On April 4, 2012, President Obama signed the Stop Trading on Congressional Knowledge Act (the “STOCK Act”), and the House Committee on Ethics issued the first set of guidance under the STOCK Act (see memorandum). Among other things, the STOCK Act confirms that Congressional Members and staff, and federal executive and judicial branch officials, owe a duty with respect to material, nonpublic information derived from the person’s position with the federal government under the insider trading provisions in Section 10(b) of the ’34 Act and related SEC Rule 10b-5. In other words, information held by such federal officials qualifies as inside information upon which an insider trading case can be based if it is shared. Although much has been said as to when a federal official can be liable as a “tipper” in an insider trading case, the following focuses on the “tippee” liability that can accrue to the company with which the official shares such information.
A company’s tippee liability is derivative of the tipper’s liability; that is, a tippee will not be found liable unless the tipper is found to be liable. For a tipper to be liable, he or she must (1) disclose material, nonpublic information to the tippee in breach of his or her fiduciary duty and (2) receive a personal benefit as a result of the disclosure. While the interpretation by the courts of “personal benefit” has not been consistent, it is important to note that a number of courts have broadly interpreted this requirement, for example finding the passing of information to maintain goodwill with the tippee sufficient to meet the test. If the elements of tipper liability are satisfied, tippees can be held liable if the tippee (1) acts on the information, and (2) knows, or reasonably should know, that the tipper’s disclosure is in breach of his or her fiduciary duty.
Given the unique nature of the information that public officials possess and the fact that a public official’s job duties include interacting with constituents (such as companies, lobbyists and consultants) on policy matters, applying a Rule 10b-5 tippee analysis can raise difficult questions. The more troublesome issues are highlighted below.
Please note that there are some practical procedural steps that a company could implement to avoid having to address these difficult issues. Moreover, in a tippee liability case, the SEC’s view (as opposed to House or Senate Ethics Committees) would be most relevant. However, there has been no indication to date that the SEC will issue any guidance, by regulation or otherwise.
Is the information public or nonpublic?
A primary responsibility of public officials, especially Members of Congress and their staff, is to communicate with constituents on matters of public importance. Accordingly, it is difficult for a company communicating with such official to determine whether information about pending legislation or other policy matters is being disseminated widely enough to consider it public information. While information broadcast during a televised press conference or interview, or stated in a newspaper article, would likely be considered public, the analysis becomes more difficult when applied to information gleaned from an official’s meeting with a small number of representatives of a particular industry or a speech given at a private event. Moreover, if an official shares his or her opinion with a company as to what will happen regarding a policy decision, it is difficult for the company to know on what type of information the opinion is based. For the same reasons, it may be difficult for a company to know whether the official has a fiduciary duty with respect to that information.
Is the information material?
For information to be material, it generally has to be able to impact stock prices. As the example in the attached House Ethics Committee Guidance suggests, materiality is easier to determine if the information is regarding a decision on a particular company. However, the materiality of a policy or legislative decision is more difficult to predict. For example, is it enough that the policy or legislation could impact an entire index of securities, and if so, how direct of an impact is required?
How will the ‘personal benefit’ requirement be applied to public officials?
As noted above, the ‘personal benefit’ element required to establish tipper liability (and, therefore, the derivative tippee liability) has been interpreted inconsistently by the courts, with some courts taking a lax view towards the requirement and others establishing it as a difficult burden to be met by the prosecution. The difficulty in interpreting this element is only heightened by the added complexity of applying it to situations involving communications between public officials and the public. Because providing information to the public is an important part of a public official’s role, it is unclear whether this would serve as a defense to a claim that a public official derived a personal benefit, such as enhanced goodwill or even political contributions, from disclosing information to a member of the public, or if a court would find that an official derived a personal benefit from selective disclosure to certain companies or individuals.
Moreover, it is unclear as to what extent the protection under the speech or debate clause of the Constitution may affect tipper or tippee liability.