All fraud is wire fraud

The first two cases of insider trading on prediction markets will soon be headed to trial: the special forces soldier who bet on Maduro’s ouster and the Google engineer who bet on Google searches. 

Both have been charged with “wire fraud,” which makes it sound like they sent their trades to Polymarket by telegraph.

But the legal theory behind the charges is even more antiquated than Morse code. Before there was wire fraud, there was mail fraud. In 1872, Congress wrote the mail fraud statute into law, making it explicitly illegal to use the post office for "any scheme or artifice to defraud."

The wording of the law suggests that Congress was primarily concerned with protecting the integrity of the postal system. The statute was titled "Penalty for Misusing the Post-Office Establishment," for example, and it specified that punishment be proportionate to "the degree in which the abuse of the post office establishment enters as an instrument into such fraudulent scheme.” (A maximum penalty of $500 and/or 18 months imprisonment was stipulated.)

Federal prosecutors, however, had other ideas. They immediately used the statute to claim jurisdiction over cases that would otherwise have been the jurisdiction of State-level courts. If a “scheme to defraud” used the federal mail system, they reasoned, it was a federal crime. 

Some courts disagreed. These took a more narrow view of the statute, arguing that it applied only when the mails were central to the scheme. Some went further, arguing that the scheme had to threaten the integrity of the mail system itself.

Whatever its original intent, a liberal application of the law was undeniably useful.

With the economy rapidly modernizing after the Civil War, new forms of large-scale swindles, get-rich-quick schemes, and financial frauds proliferated. 19th-century criminal codes — designed for local considerations in rural societies and confined by state boundaries — were ill-suited to combat them. Faced with these limitations, judges usually agreed with prosecutors that federal intervention was necessary.

Congress eventually agreed, too. In 1909, it amended the mail fraud statute, eliminating the mail-emphasizing language that defendants used to argue that the law only applied when the post office was central to a scheme.

This freed federal prosecutors to claim jurisdiction whenever a fraud scheme touched the mail system, however incidentally.

The statute and its direct descendant — the wire fraud statute of 1952 — have been a favorite of prosecutors ever since.

“To federal prosecutors of white collar crime,” US district judge and legal historian Jed S. Rakoff once wrote, “the mail fraud statute is our Stradivarius, our Colt 45, our Louisville Slugger, our Cuisinart — and our true love.”

Prosecutors loved it because it was so versatile, adaptable, and expansive. The mail and then wire fraud statutes became the government’s first line of defense against virtually every new form of fraud to develop in the United States.

Often, it was the only line of defense.

“Where legislatures have sometimes been slow to enact specific prohibitory legislation,” Rakoff wrote, “the mail fraud statute has frequently represented the sole instrument of justice that could be wielded against the ever-innovative practitioners of deceit.”  

The innovation of insider trading via event contracts is a textbook example: insiders who trade on prediction markets are charged with wire fraud because event contracts do not obviously belong to any of the categories of fraud specifically prohibited by law.

There is no single category of “fraud” because fraud is surprisingly difficult to define. Where, for example, is the line between an exaggerated sales pitch and a fraudulent one?

The answer depends on context, so Congress has had to tackle the problem piecemeal, passing separate laws for bank fraud, securities fraud, commodities fraud, and other specific forms of deception.

Event contracts are not securities, so the Maduro and Google defendants cannot be charged with securities fraud.

They might, for legal purposes, be deemed a kind of commodity. But that hasn’t been established yet, so charging them with only commodities fraud would be risky for prosecutors.

As a result, both alleged insiders are charged with wire fraud — the catch-all category for any fraud not yet specifically criminalized by Congress. 

Will the charges stick?

It might depend on whether the non-public information the defendants traded on is deemed a form of property.

The wire fraud statute prohibits a "scheme or artifice to defraud," but never defines fraud itself. 

This creates a problem. If “fraud” is understood as any dishonest conduct, federal prosecutors could criminalize almost anything. Under-reporting your age on a dating site, say. Or claiming to make the world’s best cup of coffee.

The wire fraud statute needed a limiting principle. Over decades, the courts have supplied it: By precedent, the mail and wire fraud statutes protect property rights, not a general right to honest behavior. (Would that it could.)

It’s therefore central to the Maduro and Google cases that the insiders have been charged with misappropriating property: military secrets in the case of Maduro and search data in the case of Google.

Are these kinds of information really property? Are event contracts commodities? Do prediction markets deserve their own congressional statute?

The Maduro and Google cases may decide it.

Until then, a law designed to protect the integrity of the postal system remains the government's best tool for policing insider trading on the internet.

— Byron Gilliam