting in their official capacity will cause shares
in those companies to trade at a discount and also threaten
Treasury's ability to eventually privatize these businesses.
To be clear, even if today's bill passes, staffers of the
Treasury and the Federal Reserve who trade shares on behalf of
the Federal Government will still be able to engage in insider
trading and what is more--and this is the interesting part--
this type of violation would not need any expansion of insider
trading law to address. It would already be covered under the
traditional, classical theory of insider trading but, for the
very special exemption that the Federal Government enjoys under
section 3(c) of the Exchange Act.
The securities laws are a finely woven fabric. Care must be
taken to ensure that change in one area doesn't harm the design
of the entire system. For this reason, I would urge this
committee to strike section 2 from this bill. I would also
recommend it consider amending section 3(c) of the Exchange Act
such that the exemption no longer applies to trading shares by
Treasury and by the Federal Reserve using funds authorized
under the Emergency Economic Stability Act.
I thank you for the opportunity to testify and I look
forward to answering your questions.
[The prepared statement of Professor Verret can be found on
page 48 of the appendix.]
Chairman Moore of Kansas. Thank you, Professor Verret.
I appreciate the testimony of the witnesses, and I now
recognize myself for 5 minutes for questions.
Mr. Kotz, you note in your testimony that you are pleased
by the Commission's announced actions taken in response to your
report if they are correctly implemented. Do you believe that
these actions, if performed several years ago, would have
prevented the matter you investigated from happening?
Mr. Kotz. Yes, I do, if those procedures were in place.
I mean, there are rules in place at the SEC; the problem
is, there was no monitoring of those rules. If there was
monitoring of those rules, those rules would have been able to
be addressed as soon as these individuals began this trading.
We found out about it from the Ethics Office and followed
up and did an investigation. But it would have been dealt with
much earlier had there been a monitoring compliance system in
place.
Chairman Moore of Kansas. Thank you.
Professor Henning, a former SEC official proposes that
Congress should prohibit anyone at the SEC from buying or
selling shares of publicly traded companies and any entities
subject to SEC regulation.
Do you believe that is necessary, sir?
Mr. Henning. Yes, I believe it is, that it will eliminate--
very much limit the possibility. You can never stop someone
from tipping, of course, but at least it would send a clear
signal to anyone who works at the SEC, don't trade, don't do
this, and if you do, you are stepping over a very clear line.
Chairman Moore of Kansas. Thank you.
Professor Henning, with your experience working in the SEC
on insider trading cases and as a law professor, I think you
made some good points in your testimony with respect to the
definition of material nonpublic information.
Since this definition has been well-defined by case law in
the Commission's use of the Supreme Court's flexible
definition, would it make more sense to remove that provision
from H.R. 682? Is there anything to be gained by codifying that
definition, or will we make the law more confusing for insider
trading cases?
Mr. Henning. One possible--the problem is, if it were
simply codified for this area and not others, that it could
have--as Professor Verret said, you have to be very careful.
When you tinker with one part of this--this is a very complex
web; when you tinker with one part, it has an effect somewhere
else. And, frankly, the Supreme Court's definition in the two
leading cases is so broad that anything can fit under for
materiality. The courts are very used to it.
So I think it would be better to simply say, ``material
nonpublic information.'' What the courts would then do is, they
would look at the Supreme Court cases and say, we are going to
follow what the Supreme Court has said.
Chairman Moore of Kansas. Thank you, sir.
Professor Ziobrowski, I am interested in the
recommendations you make at the end of your testimony, that
rules associated with blind trusts should be tightened.
Would you describe the problem? And do you have any
suggestions on how Congress should do that, sir?
Mr. Ziobrowski. Actually, I am not going to pretend I am a
lawyer and try and tell you how to tighten the laws. But the
fact of the matter is that there is evidence that--
particularly, I think, in the first case, where there was
evidence that we had reason to believe that he knew what was in
the blind trust--if you are going to have a blind trust, it has
to be truly and absolutely ``blind,'' meaning you don't know
what is in it.
And that, again from a legal standpoint, how you write that
up is not my bailiwick, but you do need to be there.
Chairman Moore of Kansas. Thank you, sir.
At this time, I will recognize Ranking Member Biggert for
questions for 5 minutes.
Mrs. Biggert. Thank you, Mr. Chairman.
Inspector General Kotz, when was your Case Report No. 481,
which recommended 11 changes to ensure adequate monitoring of
employees' future securities transactions, when was it issued?
Mr. Kotz. In the beginning of March.
Mrs. Biggert. In the SEC's written testimony submitted for
the record, they mention that on May 22, 2009, they submitted
to the Office of Government Ethics proposed new rules. Have you
received these proposed new rules and do they address your
concerns?
Mr. Kotz. We have received information about the new system
that the SEC is putting into place. We haven't seen all the
parts of it yet. They are still in the process of putting that
together.
As designed, it does address our recommendations--and in
fact in a couple of cases even goes further than our
recommendations--but we plan to scrutinize the implementation
of this system because it is important to have a system that is
designed appropriately, but then also implemented
appropriately. So we plan to follow up and ensure that, as
implemented, it will address all the concerns in our report.
Mrs. Biggert. Then Mr. Verret, why are the Treasury
Department and the Federal Reserve employees granted immunity?
Mr. Verret. I can only guess that in 1934, the thought was
that the Federal Government had before and probably--maybe they
didn't know this in the future, but during World War II, the
government owned a lot of companies basically that they ran.
And I guess the thought was we don't have to worry about those
pesky securities laws when you run these companies.
I think that is a long time past. And what we are dealing
with now is, I think everybody agrees, hopefully short-term
nationalization of companies. At least I hope everybody agrees
that it will be short-term nationalization.
And so the issue is, between now and the time we hopefully
eventually privatize these nationalized companies--effectively
nationalized companies, in Citigroup and AIG and General
Motors, that between now and then there is always the prospect
that the ultimate both control shareholder and informed
shareholder--who, by the way, also regulates the companies--the
ultimate insider will engage in insider trading because of the
protections of section 3(c).
Mrs. Biggert. Do they have any safeguards in place to
prevent insider trading by officials or their staff?
Mr. Verret. Well, I would imagine there are probably some
sort of ethics rules, although we have already seen some
allegations that regulators might have perhaps not exactly
followed the securities laws during the crisis and in the
aftermath of the crisis. So I think it is very possible that
Treasury officials will use inside information to trade top
shares.
Mrs. Biggert. Well, we have the TARP program now. Do you
have any concerns that, with this immunity, that this could be
a problem?
Mr. Verret. I think so, absolutely. And I think in addition
to the special immunity carved out in section 3(c) of the
Exchange Act, the Federal Government also enjoys a special type
of immunity as a shareholder that other shareholders don't get.
In State corporate law, if you are a shareholder that controls
a company, you are treated just like a director or an officer.
You run that company, so you have a fiduciary duty to the other
shareholders in the company not to use it for some purpose that
harms the rest of the shareholders. The Treasury Department, as
a shareholder, enjoys immunity from control person liability
under State corporate law. And so to that extent, we could see,
potentially, by Treasury using the company to, for instance,
subsidize lending in a certain type of State.
One thing we see in Italy, frankly, in terms of government
ownership in private companies, we see Italian banks in the
south subsidize lending versus the north because that is where
the ruling coalition of Parliament gets all of their power. So
I think it is not crazy to think we could see subsidized
lending, for instance, in battleground States by TARP shares.
So I think those sorts of things would be covered if Treasury
weren't immune from control person liability, but since it is,
it is very possible.
Mrs. Biggert. Do you see the price, that billions of
dollars in the financial institutions stock that are owned by
the U.S. Government, that there could be a change in that?
Mr. Verret. Yes. It could definitely hurt the long-term
stock price, absolutely.
Mrs. Biggert. Thank you.
I have one more question, but maybe we will have another
round.
Chairman Moore of Kansas. Go ahead.
Mrs. Biggert. Mr. Kotz, on December 16, 2008, former SEC
Chairman Chris Cox asked you to investigate the SEC's
examination and oversight of Madoff. And I understand that you
will be releasing your office findings next month.
Unfortunately, Congress won't be in session when you release
your report. So now that Madoff has admitted his guilt and been
sentenced to 150 years in prison for the thousands of seniors
and American families who lost their life savings, I think they
deserve an answer as to what the SEC knew and what they knew
about Madoff. After 7 months of investigation, what can you
tell us about the SEC's failure to uncover the Madoff Ponzi
scheme?
Mr. Kotz. Sure. We are planning to provide that
comprehensive review. The report will detail all of the
different investigations and examinations that occurred by the
SEC of Bernard Madoff and related entities from the period of
time of 1992 until December 2008, when Mr. Madoff confessed. So
it is going to be a very long and comprehensive report. We have
interviewed over 100 witnesses, we have looked at literally
millions of e-mails, and we are in the process of finalizing
the report. We wanted to make sure that the report, when
issued, would be fully comprehensive and thorough. And so it
has taken some time, but for such a large topic of different
audits, examinations, and investigations that were multiple in
nature over a period of almost 20 years, we needed the time in
order to get the full story.
The report that we issue at the end of August will address
all the issues relating to the SEC's interactions with Bernard
Madoff and related entities.
Mrs. Biggert. Well, since the Inspector General doesn't
investigate the alleged security laws violations, were you or
any of your predecessors ever informed about any of the
allegations made against Mr. Madoff and the SEC's failure to
investigate him?
Mr. Kotz. No. There was never any complaint or even hint of
anything that came to the Office of the Inspector General at
the SEC.
Mrs. Biggert. Thank you. I yield back.
Chairman Moore of Kansas. Thank you, Congresswoman.
I will now recognize Congressman Baird for 5 minutes, sir.
Mr. Baird. I thank the chairman and the ranking member for
allowing me to participate. Again, I would thank the witnesses
for their interesting testimony. I particularly appreciate the
points made about materiality. We have heard that from others
since we introduced the bill, I think we can create that; it
probably does create problems elsewhere, oversight of insider
trading. And also the suggestion by Professor Henning about
nondisclosure requirements for tippees I think is also
particularly helpful.
To cut to the chase, many people say, why would you need
this legislation that Congresswoman Slaughter and I have
proposed? Let me just start with this simple question, yes or
no.
Do you think current transparency requirements in the House
financial reporting are adequate to allow people to identify if
there has been any insider trading or not? And just go down the
row.
Mr. Kotz. Well, I haven't analyzed that process within the
House, but I would certainly say that clearer procedures put in
place will allow for a much better process than is in place
now.
Mr. Ziobrowski. If we are talking about financial
disclosure, I still, as I have indicated in my testimony, have
a great deal of problem between the notion of filling out
financial disclosure forms and what people actually do in the
office. In other words, for one thing, just because you own a
stock doesn't mean that you are going to do things to cause
that stock to go up. So the fact of the matter is that there
really isn't any--and you would almost have to be, as an
American, almost have to be an expert. If we are looking at
this from the standpoint of a voter, there is no way as a voter
you could simply look at an FDR and decide whether or not there
is a conflict of interest. You really have to be intimately
familiar with every vote that Member has cast, and you have to
be intimately familiar with the details of the bill they voted
on.
Mr. Baird. But the media do it right now. I mean, we wait a
year before we report what our trades were. And some of you
mentioned in your testimony, if you are an investment firm, you
have to report within 48 hours.That would be, frankly, my
preference. We actually extended it to 90 days in this bill as
a compromise, I would rather go back to 48 hours.
Professor Henning?
Mr. Henning. Certainly, I am never going to oppose
transparency. That is a terrific idea, and it will be the press
that will monitor it.
I guess the greater problem that occurs in insider trading
is not so much when people do it on their own, but when people
tip and feed the information. When you see the various insider
trading cases that come out of Wall Street, it is not just one
person trading; that is, they tell three or four others, and
you have a ring. And then, of course, transparency is unlikely
to show. But still, that is a very good starting point.
I think you made a very good point in your testimony that
everyone needs to know that this is wrong and that you can't do
this. Every company and law firm that I am familiar with makes
their people do it quarterly. That is a very important piece of
paper that they have, and that is a very good starting point.
Are you going to be able to stop a thief? Ultimately, no. But
it would be a very good starting point.
Mr. Verret. Congressman, to answer your question, as a
taxpayer and a voter, I like some of the thoughts behind this
bill. I would just offer that I am only a securities law
expert, and I think this is not an issue of securities law.
That Washington insider is not the same thing as a corporate
insider. And insider trading laws are only built around looking
at corporate insider trading; they are not built around looking
at Washington insider trading.
So I am glad to hear that discussions are going on about
congressional ethics rules, about agency policies about this
issue, but this is not insider trading for the purposes of the
securities laws.
Mr. Baird. That is an excellent point. But that is
precisely why we need something like this, in my judgment. My
understanding, in talking to a number of legal scholars, is
that we might be able to address this just by much more clearly
defining within our House ethics codes what our duty is. And
having defined that duty more explicitly and trained our staff,
it might then open it up to securities law enforcement because
there are other cases, which are examples, where SEC has been
able to take action against government employees because they
had a clear-cut duty or they engaged in misappropriation of
information.
And so what we are trying to get at here is, you know, I
said I am not an attorney, but I do know what smells bad. And
when you go to a town hall and you say, should a Member of
Congress who has nonpublic information that you or your
neighbor could not get, should they be able to make a trade and
make a personal profit or give information to their brother-in-
law or somebody? The answer is ``no'' in the minds of the
general public. That is not why they sent us here.
So the second question for me is, does our current ethical
standard, to the best of your knowledge, and preparation of our
staff, or lack thereof, adequately prevent what is tantamount
to insider trading, even if not technically under current law
defined as insider trading? Does it protect the integrity of
the markets?
Professor Henning?
Mr. Henning. I would say--and again, I don't want to--I
don't have any information that this is rampant or happening a
great deal. I think if it happens once it is a problem, and so
the ethics rules need to be clear. And so often the ethics
rules in any area are not particularly clear, but it should be
clear that you cannot use any information that you glean from
your job for your own personal benefit.
I agree with Professor Verret that this is not classic
insider trading, but it is--congressional information can have
such an impact on the markets now, and especially at this point
in time, that it has to be made clear, not just on Capitol
Hill, but to government employees anywhere--
Mr. Baird. Exactly.
Mr. Henning. --that you cannot use this information to
benefit yourself or to tip others. That does have to be made
clear.
Mr. Baird. Let me, if I may, Mr. Chairman, Professor
Verret, in your testimony you said section 2 of the bill
penalizes--
Chairman Moore of Kansas. Without objection, you are
recognized for 2 more minutes.
Mr. Baird. Thank you very much.
Section 2 of the bill penalizes resourceful investors.
Could one not also argue that the traditional insider trading
case penalizes resourceful investors if resourceful is meaning
to gather information not yet known by the public, and
particularly purposely not known by the public, classified
information within a company, doesn't that make you just
particularly canny and resourceful?
Mr. Verret. Well, unless it relates to trades based on
information obtained by an investor's fiduciary. So it is not
about duties to sort of the general public, it is about duties
to a specific set of investors at a specific company. And
insider trading law has definitely expanded over the years. I
think probably the most controversial expansion is the one you
just mentioned, the misappropriation doctrine. And I take your
point that changes in ethical rules and secrecy requirements
might bring some of what you are talking about under the
misappropriation doctrine. I understand that. Although the
misappropriation doctrine certainly is controversial in the
academic literature, but it would not apply to the political
intelligence operations. In other words, tipping to a tippee
where you don't expect some direct benefit wouldn't fall under
the misappropriation doctrine. So a lot of what political
intelligence sort of operatives--if you want to use that word--
do would not even fall under misappropriation.
Mr. Baird. If I talk to a committee staff member who gives
me information, and I make an investment based on that
information, and I take a portion of the profits of that
information and pump it back into a 527 or a campaign
committee, does that apply?
Mr. Verret. I am not sure whether it would or not. But I
would bring you back to the question, would that violate other
laws already on the books?
Mr. Baird. I am not sure; that is the question. And that is
what we are trying to get at here is, the fact that you are
saying I am not sure is part of the question.
Mr. Verret. I think that direct set of facts that you have
given me might potentially risk current liability under the
misappropriation doctrine, but I think it is uncertain.
Mr. Baird. And that is my point, if it is uncertain, we
ought to correct it. And I know you have other questions, Mr.
Chairman.
Chairman Moore of Kansas. Thank you, Congressman Baird.
Thank you, Ranking Member Biggert. And I want to thank our
witnesses, some of whom traveled a long way for their testimony
today.
Today's hearing gives us a better perspective of the access
to valuable and sensitive information that officials may have
throughout the government. The vast majority of public
servants, I think we all would agree, are hardworking
individuals who enjoy the privilege of serving the American
people. But no government official, no matter what their
position, is or should be above the law. We need to continue to
carefully explore these issues, including the best process to
guard against any unfair use by any government official of
inside information.
The Chair notes that some Members may have additional
questions for our witnesses which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 30 days for members to submit questions to the witnesses
and to place their responses in the record.
This hearing is adjourned. And again, I thank the members
of the panel and the witnesses for their participation. Thank
you all.
[Whereupon, at 3:12 p.m., the hearing was adjourned.]
A P P E N D I X
July 13, 2009
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