Key Takeaways¹

• A divided panel of the U.S. Court of Appeals for the Second Circuit held, on December 27, 2022, in United States v. Blaszczak (“Blaszczak II”) that an agency’s confidential, pre-decisional information did not count as “property” or a “thing of value” under the federal fraud and conversion statutes.²
• The decision followed the Supreme Court’s grant, vacatur, and remand of an earlier Second Circuit decision. The original panel had held that (1) such confidential information was “property” and a “thing of value,” and (2) the personal benefit test that is applicable to traditional Title 15 or “10b-5” insider trading actions did not apply to Title 18 insider trading prosecutions.³
• Blaszczak II extends the Supreme Court’s holding in Kelly v. United States.⁴  Now, the government cannot predicate certain wire fraud, securities fraud, and conversion charges on schemes to obtain confidential information about a future exercise of regulatory power.
• In addition, the Supreme Court’s vacatur of Blaszczak I reopened the question whether the government must satisfy the personal benefit test when prosecuting defendants for Title 18 insider trading, which it must do when prosecuting insider trading under Section 10(b) (i.e., Title 15). Although Blaszczak II did not need to reach that issue, two members of the court, in a concurrence, cast serious doubt on the reasoning in Blaszczak I.⁵

Introduction

Between 2009 and 2014, an employee of the Centers for Medicare and Medicaid Services (“CMS”) passed confidential information to a former agency employee concerning when and how CMS would change reimbursement rates for several health conditions. The former employee then passed that information to partners at a hedge fund, who in turn used the information to take short positions in companies that would suffer from the rate cuts. The scheme yielded several million dollars in profits.⁶

The scheme also yielded a federal indictment. Prosecutors charged those involved with traditional insider trading under Section 10(b) (which is contained in Title 15) and Title 18 securities fraud (which was enacted in 2002 but has only recently been used to prosecute insider trading), as well as wire fraud, conversion of government property, and conspiracies to commit the same.⁷

At trial, Judge Kaplan of the Southern District of New York instructed the jury that traditional Title 15 insider trading required proof that the CMS employee had received a “personal benefit” in exchange for the information, and that the others could be convicted only if they knew that the CMS employee had made such an exchange.⁸ However, the court did not issue that instruction for the Title 18 securities and wire fraud counts. The jury eventually issued a split verdict. It acquitted all defendants of the Title 15 charge, convicted all on the conversion and wire fraud counts, and convicted some defendants on Title 18 securities fraud and conspiracy.⁹

On appeal, the defendants argued, as relevant here, that (1) the confidential CMS information did not count as “property” under the fraud statutes¹⁰ or as a “thing of value” under the conversion statute,¹¹ and (2) the district court should have instructed the jury that Title 18 securities and wire fraud included the same personal benefit element as Title 15 securities fraud.¹² A divided panel of the Second Circuit rejected their arguments and affirmed the convictions.¹³

The defendants petitioned the Supreme Court for certiorari. Rather than hear the case, the Court granted certiorari, vacated the judgment, and remanded with instructions to reconsider the opinion in light of Kelly v. United States, a recent decision narrowing what qualifies as “property” under the federal fraud statutes.¹⁴ On remand, the government confessed error as to the substantive offenses and one conspiracy offense because it no longer thought that the confidential information counted as “property” in light of Kelly. However, the government argued that the other conspiracy convictions should stand.¹⁵ As described below, a divided panel of the Second Circuit reversed the substantive convictions and remanded for retrial of the conspiracy convictions.

Background on Kelly v. United States and the “Personal Benefit Test” in Securities Fraud

In Kelly, the “Bridgegate case,” the Supreme Court held that a State’s regulatory power—its “intangible rights of allocation, exclusion, and control”—is not a form of “property” the deprivation of which would satisfy the necessary element under the federal fraud statutes.¹⁶ Thus, the defendants’ scheme in that case, which sought to close lanes on the George Washington Bridge to retaliate against the Mayor of Fort Lee, did not violate the federal wire fraud or federal program fraud convictions that target “property fraud.”¹⁷

The Supreme Court’s vacatur and remand orders in Blaszczak did not expressly address the Second Circuit’s holding on the personal benefit test in Blaszczak I. That personal benefit test originated in an earlier Supreme Court case, Dirks v. SEC, which considered what the government must show in a Title 15 securities fraud action based on an insider’s provision of a confidential tip to an outsider who trades on the information.¹⁸ In Dirks, the Court adopted the personal benefit test, which requires a showing that the “the insider personally will benefit, directly or indirectly, from his disclosure.”¹⁹ Courts later ruled that when the government brings such an action against the outsider who received a tip, it must prove that the outsider knew that the insider-tipper received a personal benefit.²⁰

The Supreme Court has not addressed whether the government must satisfy the personal benefit test when prosecuting defendants for insider trading under Title 18 securities fraud, which uses language that is materially identical to the relevant language found in Rule 10b-5, the SEC regulation at issue in a Title 15 case,²¹ or when it prosecutes insider trading under the federal wire fraud statute.

The Blaszczak II Decision

In Blaszczak II, a divided panel of the Second Circuit revisited its prior decision on remand from the Supreme Court, reversed the substantive convictions and one conspiracy conviction, and vacated the other conspiracy convictions pending retrial. Writing for the court, Judge Kearse agreed with the government that under Kelly, pre-decisional CMS confidential information did not count as “property.”²² In the court’s view, the Blaszczak defendants sought “to obtain and promptly utilize advance information as to how the regulatory power would be exercised by CMS.”²³ The court reasoned that, if the Kelly defendants did not deprive the government of property by “altering a regulation,” then the Blaszczak defendants did not deprive the government of property by “merely obtaining advance information as to what the agency’s preferred regulation would be, and when it would be announced.”²⁴

Next, the court vacated the conspiracy convictions. The court explained that the conspiracies were each predicated on multiple substantive crimes, including crimes of which the defendants had been acquitted and crimes that the majority had just reversed. Because the jury form did not indicate which underlying substantive crime predicated the conspiracies, the court could not tell whether the conspiracy convictions rested on permissible predicate crimes. The court thus remanded for retrial of the conspiracy charges.²⁵

Judge Walker, joined by Judge Kearse, issued a separate concurrence to explain why he thought that the original panel erred by refusing to apply the personal benefit test to Title 18 insider trading. First, he reiterated a central point that the Supreme Court made in Dirks—that markets cannot operate efficiently absent the free flow of information. That information often comes from securities analysts tasked with “ferret[ing] out and analyz[ing]” information, including nonpublic information.²⁶ But the line between legal collection and analysis and illegal insider trading can be thin and obscure. In Judge Walker’s view, “[t]he personal benefit test creates at least some legal distinction” between “obtain[ing] tips fraudulently” and “the honest disclosure and collection of corporate information.”²⁷ He feared that, absent this distinction, Title 18 securities fraud might chill the free, legal exchange of insider information between insiders and analysts, with pernicious effects on the efficiency of the market.²⁸ Second, Judge Walker noted the “incongruence” created by the original panel’s holding. Because the public-benefit test applied to civil actions under Title 15 but not criminal actions under Title 18, the government would likely have an easier time proving a criminal case than a civil one. Judge Walker expected that the threat of such a “weighty cudgel” would lead parties to agree to unfavorable plea bargains or extortionate civil settlements.²⁹

Judge Sullivan dissented. He believed Kelly distinguishable and viewed the controlling case to be Carpenter v. United States, where the Supreme Court had read “property” under the fraud statutes to include the publishing schedule and the contents of forthcoming Wall Street Journal columns.³⁰ In his view, the CMS information “more closely resembles the misappropriated property recognized in Carpenter than the allocation of traffic lanes at issue in Kelly,” and the government enjoyed as much of a property interest in the confidential CMS information as the Journal did in its unpublished columns.³¹ And Judge Sullivan reiterated his view that courts should not apply the “judge-made” personal benefit test to Title 18 securities fraud.³²

Conclusion

The Second Circuit’s opinion is noteworthy for two reasons. First, it extends Kelly’s holding on the definition of “property.” While Kelly held that an exercise of regulatory power is not government “property,” Blaszczak II holds that confidential information about a future exercise of regulatory power is not government “property” either. As such, a scheme to obtain such information cannot give rise to certain federal prosecutions under the federal securities fraud, wire fraud, or conversion statutes. Second, the Supreme Court’s vacatur and remand reopened the question whether the government must satisfy the personal benefit element when using statutes such as Title 18 securities fraud and wire fraud, rather than Title 15 or traditional Section 10(b), to prosecute insider-tippers and outsider-tippees. “Of necessity” a Supreme Court “decision vacating the judgment of the Court of Appeals deprives that court’s opinion of precedential effect.”³³ Or, as the Second Circuit has put it, “vacatur dissipates precedential force.”³⁴ Here, the Supreme Court vacated Blaszczak I, and the Blaszczak II panel declined to reach the personal benefit question because it was “no longer outcome determinative.”³⁵ Thus, the question is once again open in the Second Circuit.³⁶

That is fortunate for two reasons. For one, Blaszczak I’s interpretation of § 1348 was flawed. Relying largely on questionable purposive arguments, the court jettisoned the personal benefit test from Title 18 securities fraud even though § 1348’s language is materially identical to that of Rule 10b-5.³⁷ The interpretation thus ran afoul of the textual canon that presumes that Congress uses language consistently.³⁸ Now, a future panel will have the chance to revisit the question. For another, as Judge Walker’s concurrence points out, Blaszczak I’s interpretation would have had pernicious practical effects. By removing the personal benefit test from Title 18 securities fraud, Blaszczak I would have made it easier for the government to pursue criminal charges rather than civil sanctions, and it would have made it easy for the government to use Title 18 to avoid a long line of Title 15 decisions setting forth the elements of insider trading. In turn it may have chilled the legal exchange of information between insiders and analysts by raising the possibility of inadvertent liability should an outsider act on the insider’s information. A future panel may now consider those potential costs when deciding the issue.

Footnotes

1. Dechert LLP represented the Alternative Investment Management Association, Ltd. as amicus curiae in both the Second Circuit and the Supreme Court appeals in Blaszczak.
2. United States v. Blaszczak, ___ F. 4th ___, 2022 WL 17926047 (2d Cir. 2022) (Blaszczak II).
3. United States v. Blaszczak, 947 F.3d 19 (2d Cir. 2019) (Blaszczak I).
4. Kelly v. United States, 140 S. Ct. 1565 (2020).
5. Blaszczak II, 2022 WL at *13 (Walker, J., concurring).
6. Id. at 26–28
7. Blaszczak II, 2022 WL 17926047 at *2, 12–13; 15 U.S.C. §§ 78j(b), 78ff; 18 U.S.C. §§ 371, 641, 1343, 1348, 1349; 17 C.F.R. § 240.10b-5.
8. Blaszczak I, 947 F.3d at 29 (citing Dirks v. SEC, 463 U.S. 646 (1983)).
9. Id. at 29–30.
10. Id. at 30–31; 18 U.S.C. §1343 (“money or property”); id. §1348(2) (same).
11. Blaszczak I, 947 F.3d at 39–40; see also 18 U.S.C. §641 (“money, or thing of value”).
12. Blaszczak I, 947 F.3d at 35.
13. Blaszczak I, 947 F.3d at 26.
14. Olan v. United States, 141 S. Ct. 1040 (Mem.) (2021) (citing Kelly, 140 S. Ct. 1565); Blaszczak v. United States, 141 S. Ct. 1040 (Mem.) (2021) (same).
15. Blaszczak II, 2022 WL 17926047 at *1.
16. Kelly, 140 S. Ct. at 1572 (quoting Cleveland v. United States, 531 U.S. 12, 26 (2000)).
17. Id. at 1571 (emphasis in the original).
18. Dirks v. SEC, 463 U.S. 646, 667 (1983).
19. Id. at 662.
20. See Salman v. United States, 137 S. Ct. 420, 423 (2016); United States v. Newman, 773 F.3d 438, 447–48 (2d Cir. 2014), abrogated on other grounds by Salman, 137 S. Ct. 420; SEC v. Obus, 693 F.3d 276, 289 (2d Cir. 2012).
21. Compare 18 U.S.C. §1348 (prohibiting “a scheme or artifice to defraud”), with 17 C.F.R. §250.10b-5 (prohibiting a “scheme, or artifice to defraud”).
22. Blaszczak II, 2022 WL 17926047 at *9; id. at *5–10.
23. Id. at *12.
24. Ibid.
25. Id. at *12–13.
26. Id. at *15 (Walker, J., concurring) (quoting Dirks, 463 U.S. at 658 & n.17).
27. Ibid.
28. Ibid.
29. Id. at *16.
30. Id. at *18 (citing Carpenter v. United States, 484 U.S. 19, 26–28 (1987)).
31. Id. at *19.
32. Id. at *27.
33. O’Connor v. Donaldson, 422 U.S. 563, 577 n.12 (1975) (citing United States v. Munsingwear, Inc., 340 U.S. 36 (1950)).
34. In re Bernard L. Madoff Inv. Securities LLC, 721 F.3d 54, 68 (2013); see also United States v. Moore, 916 F.3d 231, 241 (2019) (“To the extent anything in our vacated .. opinion may have supported [the defendant’s] position, it has no precedential value.”).
35. Blaszczak II, 2022 WL 17926047, at *13 (Walker, J., concurring); id. at *26 (Sullivan, J., dissenting).
36. See also id. at *13 (Walker, J., concurring) (implying that the question remained open for Second Circuit review by suggesting that the criminal/civil “asymmetry deserves further attention of our court, the Supreme Court, and Congress” (emphasis added)).
37. Blaszczak I, 947 F.3d at 34–37.
38. See A. Scalia & B. Garner, Reading Law: The Interpretation of Legal Texts 73, 170–73 (2012).