[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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                 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

                              ----------                              
                                                                   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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