By Dan Portnov
2019 ended with Congress trying to tackle insider trading but 2020 begins with the Second Circuit Court of Appeals once again commanding center stage in defining the elements of the offense. In United States v. Blaszczak (issued on December 30, but no one was paying attention), the court considered insider trading charges based under a newer criminal securities fraud law: Title 18 Section 1348.
The Blaszcak decision made clear that the Second Circuit’s insider trading precedent—Dirks, Newman, et al.—only applied to insider trading cases brought under the 1934 Exchange Act (Title 15 Section 78a). As a result, prosecutions brought under § 1348 should be easier to prove than charges of insider trading in violation of Exchange Act Section 10 or Rule 10b-5 promulgated thereunder.
Background
Defendant David Blaszczak previously had worked for the Centers for Medicare & Medicaid Services (CMS) before leaving to become a political intelligence consultant for hedge funds. Tapping his network of former colleagues at CMS, he learned and passed information about pending changes in CMS reimbursement rates to hedge funds Visium Asset Management and Deerfield Management Co. Deerfield, a healthcare-focused hedge fund, traded on this information.
After jury trial in the Southern District of New York, Blaszczak and three co-defendants were acquitted of Exchange Act securities fraud, but Blaszczak and two others were found guilty of § 1348 securities fraud and conspiracy. (All four defendants were found guilty of wire fraud and conversion.) They appealed their convictions to the Second Circuit.
The Decision
Writing for the majority of the Second Circuit panel, Judge Richard Sullivan affirmed each conviction. Among other things, the Court held that the “personal benefit” test established in Dirks v. SEC in 1983 (and upheld by the Second Circuit in U.S. v. Newman in 2014) is not an element of § 1348 securities fraud.
That is to say that, for § 1348 cases, prosecutors will not need to show that the tipper received a personal benefit and that the tippee(s) knew about it. This is potentially a very big deal since those were two of the toughest elements for a prosecutor to satisfy at trial.
One of the reasons that the government brought charges under the Exchange Act and § 1348 was because the facts of Blaszczak did not fit neatly into typical classical or misappropriation theory insider trading. Here, the information traded on was nonpublic pre-decisional information of the CMS—a non-private entity. The Second Circuit held that this information constituted property under both § 1348 and the wire fraud statute.
Prior to Blaszczak, § 1348 was primarily used to prosecute securities frauds such as account churning, embezzlement, Ponzi schemes, selling securities without license or selling unregistered securities. With last week’s decision, it appears that misappropriation theory insider trading is now on the table.
Consequences
As ominous as it sounds, the consequences of the Blaszczak decision will take some time to shake out.
First, another SDNY decision (U.S. v. Mittendorf), holding that Public Company Accounting Oversight Board (PCAOB) audit inspection lists can be considered property for the purposes of the wire fraud statute, will soon be heard by the Second Circuit and may modify the second holding of Blaszczak. Additionally, the dissent of Blaszczak strongly invites an en banc review of this case, further signaling its impermanence.
Second, the nonpublic information traded on by Blaszczak’s co-conspirators did not come from a private company. Commentators believe traditional fact patterns involving nonpublic information misappropriated and/or traded on from private companies will still be charged under the Exchange Act (Title 15). Newman’s personal benefit element has already been softened U.S. v. Martoma (2019), further favoring the government in Exchange Act insider trading prosecutions.[1] § 1348 will therefore provide prosecutors with an additional charging option for murkier cases.
Third, the different elements of insider trading under the Exchange Act line of cases versus § 1348 charges may lead to struggles between DOJ and the Securities and Exchange Commission (SEC). DOJ and SEC often conduct parallel investigations and bring coordinated enforcement actions under the Exchange Act. Following Blaszczak, however, DOJ may choose to charge under § 1348 while the SEC, not able to bring criminal charges under Title 18, will be limited to traditional Exchange Act enforcement. The agencies’ parallel proceedings and coordination may suffer as a result.
Finally, Article II fanatics may see this legal development as a renewed call for Congress to resume its efforts to pass a uniform insider trading prohibition—one that is malleable enough to cover nonpublic information taken from CMS or the PCAOB.
In conclusion, U.S. v. Blaszczak will almost certainly be reexamined by the Second Circuit and may not lead to a watershed of additional charges (overcharges) by prosecutors.
But only time will tell. Meanwhile, the Department of Justice has another arrow in its quiver to prosecute insider trading.