The Stop Trading on Congressional Knowledge (STOCK) Act: a Tutorial

"Whenever the people are well-informed, they can be trusted with their own government ... Whenever things get so far wrong as to attract their notice, they may be relied on to set them to rights." 
--
Thomas Jefferson

"You can know the name of a bird in all the languages of the world, but when you're finished, you'll know absolutely nothing whatever about the bird ... So let's look at the bird and see what it's doing -- that's what counts." 
-- Richard Feynman

Going on two years now, we've sounded the alarm about a problem in Washington: Congressmen (and -women) trading stocks based on inside knowledge of laws that will affect these same companies. Lawmakers are getting rich at the expense of the people they're elected to represent.

More recently, we've told you of a law working its way through Congress that aims to fix this problem: the Stop Trading on Congressional Knowledge (STOCK) Act. Ever since 60 Minutes ran a story on how certain U.S. Congressmen have been trading shares of Visa (NYS: V) , General Electric (NYS: GE) , UnitedHealth Group (NYS: UNH) , and other stocks based on knowledge of laws working their way through Congress, public support for the STOCK Act has grown. Support in Congress itself is also growing. At last count, 242 members of the House of Representatives and 32 U.S. Senators support the STOCK Act.

But did you know there is more than one STOCK Act?

Two's company, five is a crowd
Depending on how you count them, there are as many as four separate versions of the STOCK Act floating around Washington today. There's the original version, based on a House bill first proposed by Reps. Brian Baird and Louise Slaughter five years ago. The Senate has two more variants -- one proposed by Sen. Scott Brown, a second proposed by Sen. Kirsten Gillibrand, and a third version that's coming out of Sen. Joe Lieberman's Homeland Security and Governmental Affairs Committee, which attempts to merge and improve upon Sens. Brown's and Gillibrand's work.

Early next year, House Majority Leader Eric Cantor -- himself an active trader of stocks ranging from Altria (NYS: MO) to Wells Fargo (NYS: WFC) -- plans to take up a version of the STOCK Act. Very soon, we could have not one, but five different STOCK Acts vying for our attention. Which brings me to my point: Maybe you support the STOCK Act. But which STOCK Act do you support? Which one should you support?

In the interests of informing this debate, I've gone through the two leading contenders with the proverbial fine-toothed comb. What I've found is that there are three key areas where the Senate's consensus version of the Act differs from the House's. Which version is better? You be the judge.

Start the clock
Right now, Congress' ethics rules require each representative and senator to file "disclosures" of their trading activity once per year. The House version of the STOCK Act tightens this up considerably, by requiring disclosure of a trade within 90 days after it takes place. The new Senate version goes a step further, imposing a 30-day deadline.

Verbosity is not a virtue
Of course, what we really want is to ensure that when lawmakers disclose their trades, they can honestly tell us they did nothing wrong, that they followed the rules and avoided trading on inside information. Both the Senate and House STOCK Acts try to ensure this, but in different ways. The most obvious difference is size... and complexity. The House STOCK Act weighs in at a hefty 18 pages, and employs such convoluted passages as:

... the Commission shall by rule prohibit any person from buying or selling any commodity for future delivery or swap while such person is in possession of material nonpublic information, as defined by the Commission, relating to any pending or prospective legislative action relating to such commodity ... if such information was obtained by reason of such person being a Member or employee of Congress ... or such information was obtained from a Member or employee of Congress, and such person knows that the information was so obtained.

By contrast, the Senate's version is a veritable model of svelte lawmaking: "No Member of Congress and no employee of Congress shall use any nonpublic information derived from the individual's position as a Member of Congress or employee of Congress, or gained from performance of the individual's duties, for personal benefit." Period.

...and neither is complexity
Now, complexity is inherent in lawmaking, and I give the House props for trying to dot all the i's, cross all the t's, and close all the loopholes in their version of the STOCK Act. Whereas the Senate bill bans use of "any nonpublic information" for personal gain, the House tries to tailor its bill to capture only "material" nonpublic information. The House also hews to the main concerns voiced about insider trading, regulating material information that relates to "pending or prospective legislation." And in an effort to regulate all possible wrongdoers, the House version favors long lists -- regulating, for example, the conduct of any: "Member, Delegate, Resident Commissioner, officer, or employee."

But if you ask me, the House spends too much time "naming birds." A better solution might be to borrow a bird book from the dedicated ornithologists at the SEC -- as the Senate has done.

The Senate, you see, incorporates by reference the whole body of securities regulation worked out over the past 80 years by simply imposing a "duty of trust and confidence of each Member of Congress and of each employee of Congress." This language is already part of the case law from decades of judges ruling on insider trading cases. The effect of this language is to clearly subject Congressional trading to the general rules on insider trading applicable to everyone else.

Personally, I think this is the more elegant solution. In fact, I think the Senate STOCK Act as a whole is more broad-reaching than the House's point-by-point attack on insider trading. But what do you think?

Email us at imoscovitz@fool.com and tell us whether you think a broad-brush ban on insider trading, and a 30-day disclosure period (as proposed by the Senate) is the best solution, or whether you think the House is right to close down the loopholes as it finds them, one by one -- and hope none escape it. In turn, we'll add you to our contact list and keep you up to date as both (or is it all three, four, or five?) of these laws make their way through Congress.

At the time this article was published Fool contributor Rich Smith does not own (or short) shares of any company named above, but Motley Fool newsletter services have recommended buying shares of Visa. The Motley Fool has a disclosure policy.The Motley Fool owns shares of Wells Fargo, UnitedHealth Group, and Altria Group. The Fool owns shares of and has created a covered strangle position on Wells Fargo. Motley Fool newsletter services have recommended buying shares of Visa and UnitedHealth Group. Motley Fool newsletter services have recommended creating a diagonal call position in UnitedHealth Group.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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