The COVID-19 pandemic has caused the first bear market in stocks in more than a decade, and the jury's still out on how much lower the stock market could fall. Many investors wish that they could have foreseen the extent of the damage that the coronavirus outbreak would do to the global economy, as they might have taken the opportunity to sell shares near record highs before people appreciated the full extent of the health crisis.

That's exactly what some members of the U.S. Senate apparently did. Thanks to financial disclosure laws, the public knows that these senators made sales of stock before the bear market hit. The question is whether those stock sales were just serendipitous in their timing -- or whether they represented a violation of laws prohibiting financial trading based on nonpublic information.

U.S. Capitol building as seen from foot of steps.

Image source: Getty Images.

What these senators did

Federal lawmakers are required to disclose financial transactions regularly. With 441 representatives and delegates in the House and 100 senators, it's not surprising that there are dozens of such reports made every month.

Yet what many people are focusing on now are a few members of the Senate who made stock trades following a confidential briefing Jan. 24 concerning the novel coronavirus outbreak. According to disclosures:

  • Richard Burr (R-N.C.) sold more than a dozen stocks between Jan. 31 and Feb. 13.
  • Dianne Feinstein (D-Calif.) sold between $500,000 and $1 million in shares of Allogene Therapeutics on Jan. 31 and another $1 million to $5 million in Allogene shares on Feb. 18.
  • Jim Inhofe (R-Okla.) made full or partial sales of positions in five different stocks on Jan. 27 and another on Feb. 20.
  • Kelly Loeffler (R-Ga.) reported dozens of stock sale transactions from Jan. 27 to Feb. 14.

David Perdue (R-Ga.) also reported numerous sells and buys throughout January and February, including the period between the Jan. 24 briefing and the market’s decline, though his disclosure history shows a pattern of regular trading.

With many stocks falling sharply following these sales, the issue is whether these senators used private information to their financial advantage. Whether that's illegal or not depends on a reading of the STOCK Act, which lawmakers passed in 2012 and the underlying facts of the respective transactions.

What the STOCK Act prohibits

The name of the STOCK Act says what its purpose was: to Stop Trading on Congressional Knowledge. Specifically, the law prohibits members and employees of the House or Senate from using material nonpublic information obtained in their official positions for personal benefit. Despite the mention of Congress in the law's name, the STOCK Act also applies to employees in the executive and judicial branches of the federal government.

Surprisingly, prior to the passage of the law, there was no clear prohibition against what amounted to insider trading among lawmakers. Having heard confidential information in briefings, representatives and senators could go out and make stock trades based on what they'd just heard -- before members of the public had seen any disclosures of that information. That stood in stark contrast to private corporate executives, who could suffer penalties under the Securities Exchange Act of 1934. 

What the senators are saying

Sens. Feinstein, Inhofe, Loeffler, and Perdue have all disclaimed responsibility for the investment sales that they disclosed. They either use blind trusts or other mechanisms under which outside third parties have responsibility for making investment decisions for their accounts. As long as the senators didn't inform the investment managers about the nonpublic information, then it's unlikely that they broke the law.

Sen. Burr, who as chair of the Senate Intelligence Committee would have received additional classified reports about the COVID-19 pandemic that other senators might not have received, has apparently not disclaimed responsibility for his trades, but he has asserted that they were legitimate. He took the extra step of having the Senate Ethics Committee look at his stock sales, saying that he relied on publicly available information -- specifically "CNBC's daily health and science reporting out of its Asia bureaus at the time" -- to guide his Feb. 13 transactions. In Burr’s case, then, the question of legality will center on the nature of the information the senator used as his basis for selling stock -- when he sold his stocks, was he relying on important facts that he only had because of his job, or could someone who followed the news as he did have known what he knew?

Hold lawmakers accountable

Many people on both sides of the aisle are looking closely at this potential scandal. Regardless of whether the insider trading laws under the STOCK Act were broken, the controversy will likely reopen debate about what officials in Washington should and shouldn't be able to do with their investments.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.