Title 18 Insider Trading.

• Author: Lustbader, Zachary J.

NOTE CONTENTS INTRODUCTION 1831 I. THE SECURITIES THEORY AND ITS FAILINGS 1836 A. Foundation 1836 B. Doctrinal Knots 1840 l. Mens Rea: Willful Violation 1840 2. Breach as Fraud: Nondisclosure 1844 a. Classical Theory 1844 b. Misappropriation Theory 1847 3. Multiparty Liability: Tippers, Tippees, and Personal Benefit 1849 4. Scope: Securities Nexus 1851 a. Why Securities? 1852 b. What Connection? 1854 II. TITLE 18: EMBEZZLEMENT WITHIN FEDERAL JURISDICTION 1855 A. Foundation 1856 B. Blaszczak and Sarbanes-Oxley Securities Fraud 1858 C. Paradigm Shifts 1863 1. Mens ilea: Knowledge 1864 2. Breach as Fraud: Embezzlement 1866 3. Multiparty Liability: Conspiracy and Complicity 1870 4. Scope: Jurisdictional Hooks 1872 D. Rounding Out the Offense 1874 1. Materiality 1875 2. Of Property 1877 III. INSIDER TRADING AS FEDERAL CRIME A. From "Judicial Oaks" to the Ban on Common-Law Crimes 1880 B. From Deference to Lenity 1881 C. The Continuing Threat of 10b-5 Liability? 1883 1. Civil Enforcement 1886 2. Criminal Enforcement 1887 IV. OBJECTIONS 1889 A. Substance 1889 1. Broader Enforcement 1890 2. Fraud on Whom? 1890 B. Institutional Prerogative 1891 CONCLUSION 1894 INTRODUCTION

Securities and Exchange Commission (SEC) Rule 10b-5 prohibits the use of any "device, scheme or artifice to defraud... in connection with the purchase or sale of any security." (1) In the 1960s, the SEC began to allege that under certain circumstances, corporate insiders break the Rule by trading while in possession of material nonpublic information (MNPI). (2) Federal prosecutors followed suit, initiating criminal prosecutions by charging defendants with "willfully" violating Rule 10b-5. (3) Over time, the courts have grown a "judicial oak" to "flesh out" 10b-5 doctrine, (4) and with it, the ever-evolving ban on insider trading.

Few are content with the regime this paradigm has produced. The law of insider trading is "arbitrary," (5) "dysfunctional," (6) "ad hoc," (7) and "maddening." (8) The field "suffer[s] from uncertainty and ambiguity to a degree not seen in other areas of law." (9) Landmark holdings quicldy become the object of precedential ping-pong between the Second Circuit and the Supreme Court. (10) Statutory codification of judge-made rules is perennially proposed, but never enacted. (11) SEC regulations offer some clarity on the margins, but they explicitly avoid disturbing "[t]he law of insider trading [as] otherwise defined by judicial opinions." (12) And as litigation rages on, the ban on insider trading continues to engender serious, even fundamental doubts: whether it is good policy, whether its elements capture core instances of the offense, whether its common-law evolution comports with due process and the separation of powers, and whether it was ever duly enacted into federal law in the first place. (13)

Through it all, courts and commentators have situated the principal legal grounds for the offense within the domain of securities regulation. Because prosecutors mirrored the SEC and pursued the agency's theory of insider trading liability, the law's mode of analysis, its enforcement apparatus, and its substantive commands all arose in tandem with broader securities jurisprudence. Criminal insider trading, by construction, must track the elements and interpretive method of Rule 10b-5. The crime is, by historical accident, a creature of the securities laws.

This Note proposes that the path out of the quagmire is to abandon the securities-regulation model altogether. The law of insider trading, at a basic level, has little to do with the byzantine regulatory and statutory scheme governing public offerings, periodic disclosure, and private distributions. (14) It is far removed even from the rest of Rule 10b-5 litigation, (15) so much so that the major securities-regulation casebooks treat the topics "Rule 10b-5 Securities Fraud" and "Insider Trading" as distinct subjects warranting separate chapters. (16) Indeed, while the paradigmatic example involves an insider trading his corporation's securities, there is no obvious reason to categorically exempt the trading of commodity futures, spot currencies, precious metals, or any other assets outside the purview of the securities laws.

Rule 10b-5 doctrine, both in substance and in form, has masked and distorted the simple conceptual basis for insider trading law: the crime of embezzlement. (17) And embezzlement--the fraudulent appropriation of property entrusted to one's care--is already prohibited elsewhere under federal law. Title 18, the U.S. Criminal Code, imposes its own sweeping prohibitions on "scheme[s] ... to defraud." (18) Since well before the promulgation of Rule 10b-5, the Court has held that embezzlement is per se an act of fraud. (19) The object of embezzlement may be tangible or intangible property, including nonpublic information. (20) When an entrusted corporate insider appropriates confidential business information to her own use, then, she has executed a scheme to defraud. If she also triggers a statutory jurisdictional hook--often by using the mails (21) or wires (22)--she has committed a federal crime.

The Title 18 approach has long stood in Rule 10b-5's shadow. Prosecutors have often successfully supplemented criminal 10b-5 counts with embezzlement-as-fraud charges, (23) but the prevailing, securities-centric narrative has been that Title 18 insider trading liability for securities transactions is practically subsumed by Rule 10b-5. (24) On this account, Title 18 has little or no independent force, securities doctrine provides the dominant mode of analysis, and insider trading in securities markets is generally not prosecutable absent a violation of Rule 10b-5. This view has persisted even as Congress, through the Sarbanes-Oxley Act of 2002 (SOX), has added to Title 18 a ban on securities fraud, which mirrors the classic mail- and wire-fraud statutes. (25) Supposing that the statute merely duplicated 10b-5 "securities fraud," some scholars noted in passing that they could not "think of any reason for the use of this unnecessary Sarbanes-Oxley Act provision." (26)

The Second Circuit shattered this consensus in December 2019 with its ruling in United States v. Blaszczak. (27) Defendants, convicted of insider trading under the Title 18 fraud statutes, argued that a crucial 10b-5 instruction--that the insider must have received a "personal benefit"--had been impermissibly omitted from the jury charge. (28) The panel, however, disagreed. (29) It held that Title 18 fraud, unlike its traditional counterpart in the securities laws, has no personal-benefit requirement at all. (30) Insider trading under Title 18, per the court's logic, is not a mere parallel vehicle of criminal liability to the conventional one under the securities laws: it is a different offense altogether, with its own elements and its own distinct legal standards. (31)

After Blaszczak, several securities scholars decried a "siege" on settled law, (32) and the list of law-firm blogs raising concern over the case's implications reads as a "who's who" of the New York white-collar bar. (33) But consistent with the Second Circuit's personal-benefit holding in Blaszczak, this Note advances a model of Title 18 insider trading independent of the law of Rule 10b-5. I argue that a standalone theory of Title 18 insider trading is not only plausible--it helps explain where insider trading doctrine went astray, and how courts can realign it with its legal and conceptual foundations.

This Note has two central objectives. The first is to sketch a doctrinal framework for Title 18 insider trading liability. I show that each of the judge-made rules of 10b-5 case law is remarkably close to--but meaningfully different from--a well-established doctrinal concept in federal criminal law. (34) By operating in the Title 18 paradigm and casting insider trading as simple embezzlement (within federal jurisdiction) from a nonconsenting information owner, courts can cut some of the Gordian doctrinal knots, rooted in the path-dependent evolution of the securities laws, that have long plagued insider trading law. Under the Title 18 model, insider trading is no more connected to securities regulation than wire fraud is to telecommunications law. Predicate fields are relevant only for delimiting the scope of federal jurisdiction: Did a defendant transmit an interstate wire communication? (35) Did the scheme have a connection with a security? (36) The remaining elements of Title 18 fraud--roughly uniform across its several sections--set the substantive contours of the offense and define, with surprising clarity, the bounds of criminally proscribed insider trading.

The second task is to demonstrate that a shift to Title 18 is worth welcoming. It is no coincidence, I argue, that each of the Title 18 parallels to Rule 10b-5 is more coherent and deeply rooted in longstanding legal norms. Time and again, the courts' securities precedents have shown that when judges openly decide outcomes on policy grounds, hard cases make bad law. (37) More egregiously, in the realm of insider trading, judicial inventions have served as the basis for criminal convictions. The use of amorphous, extralegal criminal standards to imprison defendants should unite in opposition civil libertarians, criminal-defendant advocates, and interpretive textualists. (38) Title 18 restrains this criminal-law adventurism by tethering the offense to common-law fraud while avoiding the common-law creation of crimes. But because Title 18 marginally expands the elements of liability relative to Rule 10b-5, it clarifies the law without sacrificing the force of criminal sanctions. Prosecutors should be among its strongest advocates.

Insider trading doctrine is at sea, but it can and should be anchored to the law of fraud as federal crime. Part I critiques insider trading case law under Rule 10b-5. Part II outlines the "embezzlement within federal jurisdiction" theory...