On December 30, 2019, the Second Circuit issued a consequential insider trading decision in United States v. Blaszczak.1 In Blaszczak, the Second Circuit faced the question whether the “personal benefit” test set forth in Dirks v. SEC2 for insider trading cases under Section 10(b) of the Securities Exchange Act (Title 15 securities fraud) also applies to tipping schemes charged as wire fraud and securities fraud under Title 18 of the criminal code. After reviewing the origin of the personal benefit test, which the court found rooted in the statutory purpose of Section 10(b), the Second Circuit held that the test has no application to Title 18 charges.3
The decision is important because it presents a potentially simpler path to conviction for prosecutors in tipping cases where the evidence of a personal benefit is thin.4 While prosecutors often couple Title 18 securities fraud charges with Section 10(b) charges (as was done in Blaszczak), following Blaszczak, prosecutors may skip Section 10(b) charges altogether in favor of a more streamlined case. The decision also raises the prospect that a person could be criminally prosecuted for securities fraud for tipping schemes that could not be reached in a civil securities fraud action brought by the Securities and Exchange Commission—a seemingly illogical result. The decision is likely to strengthen calls for insider trading legislation that would create a consistent standard (a recent bill passed by the U.S. House of Representatives would not).
The Blaszczak decision is the latest in a string of recent developments that are changing the landscape for insider trading enforcement. For additional information, see our Insider Trading Law Alerts: Better The Devil You Know? Tipping Liability, Martoma and the Rise of 18 U.S.C. § 1348 and Insider Trading Prohibition Act Passed by the House of Representatives.
The Blaszczak Tipping Scheme and the Absence of a Dirks Personal Benefit
In Blaszczak, the government charged several individuals in a tipping scheme involving confidential predecisional information of the Center for Medicare and Medicaid Services (“CMS”). According to the indictment, David Blaszczak, a political intelligence consultant, received nonpublic, market-moving information about prospective changes to Medicare reimbursement rates from a former colleague who still worked at CMS. Blaszczak then shared the information with individuals at two hedge fund clients, who in turn earned millions of dollars on trades in the securities of healthcare companies that would be impacted by the changes once they were announced publicly.5 On the basis of this tipping scheme, the government charged the defendants with securities fraud under Section 10(b) of the Securities Exchange Act, as well as wire fraud and securities fraud under Title 18 of the criminal code (18 U.S.C. § 1343 and § 1348, respectively).6
The case, however, had a wrinkle. While Blaszczak received consulting fees from the hedge funds, neither Blaszczak nor the hedge funds paid the CMS tipper for the information he disclosed to Blaszczak. Instead, the government argued that the CMS tipper personally benefitted from the tips he provided because he and Blaszczak were friends for many years, because Blaszczak provided private sector employment advice and professional introductions to him (including a job opportunity he could leverage for a promotion), and because the CMS tipper understood Blaszczak would share the confidential CMS information with hedge fund clients, who would trade on it.7
All of this mattered because, following the Supreme Court’s 1983 decision in Dirks v. SEC, Section 10(b) liability will not attach in a tipping case unless the government produces evidence that the tipper received a “personal benefit” in exchange for the material, nonpublic information tipped.8 Even more, a tippee is not liable for trading on tips under Section 10(b) unless he or she knows that the tipper shared the information in exchange for a personal benefit.9
At the end of the trial, the district court instructed the jury with respect to the Dirks personal benefit test for the Section 10(b) securities fraud charges.10 For the Title 18 charges, however, the district court gave no similar Dirks instruction. Instead, the court instructed the jury that it could convict defendants of Title 18 securities fraud if it found that defendants “knowingly and willingly participated in a fraudulent scheme,” and that it could find a scheme to defraud existed if defendants “participated in a scheme to embezzle or convert confidential information from CMS by wrongfully taking that information and transferring it to his own use or the use of someone else.”11 After four days of deliberation, the jury acquitted all defendants on the Section 10(b) charges, but convicted on the Title 18 charges.12
The Second Circuit’s Decision
On appeal, the defendants argued that their Title 18 convictions must be overturned because the requirements for insider trading liability cannot be different under Title 18 and Title 15. Put simply, defendants argued that the district court erred in not providing a Dirks personal benefit instruction for the Title 18 charges too.13
The Second Circuit disagreed. The court reasoned that the Dirks test was not rooted in the embezzlement theory of fraud—which both Section 10(b) and Title 18 encompass—but was derived from the specific statutory purpose of Section 10(b):
As Dirks explained, in order to protect the free flow of information into the securities markets, Congress enacted the Title 15 fraud provisions with the limited “purpose of … eliminat[ing] [the] use of inside information for personal advantage.” Dirks effectuated this purpose by holding that an insider could not breach his fiduciary duties by tipping confidential information unless he did so in exchange for a personal benefit.14
The Second Circuit then observed that the statutory purposes behind Title 18, including its securities fraud provision, differed from Section 10(b).15 As support, the court observed that the Sarbanes-Oxley Act of 2002 added a securities fraud provision to Title 18 of the criminal code “in large part to overcome the ‘technical legal requirements’ of the Title 15 fraud provisions.”16 Because of these different purposes between the two securities fraud statutes, the court declined to “graft” the personal benefit test from Dirks and Title 15 onto Title 18.17
The Second Circuit recognized that its decision would clear a path for the government to circumvent the Dirks personal benefit test by charging tipping schemes exclusively under Title 18’s securities fraud provision. The court declined to give effect to “such enforcement policy considerations.”18 The court instead noted that “Congress was certainly authorized to enact a broader securities fraud provision, and it is not the place of the courts to check that decision on policy grounds.”19
What Happens After Blaszczak
The Second Circuit’s decision in Blaszczak presents yet another significant twist for insider trading enforcement. While only time will tell the full extent of the decision’s impact—especially in light of other recent developments in this area—we see at least three practical upshots:
First, following Blaszczak, prosecutors will rely even more heavily on Title 18 securities fraud charges in insider trading cases going forward. While prosecutors often couple Title 18 securities fraud charges with Section 10(b) charges (as was done in Blaszczak), following Blaszczak, prosecutors will be more emboldened to skip Section 10(b) charges altogether in favor of a more streamlined case.20
Second, the decision raises the prospect that a person could be criminally prosecuted for tipping schemes that are beyond the reach of the Securities and Exchange Commission’s civil enforcement authority. The SEC is authorized to pursue civil fraud charges under Section 10(b) of the Securities Exchange Act; the SEC is not authorized to pursue criminal charges for Title 18 securities fraud. What this means is that—in circumstances where the evidence of personal benefit is thin or absent—a criminal prosecution may be attainable where a civil SEC verdict is not. Notably, parallel SEC proceedings against the Blaszczak defendants were stayed while the criminal proceeding was underway. It is yet to be seen whether the SEC will continue its pursuit of these cases following the split verdict.
Third, the decision will likely strengthen calls for insider trading legislation to create a consistent standard. As we reported last month, a large bi-partisan majority of the U.S. House of Representatives recently passed a bill that would explicitly codify a ban on insider trading.21 The Insider Trading Prohibition Act, as passed by the House, largely adopts and incorporates concepts and theories of liability from prior insider trading case law. The bill includes a personal benefit requirement for certain liability theories.22 Notably, the bill, if enacted into law, would not create an exclusive insider trading standard—such that the government still would remain free to pursue insider trading cases under Title 18. As of the time of this writing, the Senate has referred the bill for consideration to the Committee on Banking, Housing, and Urban Affairs.23
WilmerHale will continue to monitor and report on these developments.