On December 30, 2019, the US Court of Appeals for the Second Circuit, in United States v. Blaszczak, held that the federal wire fraud and Title 18 securities fraud statutes prohibit insider trading conduct that falls beyond the reach of Section 10(b) of the Securities Exchange Act. Specifically, the Court held that to prove fraud under Title 18 in the context of an insider trading case involving tipping, the government need not demonstrate that the tipper received a “personal benefit.” The Court further held that confidential information may constitute “property” when held by a government agency and therefore that the misappropriation of such information can be prosecuted as fraud. The ruling is a significant victory for the US Department of Justice (DOJ), which had suffered a high-profile setback in another insider trading case before the Second Circuit several years ago. The decision could lead to more aggressive insider trading enforcement, including in cases involving confidential government information.

The Blaszczak Prosecution

The prosecution involved an insider-trading scheme in which employees of the Centers for Medicare & Medicaid Services (CMS) disclosed to a political intelligence consultant confidential, pre-decisional information concerning, among other things, a contemplated agency rule change that would reduce the reimbursement rate for certain treatments. The consultant, in turn, tipped the information to employees of a healthcare-focused hedge fund, which traded on it.

Based on this misappropriation of confidential CMS information, the DOJ charged the participants in the scheme with conversion of US property, securities fraud under Section 10(b), Title 18 securities fraud, and wire fraud.

At trial in the Southern District of New York, the district court instructed the jury that to convict the defendants of violating Section 10(b), it must find that the CMS insider tipped the information in exchange for a “personal benefit,” as required by the Supreme Court’s ruling in Dirks v. SEC, 463 U.S. 646 (1983); the district court, however, declined to give this same instruction on the wire fraud and Title 18 securities fraud counts. In May 2018, the jury returned a split verdict, convicting the defendants on certain conversion, wire fraud, and Title 18 securities fraud counts, and acquitting all defendants on the Section 10(b) securities fraud counts.

On appeal, the defendants contended, among other things, that (1) confidential government information is not “property” for purposes of the wire fraud and Title 18 securities fraud statutes; and (2) the personal-benefit test established in Dirks with respect to Section 10(b) applies equally to these Title 18 fraud statutes. The Second Circuit rejected both arguments.

Government Agency’s Confidential Regulatory Information is Property

In holding that confidential government information is property in the hands of a government agency for purposes of the federal fraud statutes, the Court relied heavily on Carpenter v. United States, 484 U.S. 19 (1987). The Supreme Court held in Carpenter that a forthcoming Wall Street Journal column was the Journal’s property because information is a newspaper’s “stock in trade.” The Court therefore found that the Journal had a property right in making exclusive use of the article pre-publication. The Second Circuit in Blaszczak ruled that, like the Journal in Carpenter, CMS similarly possessed a right to make exclusive use of its nonpublic pre-decisional information.

The Personal-Benefit Test of Dirks v. SEC Does Not Apply to Title 18 Fraud Statutes

The Second Circuit further concluded that the wire fraud and Title 18 securities fraud statutes give the DOJ broader enforcement authority with respect to insider trading than does Section 10(b). The Court held that the DOJ is not required to prove under these statutes an element that the Supreme Court has required under Section 10(b), namely, that an insider tipped information in exchange for a personal benefit.

The Supreme Court established the personal-benefit requirement under Section 10(b) in Dirks, holding that a tippee who receives material, nonpublic information from a company insider acquires a duty to abstain from trading only where the insider personally benefitted from the disclosure. The issue has been the subject of substantial litigation in recent years, arising from insider trading prosecutions of traders who received tips directly from insiders as well as other traders who were further removed from the original tip.

In 2014, the Second Circuit issued a landmark insider trading decision in United States v. Newman, 773 F.3d 438 (2d Cir. 2014), holding that (1) the government must prove that the tippee was aware the tipper received a personal benefit in disclosing inside information, and (2) a personal benefit could be inferred from a relationship between the tipper and the tippee only where there is proof of a “meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature.” The case was widely viewed as limiting the government’s ability to prosecute tipping cases.

In the wake of Newman, the Supreme Court took up an insider trading case for the first time in three decades to address the personal-benefit requirement. The case, Salman v. United States, 137 S. Ct. 420 (2016), involved tips from an investment banker to his brother. The Court held that a gift of trading information to a trading relative or friend satisfies the personal-benefit requirement because it is the “same thing as trading by the tipper followed by a gift of the proceeds.” In doing so, the Court rejected Newman’s holding that the tipper must receive something of a “pecuniary or similarly valuable nature.”

Following Salman, the Second Circuit further limited Newman’s reach. In United States v. Martoma, 894 F.3d 64 (2d Cir. 2017), the Second Circuit held that the government can satisfy the personal-benefit test by proving either (1) a relationship between the insider and the tippee that suggests a quid pro quo, or (2) that the insider intended to benefit the tippee.

In Blaszczak, the Second Circuit has gone further still in holding that the personal-benefit requirement does not apply at all in insider trading prosecutions brought under the wire fraud and Title 18 securities fraud statutes rather than under Section 10(b). Describing the personal-benefit test as “a judge-made doctrine premised on the [Securities] Exchange Act’s statutory purpose,” the Court declined to apply Dirks’s personal-benefit test beyond the context of Section 10(b). In reaching this conclusion, the Court noted that the Title 18 securities fraud statute and Section 10(b) do not share the same purpose, because the Title 18 securities fraud statute was intended to overcome certain technical requirements of Section 10(b) and to give prosecutors broader enforcement authority. The Court further held that the personal-benefit test does not apply when the government relies on an embezzlement theory of fraud. The fraudulent misappropriation of confidential information constitutes embezzlement, the Court concluded, regardless of whether the embezzler tips the information in exchange for a personal benefit.

Potential Implications

The Court’s holding that confidential government information is property and that its embezzlement can constitute fraud is both novel and significant. In recent years, the DOJ has brought multiple cases involving allegations that government employees misappropriated confidential government information as they sought jobs in the private sector. To date, such conduct has typically resulted in charges against the government employees for obstruction of justice, unlawful access to government computers, the unauthorized disclosure of confidential information, or conspiracy to defraud the United States under a so-called “Klein conspiracy” theory. Going forward, under Blaszczak, the DOJ may be able to bring fraud charges against not only a government employee who misappropriates confidential information, but also any individuals in the private sector who knowingly receive or make use of such information. This fraud theory may be attractive to the DOJ because it could be used in a number of contexts, including in cases that do not involve trading in the securities markets, and would not require the DOJ to prove some of the more technical elements of other statutes.

The ruling regarding the personal-benefit test for insider trading is even more consequential. By allowing the DOJ to prosecute insider trading under the Title 18 fraud statutes without having to satisfy the requirements of Dirks and Newman, Blaszczak may embolden the DOJ to pursue insider trading more aggressively. The DOJ can more readily prosecute tipping cases under these statutes where there is little or no proof that an insider received a benefit for tipping confidential information. As a result, the DOJ is likely to increasingly rely on these statutes in insider trading cases. Oddly, because the US Securities and Exchange Commission (SEC) lacks enforcement authority with respect to these Title 18 offenses, there may be circumstances in which the DOJ is able to prosecute an insider trading case criminally that the SEC cannot pursue under Section 10(b).

The recent spate of appellate litigation in insider trading cases highlights the extent to which this area of law is the product of judicial decisions. That Section 10(b) and the Title 18 fraud statutes have now been interpreted to apply differently in insider trading cases, with the result that the DOJ has broader enforcement authority than the SEC, may be fodder for the ongoing discussions currently playing out in Congress regarding a potential insider trading statute. Just last month, the House of Representatives passed and sent to the Senate a bill which would codify insider trading law. Under the proposed House bill – the Insider Trading Prohibition Act – proving that a tipper received a personal benefit in exchange for providing an inside tip would be only one of several ways of establishing liability. Even then, the bill would not require proof that a tippee be aware that a tipper received any such benefit.