Two hedge-fund analysts asked the Supreme Court to review a Second Circuit holding that the government can avoid proving a personal benefit when it prosecutes insider trading under the criminal code.
Investment fund analysts who were convicted of wire fraud for trading on regulatory information are appealing that conviction to the Supreme Court. The petitioners for writ of certiorari argue that the Dirks personal-benefit test applies equally to Title 18 insider-trading prosecutions as it does to cases under Title 15. The petitioners also maintain that the Second Circuit panel majority erred in allowing information about a proposed government regulation to form the basis for a criminal conversion case (Olan v. U.S., September 4, 2020).
The petitioners, as analysts for Deerfield Management Company, L.P., received information about potential regulations from a former employee at the Centers for Medicare & Medicaid Services (CMS). Deerfield then traded on that information. For instance, in July 2009, the Deerfield partners shorted stock in a radiation-device manufacturer based on a tip that CMS would soon reduce the reimbursement rate for certain radiation oncology treatments. The trading, which the government argued amounted to illegal insider trading, continued through 2013.
The Second Circuit last year upheld the petitioners’ convictions for insider trading. The panel majority held that the Dirks personal-benefit test does not apply in criminal prosecutions under the wire fraud and securities fraud provisions of Title 18 of the U.S. Code. The court also held that confidential government information may constitute "property" for purposes of the same statutes. Dissenting, one judge disagreed with the holding that predecisional information allegedly misappropriated from the Centers for Medicare & Medicaid Services constituted property of the agency or the government.
The petitioners maintain, however, that their job of analyzing information was "necessary to the preservation of a healthy market" under Dirks v. SEC (U.S. 1983); that they circulated the information openly in emails that included in-house counsel and compliance personnel; and that they did not personally profit from the trading. In their view, the appeals court violated the principle that "it is the responsibility of Congress—not overzealous prosecutors or courts implementing their own views of sound public policy—to determine what is and is not a federal crime." The holding that the information constituted "property" allows the government to prosecute not just analysts but also whistleblowers and journalists, criminalizing leaks that "occur many times daily in Washington, D.C., and state capitols." And eliminating the personal-benefit requirement extends the prohibition on fraudulent trading to all trading in material nonpublic information, however it was obtained.
Property. In determining that the CMS information was "property," the appellate majority relied heavily on Carpenter v. U.S. (U.S. 1987, holding Wall Street Journal had a property right in its publication schedule and contents of forthcoming articles) and Cleveland v. U.S. (U.S. 2000, holding that the state’s right to control the issuance of gaming licenses implicated its role as sovereign, not as property holder). The petition argues that the Second Circuit’s holding conflicts with Cleveland and with the intervening decision in Kelly v. U.S. (U.S. 2020), both of which foreclose wire-fraud prosecutions for conduct that causes the government no economic harm. Contrary to the Second Circuit majority’s reasoning, the holding of Cleveland is not limited to the specific facts of that case, and both Cleveland and Kelly would have come out the opposite way under the appeals court’s analysis. The petitioners also argue that the holding transforms even state and local government information into government property, and in turn makes a federal crime such activity as a police officer’s disclosure of body-camera footage or a journalist’s report on a governor’s criteria for staff hiring.
Personal Benefit. The Second Circuit’s other significant holding was that the personal-benefit test established in Dirks v. SEC (U.S. 1983) does not apply to the wire fraud and Title 18 securities fraud statutes. The court read Dirks as establishing the personal-benefit test based on the statutory purpose of the Exchange Act to protect the free flow of information into the securities markets in part by "eliminating the use of inside information for personal advantage"—a context that does not exist for Title 18. But the petitioners argue that the provisions of Title 18 use identical language as the analogous antifraud provisions of the Title 15 securities laws and that the Second Circuit holding amounts to a "sea change in insider-trading law." Nothing in Dirks limits the holding to Title 15 or suggests that the Court intended to implement a statutory purpose unique to Section 10(b) fraud cases. Conversely, the legislative history to the criminal code statute, Section 1348, does not suggest that Congress intended to alter the meaning of fraud in tipping cases.
The petitioners conclude that the Second Circuit’s decision means that the government will never charge inside trading under Title 15, instead opting for Title 18 prosecutions that do not require proof of a personal benefit. This in turn will create a disparity between civil charges, which the SEC must bring under Title 15, and criminal charges under Title 18. "It would be bizarre if trading that involves no personal benefit and therefore does not trigger even the monetary penalties that arise from SEC enforcement action nevertheless subjects the tippee to criminal liability and years of imprisonment," the petitioners write. The decision will subject market participants to criminal prosecution just for conducting market analysis, particularly remote tippees like the petitioners, who are not alleged to have known who provided the information.
The case is No. 20-306.
Attorneys: Eric S. Olney (Shapiro Arato LLP) for Robert Olan. Jacobus P. van der Ven (Munger, Tolles & Olson LLP) for Theodore Huber.
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