Imagine, for a moment, that you're on the board of a major company. Let's make it fun and give you a seat on the Apple board of directors. As you know, each quarter, Apple announces its earnings to the public and, if you knew them ahead of time, you could make some major money. The good news is that you do know them ahead of time, so why not cash in, right?


SEE: Top 4 Most Scandalous Insider Trading Debacles


You know that Apple will announce earnings to the public in two days, so you call your broker and purchase 5,000 shares, because you already saw the report and it's pretty amazing; however, your plan has a minor flaw. That kind of activity is illegal and you would be busted for insider trading, joining the likes of Bernie Madoff, Raj Rajaratnam, Allen Stanford and the many other Wall Street investors who tried to get around the laws.

So, let's put you in another role. Now you're a high ranking Congressman who sits on the committee that drafted the Obama healthcare law. Knowing that the law would soon be unveiled, you talked to the people who managed your investments and told them to buy 10,000 shares of a certain drug company. A few days later, that company saw a big stock gain, as a result of the newly unveiled Obama healthcare plan.

Doing something like will land you in jail with Washington's white collar inmates, right? Up until recently, that action was completely legal and not only would you still be a Congressman, you would be a lot richer than you were only days before. Certainly that didn't happen, right? A 2011 report found "… strong evidence that Members of the House have some type of nonpublic information which they use for personal gain."

SEE: No More Insider Trading For Congress

The STOCK Act

Yes, it's true. Congress was permitted to trade on insider information, but Wall Street investors were not, and although the issue had been raised in the past, as far back as 2006, legislation to make that illegal was never voted into law until recently. The STOCK Act was passed to place everybody under the same rules. Here's how it works.

First, the law makes it mandatory that a Washington official hold confidential any information that is not public knowledge. To make it simple, the first part of the Act now makes all SEC insider trading laws applicable to Congressional members, as well as other high ranking Washington officials.

Second, the Act prohibits Congress and high ranking public officials from getting preferential treatment from investment bankers. Therefore, when Facebook shares were available to the big investors, Washington lawmakers couldn't receive first access to these shares, because of their position of power.

Finally, any stock trade or other transaction must be disclosed to the public within 30 days of the transaction. This will be reported via electronic systems and rapidly available to the public. This part of the bill is meant to keep Washington officials honest by putting their activities on display.

The Bottom Line
Although a big leap forward, there are still at least two areas of leakage that weren't plugged. First, hedge fund managers can still pay Washington officials for "political intelligence." This is a legal way to purchase insider information in order to make their fund more profitable. Second, members of Congress can still draft and vote on legislation that could positively affect their stock holdings. If they own a large amount of Exxon stock, they could still draft and vote on legislation that would benefit the oil industry.

The STOCK Act isn't perfect, but it goes a long way in holding Washington officials accountable for the same insider trading rules as Wall Street investors.

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