Attorneys for two former hedge fund employees convicted on charges of securities and wire fraud have petitioned for an en banc rehearing of a divided Manhattan appeals court ruling that, they said, dramatically expanded the reach of federal criminal statutes and "upended" decades of settled insider-trading law.

In a filing with the U.S. Court of Appeals for the Second Circuit, attorneys from Munger, Tolles & Olson; Allen & Overy; Shapiro Arato Bach; and Kramer Levin Naftalis & Frankel argued that the panel decision defied U.S. Supreme Court precedent and raised issues of "exceptional importance" that warranted review by the full bench of the appellate court.

The joint petition, in the case United States v. Blaszczak, challenged the Dec. 30 panel ruling,  which upheld the convictions of a former federal employee, a hedge fund consultant and employees of a hedge fund who were charged with using confidential government information to boost revenues.

The case involved the leaking of confidential information by Christopher Worrall, a former CMS employee who was accused of passing nonpublic information to hedge fund consultant David Blaszczak. Prosecutors in the Manhattan U.S. Attorney's Office alleged that Blaszczak, who also used to work for CMS, then gave the materials to Robert Olan and Theodore Huber, two employees of health care-focused hedge fund Deerfield Management Co. who in turn made trades based on insider knowledge of CMS' regulatory actions.

Olan and Huber were both sentenced to three years in prison and ordered to pay $1.2 million in fines.

Olan is represented by Donald Verrilli Jr. and Elaine Goldenberg of Munger Tolles. Huber is represented in the case by Alexandra Shapiro of Shapiro Arato.

In a 2-1 decision, the court held that confidential information from the Centers for Medicare & Medicaid Services, an agency of the federal government, can be considered "property" for purposes of prosecuting securities and wire fraud, and ruled that prosecutors did not need to show the defendants obtained a "personal benefit" to convict them on charges of Title 18 securities fraud.

The joint petition for rehearing, filed on behalf of two ex-Deerfield employees, took aim at both of those conclusions, claiming that the Second Circuit's decision "vastly expands the scope of federal criminal law."

With regard to the first finding, the attorneys argued that regulatory information could not be considered property in the context of Title 18 securities fraud because it is neither the product of commercial competition nor sold as a commodity. To consider it such, they said, would also lead to "disturbing consequences" that could jeopardize whistleblowers and others trying to expose wrongdoing within the federal government.

"A whistleblower who reveals government malfeasance, a journalist who reports that revelation and a reformer who publicizes it would all be committing fraud and conversion," attorneys from Munger, Tolles; Allen & Overy; Shapiro Arato and Kramer Levin wrote in the 19-page filing.

"The carefully calibrated federal statutes penalizing disclosure of classified information in specific circumstances would become defunct, because the fraud and conversion statutes would now indiscriminately cover the same ground and more," they said.

Turning to the second issue, the attorneys argued that the Second Circuit's decision "sweeps away" four decades of precedent requiring prosecutors to establish a "personal benefit" in order to prove insider-trading fraud.

Historically, the filing said, no circuit court had defined insider-trading fraud under Title 18 and Title 15.

The panel, however, held that the personal benefit standard only applied to Title 15 securities fraud charges, finding that Title 18 "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."

The finding was crucial because both Olan and Huber were cleared by a jury on the Title 15 securities fraud charges due, at least in part, to the absence of a personal benefit. That meant, that had the Second Circuit decided that the personal benefit standard also applied to Title 18 securities fraud, there was a chance their convictions may have been thrown out.

The filing, however, warned of "crippling uncertainty" and potentially wide-ranging consequences should the decision be allowed to stand as the "law of this circuit."

"Market participants would risk criminal liability for securities trading that could not support a civil SEC enforcement action. And because almost every securities transaction touches New York, the decision would have nationwide consequences," the attorneys said.

 

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