Recent Developments In The Law Of Federal Property Fraud: It's A Long And Winding Road

In two recent high-profile decisions, Chastain v. United States and Johnson v. United States, the U.S. Court of Appeals for the Second Circuit reversed wire fraud convictions that were based on theories resembling insider trading.¹ In both cases, the government invoked the wire fraud statute, and not a securities fraud statute, because the products at issue (non-fungible tokens and spot foreign currency) were not securities. These cases mark the latest developments in a long-running, ongoing and sometimes head-spinning debate in the courts concerning the breadth of the federal property fraud statutes.

In Chastain, the court held that confidential business information obtained by an employee that lacks commercial value to the employer is not a "traditional property interest" under the wire fraud statute. This decision can be seen as a logical extension of United States v. Blaszczak, a Second Circuit decision from 2022, which held that confidential government information was not property for purposes of the federal fraud statutes because the information did not have commercial value to the government. The Chastain majority also criticized a different jury instruction administered by the district court'which permitted the jury to convict the defendant if he "conducted himself in a manner that departed from traditional notions of fundamental honesty and fair play in the general and business life of society"'as overbroad because this language would effectively criminalize almost any deceptive act.

In Johnson, the defendant was convicted of wire fraud based on alternative theories that: (a) he defrauded a trading counterparty of its "right to control" the use of its assets; and (b) he misappropriated confidential information from the counterparty. In a recent decision, the Second Circuit granted exceedingly rare coram nobis relief because, after the "right to control" theory was invalidated in Ciminelli v. United States, the evidence of misappropriation was too weak to sustain the conviction. The court emphasized that the misappropriation theory of fraud requires a "pre-existing fiduciary or quasi-fiduciary relationship" and proof of "control and dominance" over the alleged victim's affairs.

These decisions, which come from the nation's leading appellate court in the area of financial crime prosecutions, illustrate the ongoing challenges of imposing predictable and workable limitations so that the government does not have the power to jail people for aggressive or unethical business practices that do not amount to federal property fraud. They also highlight emerging lines of defense for individuals subject to prosecution under the federal property and securities fraud statutes.

However, even as the Second Circuit has pared back aspects of federal property fraud, the Supreme Court appears to have opened a new avenue of prosecutions in its recent decision in Kousisis v. United States, which approved the "fraudulent inducement" theory of federal property fraud.² Kousisis cuts against the grain of many other Supreme Court decisions in the past generation, each of which curtailed the scope of the federal fraud statutes to avoid sweeping criminalization of a wide range of deceptive acts. Although the implications of Kousisis remain to be seen, the newly-approved fraudulent inducement theory appears, on its face, to be potentially expansive.

Chastain: Commercial Value of Information and Rejection of Overbroad Jury Instructions

OpenSea is the largest marketplace for non-fungible tokens (NFTs), which are digital assets recorded and traded on the blockchain that are often associated with art, memorabilia and other media. Nathaniel Chastain, the head of product at OpenSea at the time, selected NFTs to be featured on the homepage of the website. An NFT featured on OpenSea's homepage typically would see higher demand in trading, resulting in increased value. Chastain, like other OpenSea employees, signed a confidentiality agreement covering information he learned through his employment. Chastain purchased several NFTs before they were featured on the website's front page, selling them after listing for a profit of approximately $57,000.

In 2022, the U.S. Attorney's Office for the Southern District of New York indicted Chastain for wire fraud and money laundering, but it did not allege a violation of the federal securities laws, thereby avoiding a requirement to prove that the NFTs he traded were securities. At trial, the prosecution contended that Chastain had misappropriated OpenSea's confidential business information by purchasing NFTs ahead of the public announcement of their listings. Chastain was convicted following a jury trial and sentenced to three months' imprisonment and three years of supervised release.

A divided panel of the Second Circuit vacated Chastain's conviction and remanded the case to the district court, holding that the jury had been erroneously instructed that it could find Chastain guilty of wire fraud if: (1) the information he allegedly misappropriated did not have economic value to OpenSea and (2) he "conducted himself in a manner that departed from the traditional notions of fundamental honesty and fair play in the general and business life of society."

Regarding the first jury instruction, the majority emphasized that the wire fraud statute covers only traditional property interests, and that not all confidential information qualifies as such.³ The majority adopted a narrow reading of the Supreme Court's seminal insider trading decision in Carpenter v. United States and held that a company's confidential business information is considered "property" for purposes of the wire fraud statute only if the information has economic value to the company.⁴ Although OpenSea's homepage selection process tended to affect the value of NFTs that were featured on the homepage, the selection process did not result in any revenue or other economic value for OpenSea, which simply collected a standard 2.5% commission on each NFT transaction.⁵ At trial, some OpenSea employees testified that the company could potentially suffer reputational harm if there were insider trading of featured NFTs, but the Second Circuit found that this was insufficient to constitute a property interest under the wire fraud statute.⁶

In its 2022 decision in Blaszczak, the Second Circuit vacated wire fraud convictions of defendants who misappropriated confidential government information from CMS, the federal agency that handles Medicare reimbursement, and then used the information to make profitable securities trades. In a prior appeal in 2019, the Second Circuit had affirmed the Blaszczak convictions, but three years later'after an intervening Supreme Court decision in Kelly v. United States'the government confessed error, and the Second Circuit vacated the convictions over a dissent from Judge Sullivan.⁷ The 2022 Blaszczak majority concluded that the government information at issue in the case did not constitute "property" under the wire fraud statute because "CMS is not a commercial entity; it does not sell, or offer for sale, a service or product" and because the disclosure of CMS's confidential information "has no direct impact on the government's fisc."⁸ Judge Sullivan wrote a strongly-worded dissent arguing that confidential information had long been recognized as "property" under the federal fraud statutes regardless of whether it had inherent commercial or economic value.⁹

With respect to the second challenged jury instruction'which invoked "traditional notions of fundamental honesty and fair play in the general and business life of society"'the majority traced the language back to appellate decisions from the 1960s and 1970s that were part of "'a federal, common-law fiduciary duty'" that was later invalidated in McNally v. United States.¹⁰ The Chastain majority was highly critical of this open-ended concept of a federal fiduciary duty, which it stated would risk a significant expansion of criminal liability for federal fraud: "If the wire fraud statute criminalized conduct that merely departed from traditional notions of fundamental honesty and fair play, 'almost any deceptive act could be criminal,'" a scenario that "would 'vastly expand[] federal jurisdiction without statutory authorization' by 'mak[ing] a federal crime of an almost limitless variety of deceptive actions traditionally left to state contract and tort law.'"¹¹ Although white collar defense lawyers will surely welcome this part of the Chastain opinion, it bears noting that Judge Cabranes in dissent expressed the view that the challenged jury instruction was consistent with longstanding circuit precedent.¹²

Johnson: Requirement of Strong Evidentiary Foundation for Misappropriation Theory

The Johnson case arose from a complex foreign exchange (FX) transaction that occurred in 2011. A British energy company, Cairn Energy, planned to sell an overseas subsidiary for approximately $4 billion and wished to convert the proceeds from U.S. dollars to British pounds sterling (GBP).¹³ After an extensive selection process led by Cairn's investment banker at Rothschild & Co., Cairn engaged HSBC to handle the transaction, which...