Two separate, recent lines of cases have continued to shape the circumstances under which insider trading prosecutions can be brought, and as a result, the insider trading compliance risks faced by companies. First, the Supreme Court recently denied certiorari in United States v. Kosinski, which held that it can be an insider trading violation for independent contractors to trade stocks based on information made available to them while subject to a confidentiality agreement. Second, in United States v. Blaszczak, the Supreme Court vacated and remanded a Second Circuit case creating ambiguity as to whether confidential governmental information can form the basis of insider trading and wire fraud convictions.
Courts have enumerated two theories of insider trading: (1) the “traditional” or “classical” theory that applies when a corporate insider trades securities of his corporation on the basis of material, nonpublic information; and (2) the “misappropriation” theory that applies when a person commits fraud in connection with a securities transaction and misappropriates confidential information for securities trading purposes. U.S. v. O’Hagan, 521 U.S. 642, 651–52 (1997).
The Supreme Court denied certiorari this week in a case that may impact “temporary insiders” and confidentiality agreements for contractors.
On June 14, 2021, the Supreme Court denied certiorari in Kosinski, Edward J. v. United States, 2021 WL 2405163, at *1 (June 14, 2021). There, a cardiologist that served as the principal investigator in a drug trial was convicted of insider trading for both selling stock in the pharmaceutical company based on adverse information about the study before it was published, and then further shorting that stock. On appeal, the defendant argued that, while subject to a confidentiality agreement, that agreement labeled him as an independent contractor and did not contain any express prohibition on his trading based on the confidential information, only disclosing the information.
Rejecting those arguments, the Court held that there was sufficient evidence to find that Kosinski owed a fiduciary duty for purposes of insider trading liability. The Court reasoned that “the absence of an express prohibition on trading [was] not fatal” and that the word “independent contractor” cannot be afforded “controlling effect where such a term, even in a private contract, implicates significant public policies.” United States v. Kosinski, 976 F.3d 135, 147–48 (2nd Cir. 2020).
The underlying ruling in Kosinski should serve as a warning that stocks cannot be traded based upon non-public information learned in confidence by “temporary insiders” regardless of formalities such as whether the trader was technically an employee at the time the information as learned. Additionally, while the defendant was ultimately convicted, companies should review their agreements with third parties in a position to learn non-public information to ensure that those agreements expressly prohibit trading based on material, non-public information. Finally, companies should ensure that their corporate insider trading programs contemplate the role of such third parties and impose appropriate policies and procedures addressing the risks of insider trading that they pose.
The Supreme Court has made clear that it seeks to limit the confidential government information that can be subject to an insider trading prosecution.
In January 2021, the Supreme Court vacated the conviction and remanded a different Second Circuit case creating ambiguity as to whether confidential information held by a federal agency could underlie an insider trading or wire fraud conviction. Blaszczak v. United States, 141 S. Ct. 1040, 1040 (2021). The Second Circuit had previously rejected the challenges of several federal employees who tipped pre-decisional information about forthcoming changes to Medicare reimbursement rates to a former co-worker turned hedge fund consultant, who then provided the information to a hedge fund that shorted stocks of companies that would be affected by those changes. United States v. Blaszczak, 947 F.3d 19 (2019). The defendants, employees of the Centers for Medicare & Medicaid Services (“CMS”) were convicted of misappropriating confidential information from CMS in violation of the Title 18 securities fraud and wire fraud statutes but acquitted for Title 15 securities fraud. The Second Circuit held that the confidential government information from CMS could constitute “property” in the hands of the government agency.
The Court also held that, contrary to long-standing precedent, Dirks v. S.E.C., 463 U.S. 646, 663 (1983), the rule that an insider cannot be convicted of Title 15 securities fraud unless the defendant received a personal benefit does not apply to the Title 18 securities fraud and wire fraud provisions. The Court explained that the personal-benefit test announced in Dirks effectuated the purpose of Title 15 because that statute was aimed at eliminating the use of inside information for personal advantage. Unlike Title 15, the Court opined that there was no support for this requirement in the embezzlement theory of fraud of Title 18.
Blaszczak comes after the Supreme Court vacated the conviction in Kelly v. United States, 140 S. Ct. 1565 (2020), and remanded it for further consideration. The Kelly case arose out of the New Jersey “Bridgegate” scandal. In Kelly, the Court held that an exercise of regulatory power such as reallocating lanes on a bridge was not a scheme to take government property and thus the defendants’ actions did not violate the federal program fraud or wire fraud statutes. Id. at 1572–74. The Supreme Court’s act of vacating Blaszczak suggests that its decision in Kelly may ultimately foreclose insider trading convictions based on government employees disclosing confidential government information. Because Title 18 applies to “property,” there can be no liability under Title 18 if this information is not classified as government property.
These recent decisions highlight the ever-changing understanding of what constitutes insider trading as caselaw continues to develop. As such, it is important that companies keep apprised of such developments so that their insider training programs accurately assess the risks present, as well as ensure that training and guidance for employees (and non-employees like in Kosinski) is accurate and comprehensive.