United States v. Blaszczak[1] has long been a one-off case that did not fit the mold of the traditional insider trading prosecution, but now — following a 2-1 decision of the Second Circuit in December, reversing most of the convictions in the case — it may destabilize the law on insider trading for some time to come. Such reversals are rare, and Blaszczak has multiple implications, some ominous and some ironic.

At the outset, it must be understood that Blaszczak was distinctive in two important respects:

First, it involved the leaking of confidential information by gossipy government bureaucrats to a former colleague who now worked for hedge funds – not by corporate employees who owe fiduciary duties to their shareholders. Still, the agency had rules protecting the confidentiality of such information. At first, this difference did not seem to matter as, either way, it looked like a misappropriation of information from the source under the O’Hagan case.[2]

Second, the jury actually acquitted the defendants of the Rule 10b-5 violations but convicted them on the wire fraud and other charges, including securities fraud under 18 U.S.C. §1348. What explains this disparity in outcomes under similarly worded securities statutes? Although one can never know the jury’s mind for certain, the high likelihood is that the jury acquitted on the Rule 10b-5 charges because the trial court charged it that a “personal benefit” to the tipper only needed to be shown in a Rule 10b-5 case but not in a §1348 securities fraud case (and evidence of such a personal benefit was sorely lacking in Blaszczak).

Still, the unexpected factor that has made Blaszczak truly destabilizing only emerged after the decision was affirmed on appeal by the Second Circuit. In a subsequent case, Kelly v. United States,[3] the Supreme Court unanimously decided that politically motivated conduct by governmental officials, even if highly deceptive, could not be prosecuted under the federal wire fraud statute where the defendants’ aim was not to obtain money or property but only to inflict political retaliation. Kelly is, of course, better known as the “George Washington Bridge case” (or “Bridgegate”) in which aides to then-Governor Chris Christie limited the highway lanes available to commuters seeking to access the bridge from Fort Lee, New Jersey, in order to inflict political retaliation on the mayor of Fort Lee (who had failed to endorse Governor Christie for re-election). Everything about the case smelled of political corruption but not of property deprivation.

Okay. Let’s assume that Kelly makes sense. But what does it have to do with insider trading? That is a good question never satisfactorily answered by the majority that reversed the convictions in the latest Blaszczak decision. When the defendants asked the Supreme Court to grant certiorari in Blaszczak on the ground that it was in conflict with Kelly, the Office of the Solicitor General was faced with a choice: either it could fight (and answer that Kelly was irrelevant), or it could confess error on some counts and hope to salvage the convictions on the others. Courage yielded to caution, as the solicitor general chose the latter option. Thus, much of the debate has surrounded whether this was a prudent tactical retreat by the solicitor Ggeneral or a craven surrender of key points in order to avoid a possibly embarrassing loss.

Effectively, the solicitor general instructed the S.D.N.Y. U.S. Attorney’s Office to abandon long-established principles of insider trading law in the hope that this would stop the Supreme Court from applying Kelly to the world of insider trading. Some of the language in the S.D.N.Y.’s papers suggests that it did so grudgingly.[4]

Heeding the solicitor general’s request, the Supreme Court did remand the case to the Second Circuit. But what happened next did not go according to plan. At the Second Circuit, the panel split. The panel majority first agreed that when the prosecution confesses error and abandons its victory at trial, it is entitled to great deference from a reviewing court. Still, the panel’s majority also concluded that government’s decision to abandon its victory had to be subjected to a measure of judicial oversight. In that light, the panel majority went through an extended analysis of why confidential information in the hands of a government agency about its regulatory plans did not constitute “property” (and thus could not be the basis for a federal fraud prosecution). Arguably, the panel majority reached a more conservative decision than the Supreme Court would have.

In overview, the panel’s analysis reads more like an attempt to justify the solicitor general’s position (which it had already announced was entitled to great deference) than to state its own independent analysis. Why the solicitor general conceded so much is a mystery. Remember that Kelly decided only that the wire fraud statute was “limited in scope to the protection of property rights.”[5] Kelly never really addressed what defines the term “property,” and an earlier decision (Carpenter v. United States[6]) had clearly held that a corporation was entitled to “exclusive possession” of its confidential business information, even when no economic injury to it was threatened.[7]

Here, the panel announced two original ideas, both of them ill-considered. First, it said that “while confidential information may constitute property of a commercial entity…, the same is not true with respect to a regulatory agency…”[8] On remand, the U.S. attorney’s brief phrased this concession narrowly, conceding that:

“[I]n a case involving confidential government information, that information typically must have economic value in the hands of the relevant government entity to constitute ‘property’ for purposes of [federal fraud statutes].”[9]

Even this language may go a bridge too far because, as the dissent points out, much traditional property has no independent economic value.[10]

Nonetheless, the panel’s opinion further aggravates this problem of underinclusion in its description of the types of confidential information that qualify as “property.” Analyzing the Carpenter decision, it suggests that the key factor there was that the Wall Street Journal’s prospective columns were “its stock in trade… to be distributed and sold to those who [would] pay money for [them].”[11] Premature disclosure of the WSJ’s columns, it argued, would injure it and decrease the value of its stock in trade, whereas the premature disclosure of confidential information possessed by a governmental agency “has no direct impact on the government’s fisc.”[12]

This was unfortunate and overbroad phrasing that may haunt the government for at least two reasons. First, the timing of disclosure may frequently have an “impact on the government’s fisc.” Take, for example, a case where the Department of Defense has decided on the location of a major new military installation to be built but has not yet disclosed its location. The department is withholding this information until it can buy up much of the land that it needs because it knows that prices will soar on disclosure. Hence, the government’s fisc is injured if insiders at an agency can leak this information to real estate speculators.

Second, this suggestion that confidential information must amount to “stock in trade” (or at least have independent economic value to the holder of the information) will likely be used as a defense in the future by insiders in private corporations. If Carpenter (a wire fraud) applies only when either (a) the confidential information has economic value in the hands of the corporation, or (b) the information amounts essentially to “stock in trade,” the scope of the law on insider trading will have been significantly cut back.

To understand this, one must recognize that in a high percentage of the insider trading cases that have been successfully prosecuted to date, the corporation would have been unable to show any economic injury to it from premature disclosure. Take, for example, the first case in which the SEC defined insider trading: In the Matter of Cady, Roberts & Co.[13] There, the key material fact was that the issuer was about to cut its dividend sharply. It could not profit from this information (except by selling itself short, which is unlawful and unthinkable). Much insider trading similarly involves the selling by insiders in advance of the issuer’s release of material adverse information. The goal of these prosecutions is not to protect “stock in trade” (or information having independent economic value) but to deny insiders the ability to sell their stock at an inflated price to their own shareholders. The Carpenter fact pattern is thus unique and atypical and should not have been used to attempt to distinguish private entities from public ones.

A second problem with the panel’s decision is its weak attempt to distinguish United States v. Girard,[14] a Second Circuit decision in 1979. There, a drug dealer was convicted of attempting to purchase confidential records of the U.S. Drug Enforcement Agency that identified the agency’s drug informants. Although Girard found that this data was “property,” the majority in Blaszczak attempted to distinguish Girard on the grounds that this information had “inherent value to the DEA,” and its theft would interfere with its investigations. Such interference will be true in many cases, and it relies on a very subjective line: Will the information’s theft seriously interfere with the agency’s functioning? Moreover, actions that disrupt a federal agency’s functioning can already be prosecuted as a conspiracy against the United States under 18 U.S.C. §371.

What will be the bottom-line impact of Blaszczak? Because insider trading cases based on the misappropriation of governmental information have been rare, its application is limited. But here there is a real irony, and we should be concerned about Blaszczak’s effect on a problem that has greatly embarrassed the Supreme Court. Assume, just hypothetically, that a Supreme Court clerk covertly releases a near-final draft of the Court’s opinion in a major case to a reporter. In the past, this could probably have been prosecuted under the wire fraud statute, with Carpenter being the leading precedent. But under the narrow reading given by Blaszczak to Carpenter, this may no longer be possible.

Where Blaszczak’s impact will be most felt is in the financial world. Although relatively few may be interested in advance notice of what regulatory changes the Centers for Medicare and Medicaid Services were about to propose in Blaszczak, much of the financial world is obsessed with knowing on a continuing basis what the Federal Reserve is about to do with respect to interest rates. Thus, it may now become open season on the Fed, as a horde of traders seek to beg, bribe, or steal information from Fed employees about pending interest rate movements. If this is not criminal, leaks will predictably occur, even though civil sanctions may be available.

To be sure, the government still has one remaining string to its bow: It probably can prosecute such conduct as a conspiracy against the United States under 18 U.S.C. §371 because uniquely §371 applies not just to property crimes, but also to any conspiracy to “defraud the United States or any agency thereof in any manner or purpose.” Indeed, the Blaszczak panel decided that this count in the Blaszczak indictment could be remanded for “such further proceedings as may be necessary on these counts, which may include a new trial.”[15] The government needs to retry Blaszczak if only to establish this point beyond doubt.

The most ominous cloud that Blaszczak leaves overhanging insider trading law is that Carpenter may in the future be narrowly construed (at least in the Second Circuit). To be sure, other courts may consider Blaszczak’s parsimonious analysis of Carpenter to be only dicta.

Ironically, Judge Walker’s concurring opinion in Blaszczak, which objects that 18 U.S.C. §1348 permits a conviction for insider trading in the absence of any proof of a “personal benefit” to the tipper, may have precisely the opposite effect to what Judge Walker intended. Although Judge Walker is distressed at this possibility, he and Judge Kearse (who joined in his opinion) have both effectively agreed and announced that, under §1348,  no showing of a personal benefit is necessary to convict the tipper. The elimination of the personal benefit requirement is exactly what the Report of the Bharara Task Force on Insider Trading recommended, and its goal may have just been effectively realized without new legislation. Although Congress could respond to Judge Walker’s objection and revise the law, Congress has been unable to pass insider trading legislation for several years now, and nothing about this new Congress suggests that it will be suddenly less partisan or divided.

Finally, a last, undiplomatic comment is necessary: In abandoning the S.D.N.Y. prosecutor’s victory at the Second Circuit in order to preclude a Supreme Court decision, the Solicitor General’s Office has paid a high price and exhibited something well short of a profile in courage. Its surrender yielded it little (if anything) because the panel majority’s decision was likely at least as conservative as the Supreme Court’s decision would have been.[16] One worries that the Office of the Solicitor General is overly risk averse. If these guys were playing five card stud poker and were dealt three aces on their first three cards, they might still do more than call and not raise the bid. At a minimum, they need to play a reasonable hand. Here, that means that they should pursue the retrial option that the panel majority gave them in order to establish that the tipping of confidential governmental information can violate 18 U.S.C. §371.

ENDNOTES

[1] For the most recent decision, see United States v. Blaszczak, 2022 U.S. App LEXIS 35638 (2022). For the earlier holding of the Second Circuit, upholding the conviction, see United States v. Blaszczak, 947 F.3d 19 (2d. Cir. 2019), vacated and remanded, 141 S. Ct. 1040 (Jan 11, 2021).

[2] United States v. O’Hagan, 521 U.S. 642 (1997).

[3] 140 S. Ct. 1565 (2020).

[4] 2022 U.S. App. LEXIS 35638, at *14. The government’s brief on remand states that “this Office is constrained to confess at the direction of the Solicitor General’s Office.” Read just a little between the lines, this is the U.S. Attorney’s Office saying in effect, “We have no choice and are obeying orders.”

[5] Kelly, 531 S. Ct. at 1571.

[6] 484 U.S. 19 (1987).

[7] Id. at 26-27. The Supreme Court emphasized that the Wall Street Journal had “been deprived of its right to exclusive use of the information” and that “exclusivity is an important aspect of confidential information and most private property for that matter.” Id.

[8] 2022 U.S. App LEXIS 35638, at *33 to *34.

[9] Id. at *13 to *14.

[10] Id. at *63 (citing Restatement (Second) of Torts §§ 222A, 911 cmt. e (“[s]ome things may have no exchange value but may be valuable to the owner”)).

[11] Id. at *33.

[12] Id. at * 34.

[13] 40 S.E.C. 907 (1961). This decision was, of course, authored by my former teaching colleague, Bill Cary, then the SEC’s chairman, from whom I learned much.

[14] United States v. Girard, 601 F.2d 69 (2d 1979). I will not dwell on this case, because Judge Sullivan’s dissent masterfully shows the majority’s inability to distinguish it meaningfully.

[15] 2022 U.S. App. LEXIS 35638 at *40.

[16] Although the Supreme Court has become more conservative in its temperament, its most recent decisions have fully accepted traditional insider trading provisions. See, e.g., Salman v. United States, 580 U.S. 39 (2016). The kind of twisted construction that the panel majority gives to the term “property” seems too crude for them

This post comes to us from John C. Coffee, Jr., the Adolf A. Berle Professor of Law at Columbia University Law School and Director of its Center on Corporate Governance.