The U.S. Court of Appeals for the Second Circuit’s decision in U.S. v. Blaszczak may have just changed the landscape for insider trading prosecutions. In order to prove an insider trading charge under the Securities Exchange Act of 1934 (the “Exchange Act”), the government has to prove that an insider received some “personal benefit” from exchanging material, non-public information. This requirement comes from the 1983 U.S Supreme Court ruling in Dirks v. SEC.
Long after Dirks was decided, and in the aftermath of the 2001-2002 financial crisis, the Sarbanes Oxley Act of 2002 (“Sarbanes Oxley”) was passed, containing, among other things, prohibitions against securities fraud. Since then, prosecutors have used those securities fraud prohibitions, in conjunction with Exchange Act provisions, to prosecute defendants for insider trading. What was unclear, however, was whether the Exchange Act’s “personal benefit” requirement extended to insider trading prosecutions under Sarbanes Oxley. The Second Circuit has just ruled that it does not.
In declining to extend the personal benefit test to Sarbanes Oxley cases, the Second Circuit noted the personal benefit test can be found nowhere within the Exchange Act itself but was rather a judicial construct arising from the purpose of the Exchange Act, which was, as the Supreme Court explained in Dirks, to eliminate the use of inside information personal advantage. Sarbanes Oxley, on the other hand, was enacted specifically to broaden the scope of enforcement mechanisms available to prosecutors to address securities fraud. Accordingly, the Second Circuit reasoned, no basis for extending the personal benefit test to Sarbanes Oxley cases can be found in the statutory purpose.