2nd Circuit abandons insider trading ‘personal benefit’ test

The 2nd U.S. Circuit Court of Appeals recently departed from decades of insider trading jurisprudence by jettisoning the "personal benefit" requirement for certain insider trading convictions. In United States v. Blaszczak, 18-2811, 2019 WL 7289753 (2d Cir. 2019), the 2nd Circuit held that, when prosecuting defendants for insider trading under the Title 18 criminal securities fraud statute (18 U.S.C. Section 1348) and the wire fraud statute (18 U.S.C. Section 1343), prosecutors do not need to prove that the tipper breached a duty in exchange for a "personal benefit," or that the tippee knew of the tipper's breach, as required under the Title 15 securities fraud provisions, Section 10(b) of the Securities and Exchange Act (15 U.S.C. Section 78j(b)) and SEC Rule 10b-5. Blaszczak thus sets a lower burden for bringing insider trading cases under Title 18 and will likely encourage prosecutors to charge more insider trading cases under Section 1348 rather than -- or in addition to -- the Title 15 securities fraud provisions, which have long been the favored vehicles for bringing such prosecutions.

The 2nd Circuit case involved a former employee of the Centers for Medicare & Medicaid Services (CMS), David Blaszczak, who had become a "political intelligence" consultant for healthcare-related hedge funds. The government alleged that Blaszczak obtained confidential, pre-decisional information concerning contemplated changes in CMS's reimbursement rates for certain medical treatments from his contacts at CMS, and then passed the information on to traders at two hedge funds who, in turn, made significant profits trading on this information. The government indicted Blaszczak, Christopher Worrall (one of Blaszczak's CMS contacts), and hedge fund employees Robert Olan and Theodore Huber for conspiracy, insider trading in violation of the Title 15 and Title 18 securities fraud provisions, wire fraud, and conversion of government property.

At the end of the three-week trial, the district court instructed the jurors that, in order to convict under Title 15, they needed to find that Worrall tipped confidential CMS information to Blaszczak in exchange for a "personal benefit," and that Blaszczak, Olan and Huber (the tippees) knew that Worrall tipped the information for a "personal benefit." But the court refused to require proof of a personal benefit in its jury instructions on the wire fraud and Title 18 securities fraud counts. Instead, it instructed the jury that to convict under Title 18 securities fraud, the government needed to prove that a defendant "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." Blaszczak, 2019 WL 7289753, at *4. The district court gave a similar instruction for the wire fraud counts.

The difference between the instructions for Title 15 securities fraud and the Title 18 offenses ultimately proved significant because there was sparse evidence of any "personal benefit." The government appears to have presented no evidence that Blaszczak made any payments to Worrall, nor that Olan and Huber were aware of Worrall's identity, much less whether he received any benefit. After four days of deliberation, the jury reached a split verdict. It acquitted all defendants on the Title 15 counts, but convicted Blaszczak, Olan and Huber of conspiracy, conversion and at least some of the Title 18 securities and wire fraud counts, and convicted Worrall of wire fraud and conversion.

On appeal, defendants challenged the district court's jury instructions for Section 1348 and the wire fraud charges. But the 2nd Circuit affirmed the convictions, holding that the district court's refusal to instruct the jury on the "personal benefit" test was proper due to the different "statutory purpose" of Title 15 and Title 18. Id. at *8-9. (Defendants also argued that CMS's pre-decisional information was not "property" because the agency had a "purely regulatory" interest in such information, and it therefore could not give rise to insider trading. Id. at *7. The panel rejected this argument, too, over a vigorous dissent from Judge Amayla Kearse. Id. at *18-21.)

Blaszczak is the first Court of Appeals decision to directly address whether the personal benefit test is required for prosecutions under Section 1348 and the wire fraud statute, and represents a significant break from past insider trading law. The Supreme Court held almost 40 years ago, in Dirks v. SEC, 463 U.S. 646, 662-63 (1983), that in order to prove insider trading under the Title 15 securities fraud statutes, the government must prove that the tipper breached a duty of trust and confidence by disclosing material, non-public information in exchange for a "personal gain." Similarly, in order to convict a tippee under Title 15, the government must prove that the tippee knew that the tipper breached a duty in return for a "personal benefit." See, e.g., United States v. Newman, 773 F.3d 438, 447-49 (2d Cir. 2014), abrogated on other grounds by Salman v. United States, 137 S. Ct. 420, 425 n.1, 428 (2016) (rejecting Newman's holding that the tipper must receive something of a "'pecuniary or similarly valuable nature'" to qualify as a personal benefit) (quoting Newman). This is an especially significant requirement in cases such as Blaszczak and Newman where the government charges sub-tippees who do not know the source of the confidential information or whether the tipper breached a duty. In Newman, for example, the 2nd Circuit reversed the conviction of two portfolio managers, who were each several levels removed from the insiders who provided the material, non-public information, in part because there was no evidence that the defendants knew that they were trading on information obtained from insiders or that those insiders received any personal benefits in exchange for such disclosures. Newman, 773 F.3d at 453.

The defendants in Blaszczak argued that, given the close similarity in language between Section 1348 and Rule 10b-5(a) -- both of which prohibit a scheme or artifice to defraud -- the court should require the same elements for insider trading prosecutions under both provisions. The 2nd Circuit noted, however, that the Supreme Court grafted onto Title 15 the "personal benefit" requirement, which is not in the statutory text, to promote the Exchange Act's "statutory purpose" of "protect[ing] the free flow of information into the securities markets." Blaszczak, 2019 WL 7289753, at *8. "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." Id. By contrast, the 2nd Circuit ruled, "Section 1348 was added to the criminal code by the Sarbanes-Oxley Act of 2002 in large part to overcome the 'technical legal requirements' of the Title 15 fraud provisions." Id. at *9 (citing S. Rep. No. 107-146, at 6). The 2nd Circuit noted that Congress intended "Section 1348 to 'supplement the patchwork of existing technical securities laws violations with a more general and less technical provision, with elements and intent requirements comparable to current bank fraud and health care fraud provisions.'" Id. (citing to S. Rep. No. 107-146, at 14).

But Congress nowhere mentioned -- either in the text of the statute or in its legislative history -- the desire to abandon the "personal benefit" test, which has been an essential element in insider trading law for almost four decades. A strong argument can thus be made that, by choosing words with a settled judicial construction when adopting Section 1348, Congress intended to adopt the construction given to those words by Dirks and its progeny in the context of Title 15. See, e.g., Bragdon v. Abbott, 524 U.S. 624, 645 (1998).

Having now been given a clear-cut path to avoid the personal benefit requirement, prosecutors will no doubt begin charging insider trading more frequently under Title 18. This creates the perverse effect of allowing the government to secure a criminal conviction under Title 18 without establishing a key element that the SEC needs to meet when bringing a civil enforcement action under Title 15. Blaszczak thus raises potential concerns for analysts who communicate frequently with company executives about a company's performance, as well as other market participants who may be several levels removed from -- and not even know -- the original source of information they receive. Without a strong "personal benefit" requirement under Title 18, these market participants may be at greater risk of criminal liability.

The debate posed by Blaszczak is far from over. On Feb. 3, defendants filed petitions for panel rehearing and rehearing en banc with the 2nd Circuit, and other appellate courts have yet to weigh in, including the 9th Circuit. 