(Reuters) - Four defendants convicted in a 2018 insider trading trial have asked the 2nd U.S. Circuit Court of Appeals to review en banc the appellate court’s split decision in U.S. v. Blaszczak, which upheld the judgment against them.
In a fiercely argued joint petition, lawyers for former hedge fund partners Theodore Huber and Robert Olan asserted that the 2nd Circuit panel defied U.S. Supreme Court precedent when it concluded that an insider trading case can be based on advance information about government regulatory decisions and when it held that prosecutors can prove wire fraud without showing that a tipster personally benefited from supplying that advance information. And unless the en banc court overturns the ruling, the petition said, the consequences will ripple beyond securities traders: Journalists, whistleblowers and government reformers will be at risk of prosecution, according to the filing, if they reveal government regulatory decisions before the regulations are made public.
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“The government has never denied the extraordinary consequences that would result from treating government regulatory information as property or from extinguishing the personal-benefit requirement,” wrote Olan’s lawyers at Munger Tolles & Olson and Allen & Overy and Huber counsel from Shapiro Arato Bach and Kramer Levin Naftalis & Frankel. “To the contrary, this is plainly a test case designed to vastly expand prosecutorial authority.”
In separate filings, former government employee Christopher Worrall and former hedge fund consultant David Blaszczak also petitioned for en banc review, though their arguments were based more on the facts of the case than the government’s allegedly expansive legal theories. I emailed the Manhattan U.S. Attorney’s office for comment on the en banc petitions but did not immediately hear back.
The 2nd Circuit is historically stingy about granting en banc review, rehearing a measly two cases between 2011 and 2016, for instance. (By contrast, the 9th Circuit granted 40 en banc reviews over that stretch of time. The 5th and 6th Circuits heard 17 en banc cases apiece in those five years.) But President Trump has appointed five new judges to the 2nd Circuit in just the past three years, raising the prospect that the court might not be wed to its old ways. One of those recent appointees, Judge Richard Sullivan, wrote the panel opinion in the Blaszczak case. Insider trading aficionados may remember that when Judge Sullivan was a trial judge in Manhattan, the 2nd Circuit found in 2016’s U.S. v. Newman that he failed to instruct jurors that the government must prove tipsters received a personal benefit.
In the Blaszczak case, prosecutors indicted the defendants not just for securities fraud but also for wire fraud and fraud under a provision of the Sarbanes-Oxley Act. Prosecutors alleged that hedge fund consultant Blaszczak, a former employee of the government’s Centers for Medicare & Medicaid Services, obtained advance word of CMS regulatory plans from inside sources, including Worrall. Blaszczak allegedly passed his information to hedge fund analysts, including Olan and Huber, who figured out how CMS regulatory changes would impact medical companies, traded accordingly and made millions. (The defendants, of course, deny the government’s allegations of criminal conduct.)
When U.S. District Judge Lewis Kaplan of Manhattan instructed jurors, he told them that the government had to prove a personal benefit to Blaszczak’s tipster to prove securities fraud - but didn’t extend the personal benefit test to the other fraud charges. Jurors found the defendants were not guilty of securities fraud but convicted them on other fraud counts.
The 2nd Circuit majority - Judge Sullivan and Judge Christopher Droney – said Judge Kaplan’s jury instructions were proper. None of the fraud statutes at issue in the case include a “personal benefit test” in their text, the majority said. The Supreme Court read such a requirement into the Exchange Act in 1983’s Dirks v. SEC because, in the view of Judges Sullivan and Droney, the securities fraud statute was specifically tailored to penalize trading for personal advantage. But the other fraud statutes, they said, treat the misappropriation of confidential information as being akin to embezzlement. Embezzlement does not require an additional showing that the tipster who misappropriated and passed along valuable information received a personal benefit from the breach of duty, the majority said. “In short, because the personal benefit test is not grounded in the embezzlement theory of fraud, but rather depends entirely on the purpose of the Exchange Act, we decline to extend Dirks beyond the context of that statute,” the majority concluded.
The majority also held that the government has an economic interest in maintaining the confidentiality of its regulatory decisions, like the Wall Street Journal had an economic interest in its not-yet-published content in the Supreme Court’s 1987 decision in Carpenter v. U.S., so the misappropriation of that information can be the basis of insider trading charges. In dissent, Judge Amalya Kearse said the more appropriate Supreme Court precedent is 2000’s Cleveland v. U.S., in which the court held that Louisiana did not have a property interest in unissued gaming licenses so defendants couldn’t face fraud charges for wrongfully obtaining them. Similarly, Judge Kearse said, the CMS did not lose anything of value to the government when Worrall allegedly tipped Blaszczak about its regulatory plans.
Both of the majority’s key holdings have been controversial, as the joint en banc petition pointed out. UCLA law professor Eugene Volokh blogged last month about the prospect that whistleblowers and journalists could be prosecuted for fraudulent conversion under the government’s theory that agencies have a property interest in their regulatory decisions. Law professors and white-collar lawyers have kicked around the policy implications of allowing prosecutors to evade the personal benefit test. (The majority nodded to those policy considerations but said the court’s job is to interpret laws, not to set policy.)
The joint en banc petition argued that each of the majority’s controversial conclusions “radically expands criminal liability.” It’s going to be interesting to see if defense lawyers have made a sufficiently compelling case to persuade the newly constituted 2nd Circuit to take another look.