This week on inSecurities we'll be doing the first of our 'Deep Dive' series. In this series, we’ll go in-depth on a single topic to provide an all-encompassing 360 degree view of it. In this episode, we take a look into the world of insider trading. Whether it's complex plans or simple ideas to trade against the market, insider trading impacts both the headlines and the securities markets across a variety of areas.



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[00:00:00.65] SPEAKER: This program is brought to you by the Practising Law Institute, a nonprofit learning organization dedicated to keeping attorneys, professionals, and accountants at the forefront of knowledge and expertise.  

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[00:00:16.28] To be a super trader, you'll need an edge to overcome the laws of probability and the uncertainty of the marketplace. That edge comes from information flow, the ability to correct your habits in terms of the market's characteristics, and being able to take risks, cut losses, expand your information network, ferret out ideas, and take recommendations. So said the late Ari Keith, a famous psychiatrist to Wall Street traders. But sometimes, that edge comes from illegal inside sources. We break down recent insider trading developments today on inSecurities.  

[00:00:56.94] [MUSIC PLAYING]  

[00:01:01.77] CHRIS EKIMOFF: Hello and welcome to the inSecurities podcast, helping you stay current on the latest securities, regulatory, and enforcement developments, with the practitioners' perspectives on the stories should be following. As always, I'm Chris Ekimoff and I'm here with my friend, Kurt.  

[00:01:16.09] KURT WOLFE: Good to see you, Chris.  

[00:01:17.37] SPEAKER: This week on inSecurities, we'll be doing the first in our Deep Dive series, where we go in depth on a particular topic to give you an overall idea of what that topic is about. Today's deep dive is into the complex and interesting world of insider trading.  

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[00:01:37.82] Insider trading is a phrase that's used often in popular media, general reporting, as well as if you ever see a prosecutor on the front steps of a courthouse after a big case. Insider trading means a lot of things to a lot of people. Unfortunately-- or fortunately, for some-- there is no single definition of what insider trading is.  

[00:01:57.26] Not to get too high above the details here, which we'll dive into, but generally speaking, insider trading involves material non-public information being used to profit or avoid a loss in trading in the markets. So classic examples are those with inside information of a company, whether they serve on a board or in a management position or a position where there's information related to a new product's drug trial or missing financial results, and using that information to go out and-- whether on their own or informing others-- make trading choices that would benefit that individual. Again, whether making a profit or avoiding a law.  

[00:02:38.75] So insider trading has been one of those tough topics to get our arms around for decades, since as early as the stock market has been around, insider trading issues have been identified, prosecuted, and defended. Kurt, why don't you talk to us a little bit about kind of the history of insider trading leading up to where we are today?  

[00:02:57.45] KURT WOLFE: Yeah. Happy to break it down a little bit. I mean, I think the important point-- you nailed it-- there is no statutory definition of insider trading. Typically, or historically to the extent that there have been insider trading prosecutions, and there have been ebbs and flows depending on how programmatically significant different prosecutor's offices or different commissions at the SEC think that is, typically, insider trading has been prosecuted or charged under the Securities Exchange Act of 1934.  

[00:03:27.53] The Exchange Act includes a general prohibition on the use of any manipulative or deceptive device, scheme, or course of business in connection with the purchase or sale of a security. So again, nothing in there specific to insider trading, but that's the general framework in which prosecutors will charge insider trading violations.  

[00:03:47.51] The specific rules that prohibit insider trading have really been created by judges or by cases over time, construing that broad prohibition, that broad fraud prohibition that's in the 34 Act. Illegal insider trading is buying or selling a security in breach of a fiduciary duty or other relationship of trust on the basis of material non-public information about the security. Some more acronym bingo here. We may slip and refer to material non-public information as MNPI from time to time during the episode today. So heads up for that one, if you happen to hear it while we're talking.  

[00:04:26.93] Essentially, we can think of insider trading in the classical sense which is, someone who works at a company learns something about the company, maybe it's about their financial health, maybe it's about a potential merger, maybe it's about a new product or some research and development that are going on at the company. But they think that the information they have is likely to impact the price of that company's stock positively or negatively. And knowing that that information is private, right? Knowing that is not generally available to the market.  

[00:05:02.03] They go out and trade in the stock hoping to make a profit. That's sort of the classic example of insider trading. To understand how it works, there are a couple key components of the definition that I think we should hit on, right? So one is this concept that the information must be material. Remember, MNPI, material non-public information, right?  

[00:05:23.39] So material information is material if there is a substantial likelihood that a reasonable investor-- right? So not the most sophisticated investor, but a reasonable investor-- would consider it important in making investment decisions. The second important aspect of this is the non-public part, which I think has changed a little bit over time. But generally, we can think of non-public as information that is not generally available in the public. It hasn't been reported in the press, it's not in a company's SEC filings, or otherwise something that is known by the market. It's something that really is only known to a select few within the company.  

[00:06:03.11] Within that framework, insider trading prosecutions have changed a little bit over time to pick up other conduct, right? So we've seen a whole body of law develop around what has become known as the mosaic theory, which is where someone who may or may not be an insider picks up and pieces together bits of information to form what they call a mosaic, right? So it's not a classic case where I found out that we are going to enter into a merger, and so I go buy the stock, right? This is more, I pick up a little piece of information here, a little piece of information there, which leads me to believe that we're probably going to enter into a merger and then I trade stock. There's a whole body of law around the so-called mosaic theory, but we can see how that doesn't necessarily fit precisely into the classical theory.  

[00:06:52.65] Another way that insider trading has evolved over the years relates to when a so-called tipper or tippee is liable for either giving away or trading on inside information. The case that set this up or the case that really established the standard for when someone who either gives or receives inside information may be prosecuted for trading on that is Dirks v. SEC. And in that case, the Supreme Court held that a breach of a duty of confidentiality occurs when based on objective criteria, the insider personally will benefit directly or indirectly from the disclosure of confidential information.  

[00:07:33.18] The court explained, quote, "For example, there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient. The elements of fiduciary duty and exploitation of non-public information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself, followed by a gift of profits to the recipient." That's the end of the quote.  

[00:08:04.95] So, essentially, what they're saying is, Chris, if I have inside information and I give it to you in exchange for a bag of cash we can both be on the hook, right? Even though you're the one that traded. I'm the insider with the information, but you're the one that traded. You can be on the hook. Similarly, if we were brothers and I just wanted you to do well and I gave you as a, quote, "gift" inside information and you traded on it, the court will say that's no different than if I had myself traded on that information and written you a check for the illicit proceeds of the trade.  

[00:08:38.31] So that's sort of what Dirk's set up. And for years and years, that is how the courts thought about the personal benefit requirement. That all changed a couple of years ago in a case called US v. Newman. In that case, the Second Circuit Court of Appeals held that an inference of a personal benefit is, quote, "impermissible in the absence of proof of a meaningfully close personal relationship that generates an exchange that is objective, consequential, and represents at least a potential gain of a pecuniary or similarly valuable nature." End quote.  

[00:09:16.41] So what they did is try to restrict the Dirk's holding to say that there needs to be more than the appearance of a quid pro quo or there may need to be more than, you're my cousin, maybe, instead of my brother, right? There needs to be something a little bit more tangible in terms of what was the benefit to the insider who gave the information away.  

[00:09:37.62] And it kicked off a couple of things. One was a whole series of cases where prosecutors and defense counsel were fighting about what is a meaningfully close personal relationship, right? So I remember a case where the argument was about whether a guy who worked at a publicly traded company, his roommate was a trader on Wall Street, and on Friday nights they would come home and drink beer and play video games and sometimes company insider would talk about things going on at work, trader would sometimes make trades or tell other friends about what he learned, right?  

[00:10:11.12] So there's this whole case about, well, they're roommates, is that meaningfully close? Did they go to college together? What is the nature of their relationship? And did he even mean to, quote, "tip" that inside information, or maybe he just had too much beer and pizza and got talkative, right?  

[00:10:28.94] The second thing that happened was it caused the US attorney's office in the Southern District of New York to drop or in some cases lose a lot of insider trading cases because this new Second Circuit decision said you have to demonstrate that there is a meaningfully close personal relationship or that there is some clear tangible pecuniary value or exchange of value between the tipper and the tippee. And that just wasn't always there.  

[00:10:53.87] That case lasted for about two years. And then it got thrown into turmoil again in a case that was ultimately called Salman v. United States. A funny thing happened here in this case. And I always like to tell this story. Some of our listeners will know it. But if we go back to US v. Newman, when that case was coming up through the federal district court, the judge that heard the case was a very famous judge-- Judge Jed Rakoff. And Judge Rakoff actually ruled that in that case the prosecution had done its job of demonstrating that there was a personal benefit. And in his view there was enough for the prosecutors to make their case. It went up on appeal to the Second Circuit and that's when the Second Circuit created this new rule that said you have to have this meaningfully close personal relationship.  

[00:11:40.31] The Salman case comes up through the Ninth Circuit, which is in California. But the Ninth Circuit is famously short of judges at the appellate court level. And in this particular instance they asked for a judge from another district to come and sit-- what they call it is sitting in designation-- to hear the case.  

[00:12:01.00] CHRIS EKIMOFF: Hey Kurt, who is that Judge?  

[00:12:02.85] KURT WOLFE: Well, I'll give you one guess.  

[00:12:04.20] [LAUGHTER]  

[00:12:05.43] CHRIS EKIMOFF: It's the only judge we've named so far in today's episode.  

[00:12:07.50] KURT WOLFE: Right. So they called up this very famous judge who knows the securities laws as well or better than any other judge in the United States-- Judge Jed Rakoff. They fly him out to California, he sits on a panel in the Ninth Circuit in designation, and ultimately writes the opinion in US v. Salman. And that opinion turned Newman on its head.  

[00:12:28.33] It essentially said, quote, "we decline to follow it." They found instead that you didn't need this meaningfully close personal relationship and in that particular case, that a family relationship was enough to assume that there was a personal benefit. That case went up to the Supreme Court and the Supreme Court agreed.  

[00:12:47.46] There was a cascading effect from the Salman case where other cases that were pending or had been pending for some time were being reconsidered, new arguments were made. I mean, famously that included the Rajaratnam case and a co-defendant named Gupta. There were two famous cases involving a gentleman named Martoma. They all started winding their way through the courts and trying to figure out how do we exist in this new Salman plus Newman world, or Newman plus Salman world.  

[00:13:17.25] And what has happened is that the judge-made law of insider trading is perhaps murkier now than it ever has been. I will say I have some friends who practice in this space that thought all of this was much ado about nothing, they continue to think it's much ado about nothing. And they will say if you want to understand insider trading law in the United States all you need to do is look at Dirks. Dirks is the benchmark, Dirks still applies. All that people have done is wrangled about what it means, but we've come full circle, right? So there is that view. But I think for a lot of observers it seems that there is a great degree of uncertainty or ambiguity in insider trading law today.  

[00:13:58.63] [MUSIC PLAYING]  

[00:14:02.55] CHRIS EKIMOFF: It really comes down to those two kind of facts you've touched on, is the monetary value of the information and the relationship between the tipper and the tippee. Or in certain cases, I know they've used the colloquialism chain of tippees, when you don't just have someone trading on information directly from an insider but there is a funnel or a phone tree, if you will, of folks who get this source of information from many steps removed.  

[00:14:26.78] How involved are they in a scheme or are they just receiving information? You can draw the examples from that classic insider trading on their own behalf to somebody dropping a piece of paper on the sidewalk and another person picking it up and saying, oh, I should go trade this stock now because I know something about it. Where do you draw the line? And that's where it seems like there's been not only ambiguity about that, but even moving back and forth on that spectrum over the case law in recent years.  

[00:14:51.18] KURT WOLFE: Yep. That's absolutely right. And I think this is all perhaps finally coming to a head, right? So I think we've mentioned in a previous episode that the United States is the only Western country, I believe, that does not have in place an insider trading statute or law. Canada has one, the United Kingdom has one that's similar, both of which deal with what they call insider dealing. But we don't have one.  

[00:15:15.82] And in fact, I sat at a conference in Toronto a couple of years ago where Judge Jed Rakoff spoke and he called for the US to create an insider trading law. He said, look, this is messy. The way that you're doing it here in Canada makes sense. At least people understand the rules of the road. In the US, everybody is arguing about what these nuanced rulings mean in the context of particular facts. But if you just have a piece of legislation that makes clear or as clear as legislation can what the rules are, prosecutions would go along much more smoothly.  

[00:15:51.72] And lo and behold, here we are a few years later. And finally a piece of legislation like that is starting to work its way through the House of Representatives and the Senate just across town here in DC.  

[00:16:04.23] CHRIS EKIMOFF: I'm sure your attendance at the conference, Kurt, is what kicked this off, you know, after Judge Rakoff made his pronouncement. Now it's rolling in down here.  

[00:16:11.97] [KURT LAUGHS]  

[00:16:12.54] Took a few years and about 450 miles, but here we are.  

[00:16:15.30] KURT WOLFE: You're welcome everybody. I went all the way up to the Great White North and brought back insider trading laws.  

[00:16:20.64] CHRIS EKIMOFF: Yes, sir.  

[00:16:21.88] KURT WOLFE: So in December, the US House of Representatives overwhelmingly passed HR-2534, which is otherwise known as the Insider Trading Prohibition Act. And overwhelmingly, I think it's worth mentioning this bill passed by a vote of 4-10 to 13, which is not close, right? And a much wider gulf than I think we see in a lot of votes these days.  

[00:16:47.13] CHRIS EKIMOFF: I think on our podcast so far, Kurt, we've only presented legislation that has been wildly bipartisan. So maybe we'll have to find a partisan piece of legislation to discuss in future episodes.  

[00:16:57.06] [LAUGHTER]  

[00:16:57.95] KURT WOLFE: Yeah. I think there could be plenty.  

[00:17:00.15] CHRIS EKIMOFF: There's comfort in consensus. I'm glad we're talking about it.  

[00:17:02.44] KURT WOLFE: You know? Some of that plays out in the SEC rule-making as we've talked about.  

[00:17:05.76] CHRIS EKIMOFF: That's right.  

[00:17:06.14] KURT WOLFE: Let me get my weekly plug for REG BI.  

[00:17:09.43] CHRIS EKIMOFF: There it is 

[00:17:10.03] KURT WOLFE: There it is. Don't sleep on REG BI, everybody. So anyway, the Insider Trading Prohibition Act would codify certain aspects of the judicially created body of insider trading law. Despite the fact that it was passed on a broadly bipartisan basis, it's really unclear whether the Senate is even going to consider the bill. So I think some uncertainty may remain in the insider trading space, but nevertheless let's tell you what the bill does in case it has legs.  

[00:17:40.93] Essentially, the bill codifies aspects of the judicially created body of insider trading law. In particular, the bill would prohibit the purchase or sale of securities while a trader is, quote, "aware of, unquote, material non-public information if the purchaser or seller, quote, "knows or recklessly disregards that such information has been obtained wrongfully or that such purchase or sale would constitute a wrongful use of such information." End quote.  

[00:18:12.25] Trading is deemed to be wrongful under the act if the information was obtained either, one, through theft bribery, misrepresentation, or espionage, two, in violation of any federal law that protects computer data or intellectual property, three, through misappropriation or any other unauthorized or deceptive taking of such information, or four, in breach of any fiduciary duty, confidentiality contract, code of conduct, or ethics policy, or, quote, "any other personal or other relationship of trust or confidence."  

[00:18:48.88] It does, I think, broadly pull together threads that run through existing insider trading cases. I think some things that it does that are interesting and maybe not how Judge Rakoff would draw it up is they use this concept of being aware of information that is material non-public information, which kind of hints at like a knowing possession standard, which is sort of what the case law on the Second Circuit says and it's definitely aligned with what the SEC rules say, which say that a trade is on the basis of MNPI if the person, quote, "was aware of the MMPI at the time of the trade."  

[00:19:31.07] I think that some that have advocated for an insider trading bill would like a little bit more clarity around what is the knowledge element of insider trading, you know? What does "aware of" mean. Nevertheless, I think it's still largely in line with what we've seen in the past. The argument that emerged in Newman and in Salman and originally in Dirks, for that matter, about the personal benefit requirement, it seems to pretty much be gone when you read through this bill. There's no requirement that a person, whether you are the insider that gives the initial tip or a tipper that exists somewhere down a chain like you talked about, Chris-- there's no requirement in this piece of legislation that person receive a personal benefit in exchange for the information.  

[00:20:17.38] So, you know, we'll see where this goes. I think, however, it's likely to get some push-back whether in the Senate or even just from commentators in the market. And Chris, I don't know-- have you seen a report that takes this on recently?  

[00:20:33.57] CHRIS EKIMOFF: You made a couple of comments that were interesting. You talked about how you didn't know if this was the way that Judge Rakoff would have drawn that up. Thankfully, Judge Rakoff is participating in a task force related to insider trading. So along with an out-of-work US attorney famous for both his position politically, as well as his podcast, Preet Bharara, the task force was started, I believe, about 18 months ago to discuss this very issue of insider trading.  

[00:20:58.49] So made up of former prosecutors Judge Rakoff, obviously other luminaries in the securities law and academic space, really focusing on getting to that answer of what is the right language statute, is it legislative? Is it judicially decided? Where should we fall in the insider trading spectrum? So this task force has been around for many months and actually just issued their report here in late January. So directly responding to or running concurrently with the House Bill that passed with such great fanfare.  

[00:21:29.53] Apart from providing a very good download all of the cases we talked about today and the issues therein-- I'd suggest all of you go and read it if you have not-- they really come up with four principal recommendations for insider trading responses. The first, which does mirror that House bill, is to aim for clarity and simplicity. So moving away from some of these tough to define standards of personal benefit or close familial relationships. Focus the language generally speaking on easy to interpret or at least well-founded standards as they relate to insider trading.  

[00:22:04.02] KURT WOLFE: I will say Chris I've got the House bill printed out in front of me. It's about two pages long, which is just a little bit shorter than the Salman decision.  

[00:22:13.43] CHRIS EKIMOFF: Yes.  

[00:22:13.73] [LAUGHTER]  

[00:22:14.48] KURT WOLFE: So, I mean, I think in terms of brevity or conciseness they're hitting at it--  

[00:22:19.23] CHRIS EKIMOFF: Yes.  

[00:22:19.91] KURT WOLFE: The question is, does it say the right things?  

[00:22:22.10] [CHRIS LAUGHS]  

[00:22:22.34] And I'm guessing our friend Preet and Judge Rakoff have a view on that.  

[00:22:27.02] CHRIS EKIMOFF: Yes.  

[00:22:27.82] [LAUGHS]  

[00:22:28.64] So to talk more about some of the technical elements that the task force released in their report this week, they want to focus-- principal two is stated as focus on, quote, "wrongful" use of material non-public information, not exclusively on deception or fraud. So again, this is about taking that information and misusing it, not in the acquisition of that information.  

[00:22:49.11] And the report talks about a case related to hacking that came down in recent years in which the decision was made in that specific case that hacking would be understood as a tool for insider trading to be illegal if the hacking involved some type of deception. So if I log in as Kurt Wolf and I am not Kurt Wolf, I have performed a deceptive device in the carrying out of my insider trading scheme, and therefore would fall on the illegal side of insider trading. Whereas if I am hacking and I identify a weakness in the controls related to the system, I do not pretend to be anyone, I do not misuse information or act deceptively to get into the system, I just merely get entry based on my skills and the weakness, that would not fall on the illegal side of insider trading.  

[00:23:39.51] So it seems like a pretty interesting hair split there, but that's what I think this principle too is really focused on situations where the deception is not the issue, it's the wrongful use of that information.  

[00:23:49.38] KURT WOLFE: Yeah, it's an interesting note. And it obviously ties back to the Exchange Act, which prohibits the use of any manipulative or deceptive device in the course of some scheme, right? They're borrowing that language specifically. Look, I think over time the concept of a manipulative or deceptive device has been broadened so substantially that at least if you're in the SEC enforcement staff, you see that anywhere you look. Right? It's even in the example that you just gave, which I think comes from the report. If there's no deception because you were illicitly logging in using my account, it's probably still manipulative if you're exploiting weaknesses--  

[00:24:29.51] [LAUGHTER]  

[00:24:30.38] --in a company's systems.  

[00:24:31.26] CHRIS EKIMOFF: Exactly. You can argue both sides pretty strongly.  

[00:24:32.87] KURT WOLFE: Yeah. So they're going to find it. But OK, I take the point. What else is in the report?  

[00:24:37.99] CHRIS EKIMOFF: Thankfully, mirroring what you just talked about with the House bill, eliminating the personal benefit requirement. This, again, is kind of one of those interesting nuances to insider trading law that has gone on both sides of the fence in recent years. So thinking directly from the task force to remove that hurdle to prove an insider trading violation or insider trading allegation would help to substantiate the law beyond some of these questionable practices, probably save some of the cases we've talked about that have gone on for years and years to prove those things out, whether relationship-wise or, as you alluded to earlier, Kurt, having a bag of cash involved. Really focusing back on that wrongful use of the information.  

[00:25:16.35] And then, finally, again, to kind of hit-- it seems like this concurrent development may be both serendipitous as well as potentially a little bit of like-minded thinking. . The fourth principle, and I quote, "clearly and explicitly define the state of mind requirement for criminal and civil insider trading as well as the knowledge requirement for tippees." So exactly to that point you brought up, Kurt, is, what is someone thinking and what is required of that thinking to understand if it's a violation of criminal statute or if there is a civil insider trading matter being brought? Do you have to do it on purpose? Are you gathering that information from a mosaic level to understand, hey, maybe it's a better idea if I sell now than two weeks from now? Those types of things this task force hopes to define in insider trading legislation in coming months.  

[00:26:02.33] KURT WOLFE: The report is certainly interesting, and they're raising all the right points. I think it's interesting that there was no comment on the scope of the Insider Trading Prohibition Act because it's been sort of narrowed over different versions or, you know, markups on different committees in the House. You know?  

[00:26:22.97] Interestingly, on this task force with Judge Rakoff and with Peet Bharara is SEC commissioner Robert Jackson, who has for years talked about the dangers of insider trading. He often talks about it in terms of what he refers to as the 8-K gap, which essentially is a period of time during which a corporate insider knows some material piece of information but it has not yet been publicly reported through a form 8-K. And some research directed by Commissioner Jackson and some scholarly articles that he wrote on that point make clear that there is a tremendous amount of trading that occurs during the 8-K gap.  

[00:27:03.28] This bill, the Insider Trading Prohibition Act, does not get at the 8-K gap. Now, there is other legislation. There are actually bills in the Senate and in the House that get at the 8-K trading gap. But I wondered if ultimately an insider trading bill would be broad enough to sort of fit all of this kind of conduct under the umbrella.  

[00:27:22.87] Similarly, the Insider Trading Prohibition Act in the final version, it struck a provision that deals with what has been referred to as automatic trading. So these may be things like 10b5-1 plans pursuant to which trades happen automatically. So if you are an executive in a company and you own their shares or have been given shares as compensation over time, part of a 10b5-1 plan could be that you will buy more shares or sell some of your shares on predetermined dates or at predetermined intervals.  

[00:27:57.52] And so it sort of shields you from any insider trading liability, right? Because that trade isn't happening because you know or learn something about the company, it's happening because two years ago with my wealth management professional I decided that it would happen on these dates. There were provisions that would sort of get in the original version of the bill when they came out.  

[00:28:19.79] So what we are left with in this bill is really something that is designed to prohibit the kind of illicit insider trading that we see in TV shows and in movies, you know? I'm an insider or an interloper and I've learned some piece of information that I either use myself to trade profitably or share with someone who uses it to trade profitably. This isn't taking a sort of broader sweep at potential insider trading going on in the market.  

[00:28:52.04] [MUSIC PLAYING]  

[00:28:56.48] So I think a good question, Chris, is, why does this all matter? Right? We've spent a little bit of time talking about sort of court-made insider trading law, a potential legislative fix, and the market's reaction or at least one task force's reaction. Why are we focusing on all of this? What is the impact or what is the importance?  

[00:29:15.41] And I think the upshot is that it's causing prosecutors to look in different directions or look for new tools to get at insider trading or alleged insider trading violations because the rules are murky, because it's not becoming any more clear, they're having to find other ways to get at this misconduct. And there have been some developments in that space recently, including a case that's been going on for quite a while, the Blaszczak case. Chris, do you want to tell us a little bit about that?  

[00:29:47.14] CHRIS EKIMOFF: The Blaszczak case really brings out a couple of different elements of the insider trading law that come from the statute side. There's a couple different elements of regulation that one can bring and insider trading related case under, and those elements actually play out in an interesting interplay here with Blaszczak.  

[00:30:04.24] The Title 15 law is what is more commonly known and has been used in the past 35 years related to all of those cases we've already talked about. The Title 18 law under the Exchange Act, a little bit newer, and actually was found in the Second Circuit Court of Appeals to not require the personal benefit element that we've talked about a bit here from both the House bill and the report.  

[00:30:27.47] So it's really kind of a roadmap after coming out of the Second Circuit that there's an avenue by which-- not to use the word "easier to prosecute," but another tool in a prosecutor's toolbox to be able to bring insider trading charges without having to pursue that kind of personal benefit or level of detail related to insider trading.  

[00:30:47.00] KURT WOLFE: Yeah. That's right. So let me back up just a little bit because I think it's important. But, you know, Title 15 you mentioned is-- Title 15 of the US Code, that is where the Exchange Act resides, right? So any of these cases we've been talking about so far have been prosecuted under the Exchange Act under section 10-B of the Exchange Act and rule 10b-5 they're under.  

[00:31:08.41] This case brought charges under the Exchange Act and under Title 18, which is the criminal section of the United States Code. And there is a section there, Section 13-48 that is designed to make illegal securities fraud. That section is only about 18 years old. And what happened here in the Court of Appeals was they sort of looked at it and said, OK, well, you know? Dirks really interprets the Exchange Act, and that case is almost 40 years old, whereas this particular section under which the prosecutors brought these charges isn't that old. It hasn't been interpreted.  

[00:31:47.08] And what the court said-- this was Judge Richard Sullivan writing for the Circuit Court said-- Section 13-48 was intended to provide prosecutors with a different and broader enforcement mechanism to address securities fraud than what had been previously provided in the Title 15 fraud provisions. We declined to graph the Dirks personal benefit test onto the elements of Title 18 securities fraud.  

[00:32:15.11] So they're sort of underscoring this distinction between the purposes of the two different laws here. And I think the reaction from the market has been, as you said, it just got really easy for prosecutors to bring insider trading cases.  

[00:32:31.48] CHRIS EKIMOFF: I feel like a lot of prosecutors got their pencils out and wrote down Title 18 under the charges they may have already been considering.  

[00:32:37.27] KURT WOLFE: Section 13-48. Got it.  

[00:32:39.50] CHRIS EKIMOFF: Yes. Good. Thanks for the reporting. This will be helpful in my upcoming case.  

[00:32:43.19] KURT WOLFE: Yeah. Look, I think in certain cases, Blaszczak definitely has the potential to lower the burden for prosecutors. But I've seen some people say that this case has the potential to make charges under the Exchange Act under Title 15 basically go away.  

[00:33:00.69] CHRIS EKIMOFF: Yeah.  

[00:33:01.48] KURT WOLFE: I am not of that view. Right? I think that this case is certainly significant as it relates to the particular section that it construes. And again, in certain cases, it may change charging decisions, it may change the criminal insider trading prosecution landscape. Those changes on the landscape may be limited to cases that are brought within the Second Circuit or regionally. It all depends.  

[00:33:29.03] But I think something that's really important to remember here is that the court was construing a criminal statute, not a civil statute, right? And just going back to fundamental principles here. The Exchange Act, those are civil cases, those are civil charges. Title 18, those are criminal charges. Generally speaking, the burden of proof is more difficult in a criminal case. Specifically, the elements of proof in an insider trading case are exactly the same in a civil case or a criminal case. But in a criminal case, the defendant must have acted willfully. In a civil case prosecuted by the SEC, they don't need to prove that the person did it on purpose. Right? They can prove that the person was reckless. That distinction didn't go away.  

[00:34:18.78] CHRIS EKIMOFF: Yeah.  

[00:34:19.09] KURT WOLFE: Which is why I think we're going to continue to see plenty of cases being charged under the Exchange Act. I mean, I think what they we're dealing with here specifically, they were grappling with this issue, again, of personal benefit. Right? And in this case, they're saying, we're not going to take this murky rule around personal benefit that now exists under the Exchange Act and put it on top of Title 18. Title 18 doesn't need to work that way.  

[00:34:47.14] But it does mean that they still satisfied the willfulness, so the knowing element of a criminal prosecution, right? You can't get around that going forward. You're not going to have more criminal cases because, oh, well, the personal benefit test is different. If you don't have the willful piece, you're never going to get there. And the willful piece is the hard piece, right? It's why you see more insider trading cases charged by the SEC or in a civil context than you do in a criminal context. It's difficult in a lot of cases to make that proof.  

[00:35:23.11] So yeah. If you've got the willful piece and what you're concerned about is the personal benefit, sure, this is the case for you, right? Your burden just got easier. But I think I at least would temper some of the sentiment that says this changes the whole game for insider trading prosecution.  

[00:35:39.64] CHRIS EKIMOFF: If you've got that smoking gun email, then maybe that makes the difference here in terms of proof too for that willful side. But otherwise, I think, Kurt, you're saying that you see the landscape shifting a bit but not changing holistically related to this.  

[00:35:51.55] KURT WOLFE: That's right. And one of the things that I think has actually gotten lost over time in this case-- because we're talking more about the specific section and the elements of this particular crime-- is this notion of insider trading based on political intelligence. There have been a few of these cases and really only a few of these cases over the past several years. And they all have a similar fact pattern.  

[00:36:13.78] It is someone who works at a US government agency, it's often something like the FDA or some other agency that controls whether or not drugs are going to get approved or whether something is going to get a license, sometimes it has to do with procurement, is someone going to get a government contract. But someone that works for a US government agency tells usually a consultant, but sometimes it's more direct-- but a consultant who has been hired to obtain, quote, "political intelligence," they tell them, hey, this drug is going to have to go through another round of approvals, or guess what? Government contractor A isn't going to win that contract unsurprisingly.  

[00:36:57.14] Consultant then shares that information with a client who is usually a hedge fund. So he's telling some analyst that a hedge fund-- that he knows about x drug or about y government contract, and the analyst will prepare a report or make a recommendation for a trade based on that information. About four years ago, everybody at least in DC was concerned that insider trading based on political intelligence was going to be this thing that exploded and was going to change the way we think about insider trading, was going to unearth all kinds of potential misconduct in this sort of political intelligence consulting space. And we just haven't really seen it in a meaningful way yet.  

[00:37:41.48] Again, there have been a few cases. Most of them were along the lines of the Blaszczak case, but there have certainly been others. It seems to be that absent a really clear case-- again, here, this is a case where the proof was strong enough that they criminally prosecuted someone. Absent some really clear evidence, neither the SEC nor the DOJ have shown a really great appetite to go after those cases yet.  

[00:38:08.72] CHRIS EKIMOFF: And to be clear, the Blaszczak case falls right in that political intelligence segment. Mr. Blaszczak was a longtime employee of the Center for Medicare and Medicaid Services, or CMS, and upon leaving that agency became a consultant and shared some information from inside the CMS related to their reimbursement policy decisions coming up. So related to those drugs and services potentially that CMS would be reimbursing for and for how much. That information was shared with exactly that, Kurt, those hedge funds out there interested in the health care space.  

[00:38:39.84] So I think the line from inside information, doing air quotes here, is pretty clear in the trading activity being built upon that. And it sounds like this is one of those kind of willful examples that you talked about that seemed pretty clear from a Title 18 perspective.  

[00:38:54.82] KURT WOLFE: Yeah. Absolutely. And to the extent that the Insider Trading Prohibition Act ever comes into effect, it's removed the personal benefit test. So I think these types of political intelligence cases are going to be prosecuted in the future civilly and criminally. And although the wave never really came, I don't think that the risk is gone.  

[00:39:16.89] [MUSIC PLAYING]  

[00:39:21.33] CHRIS EKIMOFF: To follow in our vein of insider trading this week, Kurt, I wanted to bring up our new segment, Fraud Focus.  

[00:39:27.63] KURT WOLFE: Oh. Fraud Focus.  

[00:39:28.86] CHRIS EKIMOFF: We talk about a new fraud case every week hopefully related to some of our topics, but the fraudsters out there will dictate what we get into. So halfway through last year there was an interesting development. The SEC charged a woman, an accountant at a publicly traded company, for insider trading. And the details of her case really kind of mirror some of the things we've talked about today-- tippers, tippees, personal benefit relationships, and so on.  

[00:39:53.43] The SEC charged Martha Patricia Bustos, an in-house CPA who served in accounting and business analyst roles at Illumina Inc, a California-based genetics and biologics company that develops, manufacturers, and markets systems for the analysis of genetic variation and biological function. They charge her along with her friend, Donald Blakstad, who is not an Illumina employee but is alleged to have traded securities illegally on the basis of non-public information.  

[00:40:19.23] The SEC alleges, and Ms. Bustos pled guilty to providing inside information to Blakstad in advance of Illumina's quarterly performance announcements for quarterly reports between 2016 and 2018. And Blakstad personally generated more than $4 million in profits from trading on that information. The SEC's information alleges that Blakstad gave Bustos lavish gifts and all-expense paid vacations in exchange for her tips about soon to be announced performance metrics at Illumina.  

[00:40:46.98] In one example, Blakstad paid for Bustos and her friends to go to New York City. The trip included $35,000 in first class airfare and a $7,500 meal at a swanky New York restaurant. Probably a place that you would go, Kurt.  

[00:41:01.32] KURT WOLFE: I don't think so, Chris.  

[00:41:02.19] [LAUGHTER]  

[00:41:03.50] CHRIS EKIMOFF: According to the SEC, Blakstad tried to hide his trading by asking two individuals to trade on his behalf. He also shared the information with four other people who traded for their own benefit, and they profited $2.2 million worth from their trades. The commission is touting its use of data analytics and technology solutions to identify that suspicious trading. As Kelly Gibson, associate director of the SEC's Philadelphia Regional Office noted, the SEC, quote, "used some of our latest advanced software to analyze trading data, as well as traditional investigative techniques to piece together and expose the betrayal of trust alleged in our complaint."  

[00:41:36.82] Kurt, this is an example I think you spoke a little bit earlier about Commissioner Jackson's work on the 8-K gap. This is the 10-Q gap. An accounting at a publicly traded company was aware of information on the company's financial performance prior to it being released to the public and shared that information with someone she had a personal relationship with, and did actually receive a personal benefit. So we're kind of outside of the murkiness of insider trading debates here. We're seeing a lot of the elements that have defined these cases in the past. So the SEC's investigation is ongoing related to other elements of this matter, but I wanted to bring up that Fraud Focus for this week related to insider trading.  

[00:42:13.78] KURT WOLFE: It's right on point and I think there are a couple of good points that come out of it. I mean, one is, you're absolutely right. Right after the 8-K gap legislation was announced or the bills were announced in the House and the Senate, I was tweeting back and forth with some folks about, well, why isn't there a 10-Q gap or a 10-K gap?  

[00:42:29.37] CHRIS EKIMOFF: Yep.  

[00:42:29.64] KURT WOLFE: Right? So to your point, the 8-K gap is not the only-- it's not the only gap. I think that one really hits that information that is not necessarily of a financial nature, right? It could be about a merger, R&D, right? To me, there is a 10-K gap when people know what the financials look like before it's revealed to the market. Right? So to my way of thinking, it's the same problem.  

[00:42:52.15] The other thing here is just the SEC's use of data analytics tools to root out potential insider trading violations. And I should say too, FINRA also has very sophisticated data analytics tools that they too use to identify potential insider trading. Both agencies have access to a plethora of market and trading data that they use to try to identify patterns or suspiciously successful trading, right? And they will use that sometimes to kick off an inquiry. They'll see something, something spikes, and they say, huh, I wonder what happened here. And then that's when they'll go into what I think the SEC enforcement person referred to as traditional investigative tools.  

[00:43:38.76] CHRIS EKIMOFF: That's right.  

[00:43:39.39] KURT WOLFE: Right? So one kind of drives the other increasingly, I think. And these are things like Midas, Magic.  

[00:43:47.22] CHRIS EKIMOFF: Magic. Yeah.  

[00:43:47.95] KURT WOLFE: All of these. The SEC has what they call a pink sheets analysis tool. All of these things are designed to find insider trading. So they are still developing new tools to root it out. It is going to continue to be an important part of the enforcement program at the SEC. And whether that is under the Exchange Act or the Insider Trading Prohibition Act or whether their friends across town at DOJ are going to be using Section 13-48 of Title 18, insider trading is not going anywhere, folks.  

[00:44:19.79] CHRIS EKIMOFF: That's right. And to your point, Kurt, the trades don't lie. If you can find the information in the data, all the contacts in the world can be hard to explain away some of those trades. So that's it for our episode today. Thank you for joining us for the inSecurities podcast from PLI.  

[00:44:33.63] KURT WOLFE: As always, you can find us on Twitter. I am @enforce_update.  

[00:44:40.59] CHRIS EKIMOFF: And I'm @ekimoffcpa. Be sure to check us out on Apple, Spotify, or wherever you get your podcasts. And feel free to jump into the conversation using the hashtag #insecuritiespod to share some topics, cases, information you'd like to hear more about 

[00:44:55.34] KURT WOLFE: Thanks for tuning in, everybody. Hope to see you next time.  

[00:44:57.75] CHRIS EKIMOFF: Have a good one.  

[00:44:58.56] [MUSIC PLAYING]  

[00:45:09.10] SPEAKER: Thanks for listening to inSecurities, a podcast from PLI, the Practising Law Institute. PLI is a non-profit provider of authoritative professional services training and continuing education. In an increasingly complex business environment where intricate corporate structures reign, inSecurities can help you make sense of it all.  

[00:45:28.08] A special thanks goes to the producer of inSecurities, Daniel Painitz, as well as hosts Chris Ekimoff and Kurt Wolfe. For more information about PLI's SEC Institute or to view hundreds of hours of fresh and relevant on-demand programming covering changes within the securities sector, visit and sign up for a privileged membership.  

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