David Blaszczak, a political intelligence consultant, will spend the next year in prison after the Second Circuit upheld his conviction for insider trading. Blaszczak, a former Centers for Medicare and Medicaid Services (CMS), used contacts he had developed during his time at the agency to solicit valuable information about decisions coming down the CMS pipeline. He then made his living by passing along this information to hedge funds that made millions by trading off the material nonpublic information (MNPI) under the veil that he was simply a political intelligence consultant. On March 28, 2018, the government filed an 18-count indictment in the United States District Court for the Southern District of New York setting forth allegations relating to his passing along of this valuable information, and the trades it informed.
Legal Framework
The Exchange Act generally prohibits trading by individuals who are in possession of MNPI in breach of a duty of trust or confidence, absent certain exceptions. Under the “tipping” theory of insider trading, an insider — the tipper — does not himself trade, but instead improperly “tips” MNPI to an outsider — the tippee — who trades based on the information. In 1983, the U.S. Supreme Court decided in Dirks v. SEC that insider trading laws are violated when an insider breaches his/her fiduciary duty through the disclosure of MNPI to an outsider for personal benefit. Thus, without personal gain there was no breach of duty and no violation of the Exchange Act. This then created a “personal benefit test” that was used as a standard in other insider trading cases.
However, in Blaszczak prosecutors brought charges under both Title 15 of the Exchange Act and Title 18 of the Sarbanes-Oxley Act, and unfortunately for Blaszczak, the Second Circuit declined “to graft the Dirks personal benefit test onto the elements of Title 18 securities fraud.” Although the court conceded that the “Title 18 fraud statutes and Title 15 fraud provisions share similar text and proscribe similar theories of fraud,” but reasoned that Title 18 was enacted to effect far broader enforcement objectives than the singular focus of Title 15 on eliminating the use of insider information for personal advantage.
An insider trading conviction under Title 18 requires the government to prove that the defendant engaged to embezzle or convert insider information and transfer it in connection with the trading of a registered security. Unlike the Exchange Act, Title 18 does not require that a fiduciary duty be breached for insider trading to occur. This decision therefore has the potential to place another arrow in the quiver of federal prosecutors pursuing insider trading, with Title 18 charges as a different means of attacking similar conduct with a lower burden of proof.
Conclusion
How the Blaszczak case will affect the way the government pursues insider trading charges in the future is still yet to be determined. What is known is that prosecutors now have an alternative to Title 15 when pursuing insider trading charges. This alternative only requires proof that the defendant knowingly participated in the scheme, rather than the more difficult showing of personal benefit derived from the scheme. Given that Title 18 is rarely used independently to pursue criminal insider trading charges, it should be expected that there will be an uptick in federal prosecutors using the dual-charge approach taken in the Blaszczak case. This is especially true when prosecutors are working in parallel with enforcement attorneys at the SEC, who cannot charge Title 18 statutes civilly. This then expands the government’s reach and lowers the threshold for conviction.
Additionally, the nature of the dissemination of MNPI in this case is worth noting. Blaszczak was a consultant solicited for his insight into governmental processes. He in turn was collecting information that turned out to be MNPI. Third-party research consultants or “experts” have long come under scrutiny. This was highlighted in the Martoma case a few years back where Martoma solicited information on a drug trial from an expert used for investment research purposes. Therefore, they should be viewed as a risk area for any firms that have them as a part of their research process.
Firms should review how employees are utilizing these consultants and additional training may be needed on how to properly identify MNPI. Additionally, thorough due diligence on the consultant must be conducted to ensure they are aware of their obligations. Finally, compliance professionals should attempt to chaperone as many calls as possible with these consultants, and vet any written information that the consultant has prepared or would like to provide to an employee.
Greyline will continue to follow this case and its application to other cases.
