Last June, we predicted that insider trading would remain a priority for the Department of Justice (DOJ), the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC) for the foreseeable future.

The new year has already had one defendant plead guilty to an insider trading offense in New York giving prosecutors from the Manhattan U.S. Attorney's Office a second conviction in an international insider trading case. A recent opinion by the United States Court of Appeals for the Second Circuit has also paved the way for the DOJ to more easily meet its burden of proof in future insider trading cases.

United States v. Blaszczak

In United States v. Blaszczak, et al., the government charged four individuals, including a Centers for Medicare & Medicaid Services (CMS) employee, with insider trading and securities fraud under Section 10(b) of the Securities and Exchange Act (15 U.S.C. § 78j(b)); Title 15 securities fraud (SEC Rule 10b-5); securities fraud (18 U.S.C. § 1348); and other offenses, including conspiracy and wire fraud.

The case arose from a series of schemes involving misappropriated, confidential nonpublic information from the CMS that was collected by Blaszczak, a “political intelligence” consultant for hedge funds, who in turn tipped the information to hedge funds employees who traded on it.

Blaszczak was a former CMS employee that had unique access to the agency’s predecisional information through inside sources at the agency. Blaszczak and his cohorts profited from this information numerous times over a four-year period until they were charged in 2018. For example, in June 2009, the hedge fund shorted $33 million worth of stock in a radiation-device manufacturer that would be affected by a proposed CMS rule yielding almost $3 million in profits. In May of 2012, Blaszczak again provided predecisional information about radiation oncology reimbursement rate changes and the hedge fund profited nearly $3 million by shorting the stock before the official agency announcement.

The defendants were convicted after trial on most counts. While they were acquitted of Title 15 securities fraud, they were convicted of securities fraud under 18 U.S.C. § 1348. The jury instruction given as to the two statutes appeared to be the distinction that made the difference in the verdict.

Under Dirks, an insider may not be convicted of Title 15 securities fraud unless the government proves a breach of a duty of trust and confidence by disclosing material, nonpublic information in exchange for a “personal benefit.” Similarly, a tippee may not be convicted of such fraud unless the tippee utilized the inside information knowing that it had been obtained in breach of the insider’s duty. However, the jury instruction did not include these requirements for the 18 U.S.C. § 1348 securities fraud counts.

According to the Blaszczak defendants, the district court erred by making this distinction between the two offenses. They claimed that the term “defraud” should be construed to have the same meaning across the Title 18 fraud provisions and Rule 10b-5, so “that the elements of insider-trading fraud are the same under each of these provisions.”

The Second Circuit disagreed and held that while Title 15 and Title 18 fraud statutes combat similar types of fraud, the personal benefit test in Dirks is not common to both. “Rather, the personal-benefit test is a judge-made doctrine premised on the Exchange Act’s statutory purpose,” which was to eliminate the use of inside information for “personal advantage,” the court wrote. Section 1348, which pertains to fraud in connection with any security, was added by the Sarbanes-Oxley Act of 2002 “to overcome the technical legal requirements” of Title 15’s fraud provisions. Since the statutes were different provisions that were enacted for different purposes, the court declined to extend Dirks beyond Title 15.

Looking Ahead

Here are four takeaways from the Blaszczak opinion and its potential ramifications on market integrity actions:

  • It just got easier for the government to prosecute insider trading. Over thirty years of jurisprudence following Dirks is moot when it comes to Title 18 securities fraud. This will make the statute an attractive alternate or additional, fail-safe theory for insider trading prosecutors.
  • Look for a future increase in investigations and prosecutions of alleged § 1348 violations. The statute’s versatility allow it to be used more generally for various types of capital markets investigations. Section 1348 has a broader scope aimed at fraud schemes “in connection with” securities, options, and commodities for future delivery than Title 15’s more limited scope of prohibiting deceptive devices in connection with the purchase or sale of securities. Section 1348 also requires no proof that wires were used to carry out the fraud. Agencies like FINRA will be monitoring transactions related in time and size to notable mergers and acquisitions.
  • Over the dissent of one judge, the Second Circuit held that confidential government information constitutes “property” for the purposes of wire fraud and Title 18 securities fraud.
  • Companies doing business with government agencies should be mindful of the risks surrounding its handling of confidential information and treat it accordingly. Measures to safeguard proprietary information, prioritizing the exercise of greater vigilance, monitoring, and compliance to strengthen confidentiality may lead to early detection of malfeasance or the identification of vulnerabilities.