Insider Trading: A Way Around The “Personal Benefit” Requirement?

ATTORNEY: LEIGH HANDELMAN SMOLLAR | POMERANTZ MONITOR JANUARY/FEBRUARY 2020

Because no statute specifically outlaws insider trading, the elements of the violation have been developed by the courts, most often in cases alleging violations of Section 10(b) of the Exchange Act.

Recently, disputes have arisen concerning whether someone providing insider information to another person must receive a personal benefit in exchange for the “tip” and, if so, what constitutes an impermissible personal benefit. As the Monitor previously reported, in 2015, the Ninth Circuit issued a controversial decision in U.S. v. Salman upholding the insider trading conviction of a defendant who had received inside information from a family member. The legal issue was whether the “personal benefit” requirement requires a financial quid pro quo, or whether conferring a “gift” on a personal friend or relative is enough. The Ninth Circuit held that an insider‘s intent to benefit his brother by tipping the information to him was sufficient to create a personal benefit for the tipper. Because the tipper’s motivation was improper, the tippee’s conviction was upheld.

This holding departed from the Second Circuit’s 2014 decision in U.S. v. Newman, which held that prosecutors must show that the tipper received a “tangible” benefit beyond the psychic benefit of helping a friend or family member. In declining to follow Newman, the Ninth Circuit held that Dirks v. SEC, a 1983 Supreme Court decision, allowed Salman’s jury to infer that the tipper breached a duty because he made “a gift of confidential information to a trading relative.’’

The split among the circuits paved the way for the Salman decision to be appealed to the Supreme Court. On December 6, 2016, the Court sided with the Ninth Circuit, holding that it properly applied Dirks to affirm Salman’s conviction. Under Dirks, the jury could infer that the tipper personally benefited from making a gift of confidential information to a trading relative.

The Supreme Court held ‘’when an insider makes a gift of confidential information to a trading relative or friend ... [t]he tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.’’ In these situations, the tipper personally benefits because giving a gift of trading information to a trading relative is the same thing as trading by the tipper followed by a gift of the proceeds. The Court held that “[t]o the extent that the Second Circuit in Newman held that the tipper must also receive something of a pecuniary or similarly valuable nature in exchange for a gift to a trading relative, that rule is inconsistent with Dirks.”

Although the Court’s decision in Salman made it easier to prove insider trading, it did not eliminate the “personal benefit” requirement. More recently, the government has tried to circumvent this requirement entirely by criminally charging defendants under 18 U.S.C. § 1343 and § 1348, which criminalize wire and securities fraud, rather than under Section 10(b).

On December 30, 2019, in United States v. Blaszczak, the Second Circuit addressed for first time whether the government can criminally prosecute insider trading under Title 18 without proving personal benefit to the tipper. The Second Circuit upheld the convictions brought by the government under those provisions, finding that in such cases the government need not prove that the defendants received a “personal benefit” in exchange for the tip.

In Blaszczak, an employee of the Centers for Medicare and Medicaid Services (CMS) allegedly provided nonpublic information about prospective changes to certain Medicare reimbursement rules to his friend, Blaszczak (the tippee), who in turn provided the confidential information to analysts at his client, Management Company. Relying on this insider information, these analysts executed trades in health care companies that were affected by the rule change, realizing gains of over $7 million. The CMS tipper did not receive any money in exchange for the tip. The only “personal benefits” he received were free meals and tickets to sporting events, and an opportunity to work at the consulting firm where Blaszczak worked, which he ultimately turned down. The tipper and tippees were both charged with violating both 15 U.S.C. § 78j(b) of the Exchange Act (Section 10(b)) and with wire and securities fraud under 18 U.S.C. §§1343 and 1348.

The jury instructions for the Title 15 charge (violation of Section 10(b)) provided that the government had to prove that the tipper breached a duty by revealing material nonpublic information for a personal benefit, and that each tippee knew it. The court told the jury that personal benefit “need not be financial” and could be “the benefit one would obtain from simply making a gift … to a relative or friend.” However, in order to prove Title 18 charges, the government only had to prove that the defendants knowingly executed a scheme to defraud, which did not require personal benefit to the tipper or knowledge of that benefit by the tippee.

After a trial, the defendant was acquitted of the Exchange Act charges but convicted of the Title 18 charges. The verdict suggests that the government could not prove a personal benefit. In addition to not having to show a personal benefit to succeed on a Title 18 claim, the Court held that confidential government information may constitute “property,” the misappropriation of which can provide a basis for criminal liability under the Title 18 wire and securities fraud statutes.

The defendant appealed the jury verdict, mainly arguing that the government cannot use Title 18 wire and security fraud claims as a way around the doctrines the courts have developed for insider trading under Section 10(b) over the past forty years. Defendant argued that because Sections 1343 and 1348 contain the same operative fraud language as Section 10(b), the same elements that apply under the Exchange Act must apply under Title 18. Specifically, the defendant argued that the personal-benefit requirement should apply to Title 18 securities fraud. The majority of the Second Circuit panel rejected this argument, concluding that the personal-benefit requirement is inconsistent with Congress’s intent, through 18 U.S.C. § 1348, to provide the government with a broader mechanism for prosecuting securities fraud than that provided by Title 15.

The ruling in Blaszczak may alter the government’s future strategy for insider trading charges. The SEC’s enforcement jurisdiction is limited to civil charges under Title 15, in which case it must still prove a personal benefit consistent with Dirks. Accordingly, particularly in cases where a personal benefit on the part of the tipper is difficult to show, the DOJ may choose to bring prosecutions where the SEC declines, or the SEC may proceed under a different legal theory.

If the Blaszczak ruling is widely followed nationwide, it will change the landscape for insider trading liability, as the government can bring and win criminal claims under Section 18 while not being successful for civil claims under Title 15 for the same conduct. The government may bring criminal charges without bringing civil charges or may bring civil and criminal charges under different statutes with different proof.