The hot story of the day is this Congressional insider trading business, which was popularized by 60 Minutes last night.

The basic gist: Congressmen are allowed to trade on whatever they want without legal ramifications, and in fact have a fantastic track record of beating the market.

But the whole thing is hogwash according to Indiana Law Professor Donna Nagy.

In this paper titled Insider Trading, Congressional Officials, and Duties of Entrustment, Nagy argues that it doesn't really make sense to say Congress is exempt from insider trading laws, since the illegality of insider trading is mostly established by the courts, and through the relatively vague SEC rule 10b5-1.

Nagy writes:

Overlooked in all of the media hullabaloo about so-called “congressional immunity” from the insider trading laws were several critical facts. First and foremost, Congress could not have “exempted itself” from its own insider trading laws because Congress has never enacted a federal securities law that

explicitly prohibits anyone from insider trading. In this respect, the United States stands in contrast with a host of other countries that explicitly prohibit certain persons from trading securities on the basis of material nonpublic information.16 The law in the United States is far more nuanced because,

despite persistent calls for legislation and several abandoned attempts in the late 1980s,17 Congress has never statutorily defined the offense of insider trading in securities.18 Rather, Congress has been content to allow insider trading to be prosecuted as a violation of Rule 10b-5, a general antifraud rule

which the SEC promulgated pursuant to its authority under section 10(b) of the Securities Exchange Act of 1934 (Exchange Act).19 Rule 10b-5 broadly prohibits fraud and deception “in connection with the purchase or sale of any security,” and violations of the rule may be prosecuted by the SEC as a civil offense or prosecuted by the Department of Justice (DOJ) as a crime. with a single exception, insider trading is illegal under the federal securities laws only insofar as it can be deemed a fraudulent practice in violation of Rule 10b-5. The result is that U.S. insider trading law has been almost entirely

judge-made, although much of that law has been subsequently codified in additional rules promulgated by the SEC.

As for why Congressional insider trading is almost certainly illegal,

Professor Tamar Frankel’s recent book and earlier writings on fiduciary law and duties of entrustment can help us to see precisely why insider trading by members of Congress and legislative staffers is already illegal under present law and why enactment of the proposed STOCK Act is not only unnecessary, but would also narrow considerably the present law that would apply to their

securities transactions in the absence of an explicit statutory prohibition. Drawing from Professor Frankel’s extensive work, and from prior applications of fiduciary principles in congressional disciplinary actions and Executive Branch prosecutions of members of Congress for honest-services fraud, this Article argues that members of Congress and legislative staffers owe fiduciary-

like duties of trust and confidence to a host of persons including the citizen-investors whom they serve, as well as the federal government, other members of Congress, and government officials outside of Congress who rely on their loyalty and integrity. Based on these duties of entrustment, this Article concludes that congressional officials engage in deception, and therefore violate Rule 10b-5, if they trade securities on the basis of material nonpublic information obtained through congressional service.

Download the full paper here.

(Via Ben Sayer)