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53–236 PDF 2009

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 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

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 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

DENNIS MOORE, Kansas, Chairman 

STEPHEN F. LYNCH, Massachusetts 

RON KLEIN, Florida 

JACKIE SPEIER, California 

GWEN MOORE, Wisconsin 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

ALAN GRAYSON, Florida 

JUDY BIGGERT, Illinois 

PATRICK T. MCHENRY, North Carolina 

RON PAUL, Texas 

MICHELE BACHMANN, Minnesota 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

(V) 

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 

(1) 

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 

2 

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. 

3 

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 

4 

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 opVerDate Nov 24 2008 13:05 Nov 12, 2009 Jkt 053236 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 K:\DOCS\53236.TXT TERRIE
5 

erated 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. 

6 

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. 

7 

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 

8 

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. 

9 

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. 

10 

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, reVerDate Nov 24 2008 13:05 Nov 12, 2009 Jkt 053236 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 K:\DOCS\53236.TXT TERRIE
11 

taliatory 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 enVerDate Nov 24 2008 13:05 Nov 12, 2009 Jkt 053236 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 K:\DOCS\53236.TXT TERRIE
12 

sure 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 

13 

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 

14 

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-apercent 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 questionand-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. 

15 

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. 

16 

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 

17 

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 

18 

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 

19 

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? 

20 

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. 

21 

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. 

22 

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. 

23 

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 defiVerDate Nov 24 2008 13:05 Nov 12, 2009 Jkt 053236 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 K:\DOCS\53236.TXT TERRIE
24 

nitely 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.] 

(25) 

A P P E N D I X 

July 13, 2009 

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