In December 2022, the Department of Justice indicted eight individuals for securities fraud for allegedly operating a $114 million social media pump and dump scheme. United States v. Constantinescu, No. 4:22-CR-00612 (S.D. Tex. Mar. 20, 2024). According to the government, the defendants promoted stocks on Twitter and Discord to increase the price of the shares they owned and sold their shares as their social media followers piled into the stocks and drove the share prices higher. The indictment painted the picture of a classic securities fraud scheme. For decades, stock promoters used boiler rooms and newsletters to pump the prices of stocks that the promoters then sold as the assets appreciated. The only twist here was that the government alleged a pump-and-dump campaign through the more modern channels of social media.
Yesterday, Judge Andrew Hanen of the Southern District of Texas dismissed the superseding indictment in full. The Court’s opinion reflects a stunning expansion of the Supreme Court’s Ciminelli v. U.S., 598 U.S. 306 (2023) ruling and a potentially devasting blow to federal securities law enforcement.
In Ciminelli, the Supreme Court rejected the right-to-control theory in wire fraud cases. Ciminelli held that the government cannot premise wire fraud on schemes to merely “deprive a victim of potentially valuable economic information necessary to make discretionary economic decisions.” Rather, money or property must be the object of a wire fraud scheme.
Judge Hanen was tasked with determining whether Ciminelli applies to securities fraud charges under 18 U.S.C. §§ 1348 and 1349, and, if so, how. Judge Hanen reasoned that Ciminelli’s teachings apply to all federal fraud statutes and so Ciminelli must govern securities fraud charges. He then held that because the alleged victims did not purchase their shares directly from the defendants, the defendants could not have engaged in a scheme to deprive them of property or money:
Unlike a traditional fraud cause, in which the victim directly surrenders their property to the defendant (or an entity in the defendant’s control), the investors here surrendered their property to the stock market at market prices, and in return, received the benefit of the bargain in the form of securities.
Put another way, Judge Hanen found that the government had only alleged a scheme to deprive victims of information which, under Ciminelli, is insufficient.
The implications here are far-reaching. This same intermediated sale structure is present in virtually all securities transactions that take place on stock exchanges and similar markets. In stock trading, for example, there will be a market maker between the seller-fraudster and the purchaser-victim. And the holding begs the question as to how its logic may apply outside the securities markets (e.g., to non-securities fraud prosecutions where a buyer and a seller are one or more steps removed from one other). An inordinate array of goods and services are sold through intermediaries every day. Manufacturers sell goods to Amazon and brick-and-mortar stores which then sell them to consumers. Auto sales play out in much the same way.
If other courts embrace Judge Hanen’s decision, Constantinescu may spark a sea of change in federal fraud prosecutions. But it seems unlikely that the Supreme Court in Ciminelli sought to effect such a breathtaking change in the law. Those involved in the securities markets should not take Constantinescu’s holding as gospel. Plus, the case addressed securities fraud charges under 18 U.S.C. §§ 1348 and 1349 only. It did not, for example, address Ciminelli’s application to 15 U.S.C. §§ 78j and 78ff, which are worded far more capaciously. Time will tell whether Constantinescu is a turning point or a blip on the radar for federal fraud prosecutions.
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