Petition — Chiarella v. United States
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— Supreme Court, U,
poems | —FTEE D
In The FEB 2 1979
Supreme Court of the Wit Stat
}:
_ MICHAEL RODAK, JR., CLERK
October Term, 1978
No. (B= 1202
a
VINCENT F. CHIARELLA,
Petitioner,
-against-
UNITED STATES OF AMERICA,
Respondent.
PETITION FOR A WRIT OF CERTIORARI TO
THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
STANLEY S. ARKIN
Attorney for Petitioner
600 Third Avenue
New York, N.Y. LO0016
(212) 869-1450
ARKIN & ARISOHN, P.C.
MARK 8S. ARISOHN
Of Counsel
Printinghouse Press — Bar Ase’n Steno Serv. ( Appeals Section) 212-840-189)
a
TABLE OF CONTENTS
Opinions of the Courts Below. ..-..l
Jurisdiction of the Supreme Court. ie
Questions Presented for Review... . 3
Constitutional Provisions, Statutes
and Regulations Involved.-. ... .3
IN im en rr g
Statutes * . e * * 7. . . > 7. > > >. * 3
WOGOLOCI ONE 6a tds 8S i ok eB
Statement of the Case ........ 4
Reasons for Granting the Writ. ..../7
Point I - The Second Circuit's
Expansion of Section 10(b)
liability is without. precedent and
conflicts with its own prior
decisions, this court's decisions,
the rulings of other federal
courts and Congressional intent .
~J
Point II - The retroactive appli-
cation by the Court of Appeals of
its new and expansive interpreta-
tion of Section 10(b) and Rule
10b-5 to affirm petitioner's
conviction violates due process . .15
Point III - The Second Circuit's
holding that intent to defraud
is not an essential element of
Section 10(b) and Rule 10b-5 is
in direct conflict with Supreme
CE ee a ee ee te en eg ee ok
>
Point IV - The admission into
evidence of a damaging state-
ment--in effect a full con-
fession--petitioner made to
the New York State Department
of Labor as a prerequisite to
seeking unemployment benefits
violated a specific New York
statute proscribing the dis-
closure of such statements and
constituted reversible error. .
a ie Te i ae a ic
APPENDICES
Opinion cf the Court of
PNAS 0 Se Re eR
Opinion of the District
Court. * . . * * > > . . > . .
Constitutional Provisions,
Statutes and Regulations
SPOON ae ee ag tee
ii
PAGE
22
26
Bl
Cl
TABLE OF AUTHORITIES
CASES:
Affiliated Ute Citizens v.
United States, 406 U.S. 128
fs) PRE AS ORES oh Ret a ae eee
Andrews v. Cacchio, 264 Avp. Div.
791, 35 N.Y. Supp. 2d 259 (2d
a hs) ee oe ea ae a ee
Bouie v. City of Columbia, 378
WiSs “SOT AL9OS) 0 we ee ce
Connecticut Mutual Life Ins. Co.
v. Union Trust, 112 U.S. 250
CEBGA) ig Me es cnS ee ie ta Tere eis
Diamond v. Oreamuno, 24 N.Y. 2d
494, 248 N.E. 2d 910 (1969) ..
Ernst & Ernst v. Hochfelder, 425
eG et ky, > ee eee ee ker ee
Eston v..Backer, 119 N.Y. Supp.
2d 273 (Sup. Ct. Queens Co.
Re we ae ee ee at Se ee
Frigitemp Corp. v. Financial
Dynamics, Inc., 524 F. 2d 275
(2? Chr VLO7TE) 2) et ee ig er tens
Funk v. United States, 290 U.S.
eek Le ak a se ee eo SS
General Time Corp. v. Talley
Industries, Inc., 403 F. 2d
159 (2d Cir. 1968), cert.
denied, 393 U.S. 1026 (1969) -
Herman Brothers Pet Supply,
Inc. v. NLRB, 360 F. 2d 176
COE Chee 2OGE oie es be ee
iii
PAGE
13,14
23
16, 17
18,19
23
24
% 9 10,
11, 14, 18
24, 25
In re Reid, 155 F. 933 (D. Mich.
3906). + ewe Ee See
In re Valencia Condensed Milk
Co., 240 F. 310 (7th Cir. 1917).
In the Matter of Cady, Roberts
& Co., 40 S.E.C. 904 (1961). .
International Brotherhood of
Teamsters v. Daniel, ge wm
, 47 U.S.L.W. 4135 (Jan. 16,
1979). — > el * > J > .- > = > .
Kohler v. Kohler Co., 319 F. 2d
634 (7th Cis. BOG ie ios eer
Marks v. United States, 430 U.S.
LBD (E9771 os es ae eed
Mills v. Sarjem Corp.,
Supp. 753 (D. N.J. 195
uk
Ww.
ww
|
+
Pacific Insurance Co. of N.Y.
v. Blot, 267 F. Supp. 956
(3-B.8.8. 29GfE- 6 oe ae
Rabe v. Washington, 405 U.S.
SAS CSTR) eae ahi aan
Radiation Dynamics, Inc. v.
Goldmuntz, 464 F. 2d 876
(2@ Cis. 2072) 6 636 eae
Rewis v. United States, 401
oe oF 808 (1971) > . 7 7 — * on
Santa Fe Industries v. Green,
430 U.S.,462 (1977) 4. . 2 |.
Schein v. Chasen, 478 F. 2d
S17 (22 Cie. Alans 4
iv
PAGE
16
Ll
10
16
SEC v. Great American Industries,
Inec., 470 F. 2d 453 (2d Cir.
1968) (en banc), cert. denied,
ee a ee AO OTA CK otk er kX
SEC v. Texas Gulf Sulphur, 401
F. 2d 833 (2d Cir. 1968) (en
banc), cert. denied, 394 U.S.
me 8g sepa REL TORS IRR eae
Simpson v. Oil Transfer Corp., .
75 F. Supp. 819 (N.D.N.Y. 1948).
Speed v. Transamerica Corp., 99
F. Supp. 808 (D. Del. 1951). .
Strong v. Repide, 213 U.S. 419
(1909) 7 . o . 7 e . . - . . o ©
Tollefsen v. Phillips, 16 F.R.D.
346: (Dx ‘MAOOs- 1954) oe koe 8
United States. v. Charnay, 537
Py a6. oan. 09th Catt £978). e 2
United States v. Dixon, 536
Pu 2a L366 £24: Cirs..1976) 66628 8
United States v. Peltz, 433
F. 2d 48 (2d Cir. 1970), cert.
denied, 401 U.S. 955 (1971)...
United States v. United States
Gypsum Co., U.5.; > 98
ome eS COO eg Glew ce ile
Wolfe v. United States, 291
ea oe ee ea ge a yg
PAGE
Fe
25
22
21
a1).
18
24
CONSTITUTIONAL PROVISION:
Fifth Amendment.
STATUTES : \
p, tah
15 U.S.C. $783 (b).
15 U.S.C. §78f£F
Rvidence. gael tater
New York Labor Law,
REGULATIONS :
17 C.F.R. §240.10b-5 .
OTHER AUTHORITIES:
American Law Institute's Pro-
posed Offical Draft of the
Federal Securities Code, §1603
(1978) <0 sae st
Aranow, E.R., Einhorn, H.A., and
Berlstein, G., Developments in
Tender Offers for Corporate
Control, p. 20 (Columbia Univer-
sity Press, 1977)
Bromberg, A. Securities Law:
Fraud (1969, McGraw Hill,
§6.3 (622)...
8 Wigmore, Evidence §2377, pp.
780-781 (McNaughton Rev. 1961).
S. Rep. No. 1455 (1934); H. Rep.
No. 1383, (1934), 78 Cong. Rec.
7861-7862 (1934).
vi
Rule 501, Federal Rules of
§537
Inc.)
PAGE
passim, Cl
3). 4, C2
23, 24, C3
23, C3
passim, C4
12
12
25
- ;
IN THE
SUPREME COURT OF THE UNITED STATES
OCTOBER TERM, 1978
«<
VINCENT F. CHIARELLA Nees
Petitioner,
- against -
UNITED STATES OF AMERICA,
Respondent.
PETITION FOR A WRIT OF CERTIORARI TO.
THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
Vincent F, Chiarella, petitioner
herein, prays that a writ of certiorari
issue to review the judgment entered in
this criminal case on November 29, 1978
by the United States Court of Appeals for
the Second Circuit.
Opinions of the Courts Below
The opinion and errands of the
United States Court of Appeals for the
Second Circuit sought to be reviewed is
reproduced in Appendix A and is not yet
officially reported. The opinion of the
United States District Court for the Southern
District of New York (Owen, D.J.) is re-
produced’ in Appendix B and is published at
450 F. Supp. 95.
Jurisdiction of the Supreme Court
The judgment of the United States
Court of Appeals for the Second Circuit
was entered on November 29, 1978. Peti-
tioner's timely petition to the Second
Circuit for rehearing with a suggestion
for rehearing in banc was denied,on Jan-
uary 4, 1979. Title 28, Umited States
Code, Section 1254(1) and Rule 22(2) of
the United States Supreme Court Rules
confer jurisdiction on this Court to re-
view the judgment in question by a writ
of certiorari.
Questions Presented for Review
1. Does the purchaser of stock in
the open market who fails to disclose
material, nonpublic information about the
issuer of the stock violate Section 10(b)
of the Securities Exchange Act of 1934 and
Rule 10b-5 where the purchaser has no fid-
uciary relationship with the issuer and
where the information was ‘obtained from
and created by a source wholly outside
and unrelated to the issuer?
2. Does the Second Circuit's retro-
active application of its new and ex-
pansive interpretation of Section 10(b)
and Rule 10b-§ to sustain petitioner's
conviction violate the Due Process Clause
of the Fifth Amendment?
2
a
3. In a criminal case charging vio-
lations of Section 10(b) and Rule 10b-5,
did the trial court violate this Court's
holding in Ernst & Ernst v. Hochfelder by
refusing to instruct the jury that “intent
to defraud" was a requisite element of the
crime?
4. Did the trial court err in admitt-
ing into evidence at petitioner's federal
criminal trial a confidential statement -
in this case tantamount to a confession -
required to be made by petitioner to the
New York State Department of Labor as a
condition of seeking unemployment benefits
when New York law makes the statement
absolutely privileged from disclosure and
makes disclosure of that statement a
criminal act?
Constitutional Provisions, Statutes
And Regulations Involved
CONSTITUTION:
Fifth Amendment
STATUTES:
15 U.S.C. §783,(b)
15 U.S.C. §78££F (a)
Rule 501, Federal Rules
of Evidence
New York Labor Law, §537
REGULATIONS:
17 C.F.R. §240.10b-5
Each of the above is set forth in
Appendix C.
Statement of The Case
Introduction
The United States Court of Appeals
for the Second Circuit, in the context of
affirming petitioner's conviction, an-
nounced a new and drastically expansive
interpretation of Section 10(b) and Rule
10b-5. Departing from all prior law and
particularly its own decisional law, the
Second Circuit ruled that a trader's
regular access to market information,
irrespective of source, places him in a
special relationship with all buyers and
sellers with whom he deals and his failure
to disclose material nonpublic information
he obtains through such access and uses in
connection with his purchase of stock
violates §10(b) and Rule 10b-5.
Never before has there been a criminal
prosecution under §10(b) for the purchase
of a corporation's stock on the basis of
undisclosed material nonpublic information
even where the purchaser is an "insider"
of the corporation. Nor has there ever
been a litigation in which even civil
liability for nondisclosure has been im-
posed under §10(b) on anyone other than
an “insider," the “tippee" of an "insider"
or a trader whose information originated
inside the corporation whose shares are
traded.
Yet in this criminal case, with no
basis in prior law, the Second Circuit
enlarged the scope of §10(b) and then
retroactively found petitioner's conduct
to fall within the enlarged scope of the
statute. We submit that the Second Cir-
cuit's expansion of §10(b) is erroneous
4
and in conflict with all prior judicial
constructions cf §10(b) and this Court's
recent caveats that §10(b) is to be con-
strued narrowly. Moreover, the Court's
ex post facto application Qf its expansive
interpretation of §10(b) to affirm peti-
tioner's conviction violates due process.
Certiorari should be granted to re-
view the Second Circuit's departure from
prior law and its ex post facto applica-
tion of its new and expansive definition
of §10(b) liability in this important case
of first impression.
Statement of Essential Facts
Petitioner was employed as a “mark-
up man" in the composing room at Pandick
Press, a financial printing establishment
in New York City. During the course of
his employment in 1975 and 1976, petition-
er worked on setting into type “tender
offer" disclosure statements for Pandick's
customers--the tender offerors. In each
case relevant here, petitioner was able
to deduce the identity of the corporation
targeted for tz‘*eover (i.e., the “target")
from data disclosed in the type set
documents and by decoding the fictitious
target names used in preliminary drafts.
Petitioner then purchased shares of the
targets' stock.
After agreeing with the SEC in a
consent decree to disgorge his profits
to those who sold him target shares,
petitioner was fired by Pandick and then
indicted on 17 counts* charging viola-
*The 17 counts of the indictment represent
17 separate purchases of target stock made
by petitioner over the course of five
tender offers by five Pandick customers.
5
of §10(t)-and Rule 10b-5.
A pretrial motion to dismiss the
indictment upon the ground that the con-
duct alleged was not within the embrace
Of §10(b) and Rule 10b-5 because the
nonpublic information utilized originated
with the offeror corporations not the
target corporations and hence petitioner
was under no duty to disclose the informa-
tion to selling target shareholders was
denied in a written opinion (Appendix B).
Following trial in the United States
District Court for the Southern District
of New York before the Honorable Richard
Owen and a jury, petitioner was convicted
On all counts and sentenced to a term of
imprisonment of one year with all but
One month suspended on each of counts one
through thirteen, to run concurrently, and
to a term of probation of five years on
counts fourteen through seventeen.
On appeal to the United States Court
of Appeals for the Second Circuit, peti-
tioner again claimed that the conduct
charged did not fall within the scope of
§10(b) and Rule 10b-5. On November 29,
1978, a divided panel of the Second
Circuit (Kaufman, Ch. J. and Smith, J.;
and Meskill, J., dissenting) announced a
new and expansive interpretation of §10(b)
and Rule 10b-5 and, relying on its new
interpretation of §10(b) and Rule 10b-5,
affirmed petitioner's conviction
(Appendix A).
Petitioner's motion for rehearing
with a suggestion for rehearing in banc
was denied on January 4, 1979.
6
—
REASONS FOR GRANTING THE WRIT
POINT I
The Second Circuit's Expansion
of Section 10(b) Liability Is
Without Precedent and Conflicts
with Its Own Prior Decisions,
this Court's Decisions, the
Rulings of other Federal Courts
_ and Congressional Intent
Prior to the Second Circuit's opinion
in this case, the undeviating judicial
interpretation of the broad and generic
antifraud provisions of Section 10(b) and
Rule 10b-5 relating to "silence" was that
nondisclosure was not “fraud” in all
cases. It was settled law that liability
occurred only when such nondisclosure was
in breach of a duty to disclose arising
out of a fiduciary relationship between
the trader or the original source of the
information and the issuer. See, Stron
v. Repide, 213 U.S. 9 (1909); Frigitemp
Corp. v. Financial Dynamics, Inc., 524
F. rr 275, 282 (2d Cir. 1975); Schein
v. Chasen, 478 F. 2d 817, 823 (2d Cir.
, Vacated on other grounds, 416
U.S. 386 4); SEC v. Great American
Industries, Inc., 470 F. 2d 453, 460 (2d
Cir. 1968) (en banc), cert. denied, 395
U.S. 920 (1969); General Time Corp. v.
Talley Industries, Inc., 403 F. 2d 159,
164 a Cir. 1968), cert. denied, 393 U.S.
1026 (1969); Kohler v. Kohler Co., oe
F. 2d 634, 65 th Cir. 1963); Speed v.
Transamerica Corp., 99 F. Supp. 808, 828-
829 (D. Del. 1951); Diamond v. Oreamuno,
24 N.Y. 2d 494, 248. N.E. 2d 910 (1969);
In the Matter of Cady, Roberts & Co.,
40 S.E.C. 907 (1961).
7
all
»
The requirement of a nexus between
che trader, the information and the issuer
was first formulated by the SEC itself in
its seminal decision of Cady, Roberts & Co.,
40 S.E.C. 907, 912 (1961), was relied upon
by the Second Circuit en banc in the land-
Mark case Of SEC v. Texas Gulf Sulphur,
401 F. 2a 833, 848 (2d Cir. 1968) (on
banc), cert. denied, 394 U.S. 976 (195969)*,
and lies at the core of every nondisclosure
— decided under Section 10(b) and Rule
Ob-5.
So firmly entrenched is this require-
ment of a nexus between the trader, his
information and the issuer of the shares
traded that in 1972 the Second Circuit
wrote:
"The essential purpose of Rule
10b-5 as we have stated time and
again, is to prevent corporate
insiders and their tippees from
taking unfair advantage of the
uninformed outsiders." Radiation
Dynamics, Inc. v. Goldmuntz, 464
Food 876,850 d 876, 890 (2d Cir. 1972).
The legislative history of §10(b)
*Interestingly, in opposing certiorari in
SEC v. Texas Gulf Sulphur, supra, the SEC
itself acknowledged that the duty to dis-
Close arises out of the fiduciary obliga-
ticn a corporate “insider” owes the
corporation's shareholders. (See Brief
for the SEC in opposition to petition for
a writ of certiorari in Coates v. SEC,
No. 68-897, p. 17).
8
6
too makes it clear that only nondisclosure
in breach of a duty to disclose arising out
of a relationship between the trader or the
source of information and the issuer of the
shares traded violates §10(b). See, S. Rep.
No. 1455, 73d Cong., 2d Sess. (1934), pp.
55, 67-68; H. Rep. No. 1383, 73d Cong., 2d.
Sess. (1934), pp. 5-6, 11, 13; 78 Cong.
Rec. 7861-7862, 8037, 8038 (1934). See
also the American Law Institute's Proposed
Official Draft of the Federal Securities
Code, §1603 (1978).
The facts in this case are undisputed
that petitioner had no relationship what-
ever with the issuer corporations (i.e.,
targets) and that his information was
derived from a source wholly outside the
issuer, namely the offeror corporations
which created the information. Thus,
petitioner owed no duty of disclosure to -
the issuers’ shareholders who sold him
their shares in the open market because
his purchases were based on information
obtained from outside the issuer and not
by virtue of exploiting any relationships
with the issuer.
It is for exactly the same reason
that the Second Circuit and other courts
have held that the common practice of open
market purchase by a prospective tender
offeror of shares of target stock without
disclosure of the impending tender offer
is not a Rule 10b-5 violation.
In General Time Corp. v. Talle
Industries, Inc., 403 F. 2d 159 (2d Cir.
1968), cert. denied, 393 U.S. 1026 (1969),
Talley Industries acquired shares of
General Time Corp. on the open market
without disclosing its plan for a merger
with General Time “whose terms might be
more favorable than the price paid for
{)
the stock being acquired." The Second
Circuit held that there was no violation
of Rule 10b-5 because the purchaser of the
shares was not utilizing information of and
had no fiduciary relation with the target-
issues. Judge Friendly wrete as follows
(id., 403 F. 2d, at 164):
"We know of no rule of law...
that a purchaser of stock, who was
not an ‘insider’ and had no fidu-
Ciary relation to a prospective
seller, had any obligation to re-
veal circumstances that might
raise a seller's demands and thus
abort the sale. ...."*
Similarly, in Pacific Insurance Co.
of N.Y. v. Blot, 267 F. Supp. 956, 957,
n. 2 (S.D.N.Y. 1967), Judge Herlands
stated:
"The Court entertains grave doubt
whether the alleged failure by the
defendant, an ‘outsider,' to dis-
close to selling shareholders the
impending tender offer...
constitutes a violation of Rule
10b-5."
*The Circuit's panel majority found .
petitioner's reliance on General Time
Corp. v. Talley Industries, Inc., supra -
a case we submit is dispositive on the
issue herein--to be “ironic" and "mis-
used" (Appendix A, p. Al2) because
purchases of target shares by a tender
offeror is accompanied by economic risk
whereas petitioner, the offeror's tippee,
took "no economic risk whatsoever" (id.).
10
ee
a. ar +
And in Mills v. Sarjem Corp., 133 F. Supp.
753, 764-765 (D. re EDF the court
wrote:
“The cases imposing a duty on the
part of a purchaser of shares of
stock to disclose his knowledge
of future prospects and plans
all involve situations where the
purchaser holds a fiduciary
(ftn. contd.)
Assuming arguendo that such a definitive
difference in risk taking exists, there is
simply no authority whatever for the
proposition that the degree of risk assumed
by a trader trading on the basis of material,
nonpublic information is at all relevant to
distinguish between noncriminal conduct and
felonious conduct.
The majority also sought to distinguish
General Time by the fact that petitioner's
use Of information he obtained from tender
offerors was in “violation of his duties
as an agent" (Appendix A, p. Al3) whereas
Talley's purchase of General Time shares
was based on information Talley itself
created. The distinction, however, is
legally impotent. This Court has speci-
fically held that Rule 10b-5 violations
are not made out by "all breaches of
fiduciary duty in connection with a se-
curities transaction." Santa Fe Industries
v. Green, 430 U.S. 462, 472 (1977).
11
position and where the knowledge | without incurring an affirmative
has been obtained by virtue of an | duty to disclose. And if he can-
'insider' position." | not disclose, [footnote omitted]
| he must abstain from buying or
The treatises on the federal securi- | selling." (Emphasis in the original.)
ties laws also teach that the common . hate | ee
practice of a prospective offeror making | Reliance by the majority on Affiliated
Open market purchases of target shares | Ute Citizens v. United States, 406 U.S.
without disclosing an impending tender | 128° (1972), for creation of its new cate-
offer is not a Rule 10b-5 violation. See, | gory of potential 10b-5 violators--"market
Bromberg, A. Securities Law: Fraud (1969, insiders"--is misplaced. In Affiliated
McGraw Hill, Inc.), §6.3 (622); Aranow, ' Ute a bank and its employees, acting as
E.R., Einhorn, H.A., and Berlstein, G., transfer agent for selling shareholders,
Developments in Tender Offers for Corporate . became market makers who were active in
Control, p. 20 (Columbia University Press, ) encouraging a market for the shareholders'
1977). stock. They devised a plan and induced
4 holders of the stock to dispose of their
The Second Circuit rejected this long | shares without disclosing the market con-
and well recognized line of authority as | ditions of which they were aware and which,
"irrelevant" (Appendix A, p. A6), failed in fact, they had created. The Supreme
§10(b) is not to be interpreted expansively | between transfer agent and selling share-
(International Brotherhood of Teamsters v. holders imposed an affirmative duty to
Daniel, U.8.. » 47 Ucwoueee SLae, 4156 disclose and failure to do so was in con-
Tan. 16, 1979); Santa Fe Industries v. travention of Section 10(b) and Rule 10b-5.
Green, 430 U.S. 462, 472, 480 (1977); . But this Court flatly rejected the concept
Ernst & Ernst v. Hochfelder, 425 U.S. 185 ) underpinning the majority's opinion here
197, 199, and n. 19 (1976), and, in the that regular access to market information
context of this criminal case, without : alone imposes a duty to disclose. Despite
precedent, formulated the new concept of : access by the bank and its employees to
"market insider" (Appendix A, p. A7-A8) market information due to their position
and relied on that concept to affirm. The : as transfer agent, the Supreme Court
majority's new and expansive rule for non- BS acknowledged that ". . - if the [bank and
disclosure liability under Section 10(b) its employees] had functioned merely as a
and Rule 10b-5 is as follows (Appendix transfer agent, there would have been no
A, p. A8): duty of disclosure here.“* (Emphasis supplied.)
1
"Anyone--corporate insider or j
not--who regularly receives ‘
material nonpublic informa- ) *This basic distinction was recognized
tion may not use that informa- ; by Judge Meskill in his dissent (Appendix
tion to trade in securities i A, Pp. A28-A29);
13
12
_*
Until the instant case it was settled
law that conduct identical to petitioner's
did not even amount to a civil breach of
Rule 10b-5. General Time Corp. v. Talley
Industries, Inc., supra. It is cruel,
illogical and senseless to impose 17
felony convictions on petitioner for non-
disclosure of information when, in a civil
context, his "tippers"--the offeror
corporations--are free not to disclose.
Certiorari should be granted to review
the Second Circuit's departure from prior
law and its new and expansive definition
in the context of a criminal case of the
scope of nondisclosure liability under
§10(b) and Rule 10b-5.
(ft. contd.)
“Thus, it was not the bank's
Clearly superior, regular access
to market information . . . but
its actions in undertaking to act
for the sellers that rendered its
Silence equivalent to a scheme
to defraud the selling shareholders.
Chiarella certainly did not under-
take to act for the sellers of the
target stock nor did he enter the
type of svecial relationship with
them which was determinative in
Affiliated Ute." (Emphasis
supplied.)
14
Ce a a
POINT II
The Retroactive Application
by the Court of Appeals of
its New and Expansive Interpre-
tation of Section 10(b) and Rule
10b-5 to Affirm Petitioner's
Conviction Violates Due Process
The Second Circuit's new and expansive
interpretation of §10(b) and Rule 10b-5 non-
disclosure tiability is without precedent and
conflicts with all prior judicial inter-
pretations of the statute and rule (see
Point I, supra.) The Court of Appeals'
unprecedented expansion of nondisclosure
liability abandoning the well entrenched
and commonly understood sine qua non for
10b-5 nondisclosure liability, to wit,
that the information utilized by the trader
originate “inside” the corporation whose
shares are traded, is not the sole or even
principal injustice in this case. Rather,
the vice lies in the use by the Court of
Appeals of its new definition of liability
(regardless of whether right. or wrong as
a matter cf law or policy) after the fact
to affirm a criminal conviction.
Dissenting from the panel majority
Opinion, Judge Meskill was "alarmed" by
the Court's disregard of the fair notice
requirement so fundamental to the concept
of due process and wrote (Appendix A, p.
A23):
"Today's decision expands §10(b)
drastically, it does so without
clear indication in prior law
that this is the next logical
step on the path of judicial
15
development of §10(b), and
alarmingly, it does so in the
context of a criminal case."
Although the panel majority gave lip
service to the fundamental tenet that a
criminal conviction cannot be upheld un-
less "a clear and definite statement of
the conduct proscribed antedate[s] the
actions alleged to he criminal" (Appendix
A, p. Al5), it cavalierly termed "irrele-
vant" the prior "clear and definite" state-
ment of precisely what circumstances
trigger Section 10(b) nondisclosure
liability and defined a new and expansive
triggering circumstance. Such judicial
erasure of previously drawn and con-
Ssistently adhered to lines defining the
perimeter of a broadly generic statute
and rule and the imposition of new lines
expanding that perimeter to include a
defendant's conduct after the fact runs
afoul of the most fundamental notions of
due process. See Marks v. United States,
439 U.S. 188, (1977); Rabe v. Washington,
405 U.S. 313 (1972); Bouie v. City of
Columbia, 378 U.S. 347 (1964).
In Bouie v. Citv of Columbia, supra,
Gefendants were convicted under a South
Carolina statute prohibiting trespass--
the entry on the premises of another after
receiving notice not to enter. The South
Carolina Supreme Court affirmed the con-
victions by interpreting the trespass
statute to cover the act of remaining
on the premises of another after receiving
notice to leave. This Court reversed the °
convictions and held that the retroactive
application of a new and expansive judicial
interpretation of a criminal statute vio-
lated due process. Mr. Justice Brennan
16
aarp
oo ee 8,
wrote (id., 378 U.S., at 352-354):
"There can be no doubt that a
deprivation of the right of
fair warning can result not
only from vague statutory
language but also from an
unfcreseeable and retroactive
judicial expansion of narrow and
precise statutory language.... [A]n
unforeseeable judicial enlargement
of a criminal statute, applied retro-
actively, Operates precisely like an
ex post facto law, such as Art I
§10, of the Constitution forbids....
If a state legislature is barred by
the Ex post Facto Clause from passing
such a law, it must follow that a
State Supreme Court is barred by
the Due Process Clause from achiev-
ing precisely the same result by
judicial construction." (Emphasis
supplied.)
The fact that Section 10(b) and Rule
10b-5 are broadly generic in scope imposing
"indefinite and uncertain disclosure obliga-
tions" (International Brotherhood of Teamsters
v. Daniel, U.S. , 47 U.S.L.W. 4135,
4139, [Jan. 16, 1979]) makes retroactive
judicial expansion that much more dangerous.
Indeed, this Court has repeatedly warned
against judicial expansion of the scope
of liability under §10(b) and Rule 10b-5
in the context of civil lawsuits.
International Brotherhood of Teamsters
v. Daniel, supra, 47 U.S.L.W., at 4136,
Santa Fe Industries v. Green, 430 U.S.
462, 472, 489 (1977); Ernst & Ernst v.
Hochfelder, 425 U.S. 185, 197, 19S, and
n.19 (1976). Surely in the context of
a criminal case where penal statutes must
17
be strictly construed in favor of an
accused (United States v. United States
Gypsum Co., _U.S.__, 98 S.Ct. 2864, 2873
ris78Ts Rewis v. United States, 401 U.S.
808, 812 [1971]), judicial expansion of
the scope of liability is particularly
offensive to due process. And in the case
at bar this is especially true since the
Second Circuit had previously interpreted
§10(b) and Rule 10b-5 as not embracing
the very conduct charged against petitioner.
See General Time Corp. v. Tally Industries,
403 F.2d 159, 164 (2d Cir. 1968), cert.
denied, 393 U.S. 1026 (1969).
The Court of Appeals panel majority
relied on signs posted by Pandick warning
its employees against the use of confid-
entjial informaton and the possibility of
criminal liability and several civil
consent decrees settling SEC lawsuits for
the proposition that petitioner "manifestly
had adequate notice that his trading in
target stock could subject him to criminal
liability" (Appendix A, p. Al5). But any
notice obtained from Pandick's or its
lawyer's views of what the law "could be
or from an enforcement agency's commence-
ment of civil lawsuits and acceptance of
civil settlements with no litigation is
"manifestly" not the notice and predict- -
ability due process requires.
In Boule, supra, this Court rejected
the contention that defendants had had
adequate notice of the violation because
of a chain with a "no trespassing” sign
attached had been placed on the premises
by an employee of the owner (id., 378
G.§.: 347; °355,,'.n.5)
18
"The determination whether a
criminal statute provides fair
«Warning of its prohibitions
must be made on the basis of
the statute itself and the
other pertinent law, rather
than on the basis of an ad hoc
appraisal of the subjective
expectations of particular
defendants."
And with respect to the SEC's view
of the law this Court has on a number of
recent occasions rejected the SEC's
interpretation of various provisions of
the Securities Act. See, International
Brotherhood of Teamsters v. ~ Daniel, supra,
47 U.S.L.W., at 4138, and cases cited in
Rs) ‘£0%
The absence of the "clear and definite
statement of law antedating petitioner's
1975 and 1976 conduct required by due
process is conceded by Chief Judge
Kaufman's cwn telling language (Appendix
A, Pe ALT, Me LE)}2
"The sign merely informed appellant
of the SEC's view of the law--a
view we today hold was correct."
(Emohasis supplied.)
But a holding of first impression
over vigorous dissent and in conflict
with all prior judicial authority inter-
preting Section 10(b) that an enforcement
agency's "view of the law. . . was correct”:
simply cannot, consistent with due process,
serve to justify the affirmance of peti-
tioner's conviction.
19
Certiorari should be granted to
correct the serious due process violations
arising from the Second Circuit's ex post
facto expansion of §10(b) and Rule Il0b-
nondisclosure liability.
20
a a
POINT III
The Second Circuit's Holding
that Intent to Defraud Is Not
an Essential Element of Sec-
tion 10(b) and Rule 10b-5 Is
In Direct Conflict With Sup-
reme Court Law
Despite the unambiguous holding of
Ernst & Ernst v. Hochfelder, 425,U.S. 185,
Id3° (1976), that in an action charging Sec-
tion 10(b) and Rule 105-5 violations it is
necessary to plead and prove "'scienter'--
intent to deceive, manipulate, or defraud,”
the Second Circuit concluded that "Judge
Owen correctly refused to charge the jury
that the Government must prove specific
intent to defraud" (Appendix A, p. A20).
The Circuit's reliance on United States v.
Peltz, 433 F. 2d 48 (2d Cir. I570), cert.
denied, 401 U.S. 955 (1971) and United
States v. Dixon, 536 F. 2d 1388 (2d Cir.
1976) to support its holding is erroneous
in that those cases had nothing to do with
the requisite mental element of Section
10(b) and Rule 10b-5 but dealt with the
general penalty provision of the 1934 Act,
Section 32(a).
The trial court's error in charging
the jury was that it permitted the jury to
find that "willfulness" under Section 32 (a)
and the Peltz and Dixon formulation of "a
realization of wrongful conduct" satisfied
the scienter requirement of §10(b) and Rule
10b-5 and failed and refused to charge
"intent to defraud" as an essential and
distinct element necessary to sustain a
21
charge of violating that section and Rule.*
Certiorari should x granted to review
the Second Circuit's refusal to follow
Supreme Court law on the important issue of
scienter in, §10(b) cases and especially in
this criminal case.
POINT IV
The Admission into Evidence al
of a Damaging Statement--in , Pd
Effect a Full Confession--
Petitioner Made to the New
York State Department of
Labor as a Prerequisite to
Seeking Unemployment Benefits
Violated a Specific New York
Statute Proscribing the Dis-
closure of Such Statements
and Constituted Reversible
Error
Over strenuous defense objection the
trial court admitted into evidence a state-
ment made by petitioner to the New York
Department of Labor setting forth his view
of the reasons for his having been termi-
nated from employment as a printer at
Pandick Press. The statement, tantamount
to a confession in this case, was required
*Insofar as United States v. Charnay, 537
F. 2d 341 (9th Cir. 1976) can be read for
the proposition that "awareness of wrong-
doing" satisfies the scienter requirement
of Section 10(b) the case directly con-
flicts with Hochfelder.
22
by law to be made by petitioner in con-
nection with the processing of his appeal
-from an initial denial of unemployment
benefits. Petitioner, promised by the
state before he spoke that his statement
would not be released under any circun-
stances, told the Department of Labor:
"I was discharged for violations
of the company rules re: dis-
closure of client information.
The allegation is true. It was
a matter of printing of stock
tender offers and I utilized
the information for myself...."
The Department of Labor's promise of
confidentiality was mandated by New York
State law. Section 537 of New York's
Labor Law specifically and absolutely pro-
hibits the disclosure of information the
Department of Labor acquires from employers
or employees pursuant to enforcing the un-
employment insurance iaw. (N.Y. Labor Law,
§537[1]) (see Appendix C). Indeed, the
public policy underlying the nondisclosure
provision was regarded so seriously by the
legislature that violation of the provision
was made a criminal offense (N.Y. Labor Law,
§537[2]) (see Appendix C). And the case
law establishes that the statutory nondis-
closure provision is mandatory. See, Simpson
v. Oil Transfer Corp., 75 F. Supp. 819
N.D.N.Y. 1948); Andrews v. Cacchio, 264
App. Div. 791, 35 N.Y. Supp. 2d 259 (2a
Dept. 1942); Eston v. Backer, 119 N.Y.
Supp. 2d 273 (Sup. Ct. Queens Co. 1953).
The admissibility in a federal criminal
trial of a statement absolutely privileged
from disclosure under state law is governed
by Rule 501 of the Federal Rules of
23
Evidence. That rule, in relevant part,
provides:
"Except as otherwise . .. pro-
vided by Act of Congress. . .
the privilege of a .. . person
. »« « Shall be governed by the
principles of the common law as
they may be interpreted by the
courts of the United States in
the light of reason and ex-
perience."
See also, Wolfe v. United States, 291
U.S. 7 (1934); Funk v. United States, 290
U.S. 371 (1933).
As originally promulgated by the Sup-
reme Court the Federal Rules of Evidence
incorporated 13 specific rules of privilege.
Though not adopted by Congress the specific
rules (Supreme Court Standards) reflect the
Supreme Court's view of the law of privilege
as applied in the federal courts and is
powerful authority that the rules of pri-
vilege stem from "principles of common law
as interpreted by the courts of the United
States in the light of reason and experience.
One of the Supreme Court rules of
privilege mandates that a statement of the
type made by petitioner is privileged from
disclosure in federal court. Supreme Court
Standard 502* provides, in relevant part,
*Federal case law compellingly supports the
view that Supreme Court Standard 502 accura-
tely states federal common law. See, Con-
necticut Mutual Life Ins. Co. v. Union
Trust, 112 U.S. 250 (1884); Herman Brothers
24
as follows:
"A person. . . making a return
or report required by law to be
made has a privilege to refuse
to disclose and to prevent any
other person from disclosing
the return or report, if the
law requiring it to be made
so provides."
The rule of privilege clearly applies
to petitioner's statement to the New York
Department of Labor "required by law to be
made" which law also prohibits its dis-
closure.
Certiorari should be granted to correct
this important evidentiary error and the
trial court's failure to accord the modicum
of comity due the state's laws by the
federal system.
(ftn. contd.)
Pet Surety Inc. v. NLRB, 360 F. 2a 176
(6th Cir. 1966); In re Valencia Condensed
Milk Co., 240 F. 310 (7th Cir. I917);
Tollefsen v. Phillips, 16 FRD 348 (D. Mass.
In re Reid, 155 F. 933 (D. Mich.
1906); 8 Wigmore, Evidence §2377, pp. 780-
781 (McNaughton Rev. 1961). ;
25
CONCLUSION
For the reasons stated herein, this
petition for a writ of certiorari should
- be granted.
Respectfully submitted,
ARKIN & ARISOHN p.c.
“Attorneys for Petitioner ‘
Vincent Chiarella
600 Third Avenue iy
New York, New York 10016
(212) 869-1450 |
|
Stanley S. Arkin
Mark S. Arisohn
Of Counsel
APPENDIX A
26
UNITED STATES COURT OF APPEALS
For tHE Seconp Crecvuit
No. 137—August Term, 1978.
(Argned October 3, 1978 Decided November 29, 1978.)
Docket No. 78-1201
a>.
-
Unitep Srates or AMERICA,
' Appellee,
——_Y —
Viscent F. Cararevwa,
Defendant-Appellant.
Before: :
Kaurmay, Chief Judge,
Smrrnx and Mesxriii, Circuit Judges.
a>.
.
Appeal from a conviction, after.a jury trial, in the
United States District Court for the Southern District of
New York, Richard Owen, District Judge, for willfully
_ misusing material nonpublic information in connection with
the purchase and sale of securities, in violation of §§ 10(b)
and 32(a) of the Securities Exchange Act of 1934, 15 U.S.C.
§§ 78j(b), T8ff(a), and Rule 10b-5.
Affirmed.
Sm
e
Stantey S. Arxry, New York, New York (Arkin
Arisohn & Cross P.C., Mark S. Arisohn, Lee
Cross, of counsei), for Defendant-Appel-
lant.
395
Al
¢
Joun S. Srrrert, Assistant United States At-
torney, Southern District of New York
(Robert B. Fiske, Jr., United States Attor-
ney, Richard D. Weinberg, Assistant United
States Attorney, of counsel), for Appellee. -
\
Kavurman, Chief Judge:
The draftsmen of our nation’s securities laws, rejecting
the philosophy of caveat emptor, created a system provid-
ing equal access to the information necessary for reasoned
and intelligent investment decisions. It is apodictic that
betting on a “sure thing’ is anathema to the ideal of “fair
and honest markets” established as the foundation of this.
statutory edifice: The present case requires us to apply
these principles in the context of a criminal prosecution
for trading on advance knowledge of stock market events.
Vincent Chiarella used confidential information obtained
through his job in a financial printing house to anticipate
impending tender offers. He bought cheap and, soon after,
sold dear. For these activities, he stands convicted of will-
fully violating $10(b) of the Securities Exchange Act of
1934 and Rule 10b-5. On appeal, he contends that his opera-
tions, hoy ever nefarious, do not fit the statutory definition
of criminal conduct and, moreover, that the trial judge
erred in instructing the jury on the crucial’issue of intent.
He also challenges numerous other aspects of Judge Owen’s
charge and a host of his rulings on evidentiary matters.
We affirm.
4
Hostile tender offers are the high drama of Wall Street,
but they have their tedious aspects. Chief among the latter
1 Securities Exchange Act of 1934 $2, 15 U.S.C. §73b.
396
A2
is the vast amount of paper they generate even before the
offer is made. Offering and transmittal letters, newspaper
announcements, and disclosure statements to be filed in
Washington must be prepared before the offeror may in-
vite tenders. These documents are produced by the spe-
cialized printing firms that cluster around our centers of
finance.
Appellant was a “markup man” in the composing room
of one such establishment, Pandick Press. Located in down-
town Manhattan, Pandick was readily accessible to law
firms and banking houses. When copy from a customer
arrived in the shop, it went first to Chiarella. He selected
type fonts and page layouts and then passed the manu-
script on to be set into type.
Between September 1975 and November 1976, in addition
to preparing more mundane documents such as annual
reports and proxy statements, Chiarella handlec the raw
material for five separate takeover bids.* To preserve
confidentiality for as long as possible—and, most particu-
larly, to avoid an anticipatory rise in the market price of
the target company’s stock should news of the impending
tender offer become public—the type was initially set with
certain vital informatiox absent or in code. Thus, when
Emhart Corp. sought to purchase control of USM Corp.,
the documents originally delivered to Pandick reed
“Arabia Corp.” and “USA Corp.” Not until the final press
run on the night before release were the true names in-
serted.
The lawyers and investment bankers who coded the docu-
ment, however, reckoned without Chiarella, Appellant was
3 Four of the transactions were in fact tender offers and one was a
merger. The record ia unclear which, if any, of the takeover bids were
“hostile” in the serse that they were opposed by the target’s manace-
ment. The parties have not treated either distinction as significant.
397
A3
not merely an ordinary printer, but a knowledgeable stock
trader who spoke with his broker as often as ten or fifteen
times a day. In each of the five cases, he was able to deduce
the name of the target company from other information in
the documents—price histories, par values, and the number
of letters in the mock corporate names. Then, disregarding
notices posted throughout Pandick that use of customer in-
formation for personal gain was both illegal and against
company rules, he would call his broker and buy shares of
the target’s stock.
Of course, when each tender offer was publicly an-
nounced, the market price of Chiarella’s recently purchased
shares increased sharply. Chiarella quickly sold out and
turned a handsome profit. In the Emhart tender offer, for
example, Emhart’s lawyers brought the first set of docu-
ment to Pandick on September 3, 1975. By September 5,
Chiarella had concluded that “Arabia” was Emhart and
“USA” was USM. On that day, he bought 200 shares of
USM common stock for his own account and 100 shares
for his father’s. On September 9, after the tender offer
was announced, he sold all the stock at a profit of $1019.11.
Over the five takeover bids covered by the indictment,
Chiarella netted more than $30,000.'
3
Purchases
Target Offeror Shares Date Date Sold Profit
USM Emhart 300 9/ 5/75 9/ 9/75 $ 1,019.11
Riviana
Foods Colgate- 2/ 5/76 to 2/26/76 to
(Merger) Palmolive 2300 2/10/76 3/16/76 $ 8,948.55
* FoodTown Delhaize 10/21/76 to
Stores Freres 1100 10/11/76 12/ 1/76 $ 2,990.30
Booth Times- ‘
Newspapers Mirror 100 10/21/76 10/22/76 3 914.56
Sprague General
Electric Cable 3200 11/10/76 11/15/76 $16,138.87
: Toran Prortr: $30,011.39
398
A4
Unfortunately for Chiarella, this “sure bet” did nct last
forever. In early 1977, the SEC initiated an investigation
into Chiarella’s activities. In May, he agreed in a consent
decree to disgorge his profits to those who had sold him
target stock* and, the same day, was discharged by Pandick.
Finally, on January 4, 1978, he was indicted cn seventeen
counts of willful misuse of material® nonpublic information
in connection with the purchase and sale of securities, pur-
portedly in violation of $10{b) and Rule 10b-5.° After
moving unsuccessfully to dismiss theyindictment on the
4 SEC v. Chiarella, No. 77 Civ. 2534 (GLG) (S.D.N.Y. May 24, 1977).
5 The information concerning the impending tender offers was stipu-
lated to be material.
3 The indictment was brought under § 32(a), the penalty provision of
the 1934 Act, 15 U.S.C. § 78ff(a):
Any person who willfully violates any provision of this chapter
(other than section 78dd-1 of this title), or any rule or. regulation
thereunder the violation of which is made unlawful or the observance
of which is required under the terms of this chapter, or any person
who willfully and knowingly makes, or causes to be made, any state-
ment in any application, report, or document required to be dled
under this chapter or any rule or regulation thereunder or any
undertaking contained in a registration statement 2s provided in
subsection (d) of section 780 of this title or by any self-regulatory
organization in connection with an application for membership or
participation therein or to beeome associated with a tnember thereof,
which statement was false or misleading with respect to any ma-
terial fact, shall upon conviction be fined not more than $10,000, or
imprisoned not more than five years, or both, except that when such
person is an exchange, a fine not exceeding $500,000 may he imposed;
but no person shall be subject to imprisonment under this section for
the violation of any rule or regulation if he proves that he had no
knowledge of such ruie or regulation.
Chiarella made seventcen separate purchases of target stock over the
course of the five takeover bids. Each count of the indictment repre-
sents a confirmation slip mailed to appellant by his broker foilowing a
telephoned buy order. These mailings were sufficient to invoke federal
jurisdiction under the securities Jaws. Little v. Tnited States, 331 F.2d
287, 292 (Sth Cir. 1964); Mathews, Criminal Prosecution Under the
Federal Securities Laws and Related Statutes, 39 G.W.L. Rev. 901,
921-22 (1971).
399
AS
ground that it did not charge a crime, he was convitted
by the jury on every count.’ This appeal followed.
II.
Chiarella admits to the activities outlined above. He
recognizes, moreover, that since SEC v, Texas Gulf Sulphur
Co., 401 F.2d 833 (2d Cir. 1968) (en banc), cert. denied,
394 U.S. 976 (1969), it has been black letter law that
anyone in possession of material inside information
must either disclose it to the investing public, or, if he
is disabled from disclosing it in order to protect a
corporate confidence, or he chooses not to do so, must
abstain from trading in or recommending the securi-
ties concerned while such inside information remains
undisclosed. Id. at 848.
But because he was not an insider of the target corpora-
tions, he argues, he did not owe a fiduciary duty to target
shareholders who sold before the tender offer was an-
nounced. Thus, he claims, he was not subject to the “dis-
close or abstain” rule of Teras Gulf Sulphur, and, conse-
quently, the indictment fails to charge a violation of Rule
10b-5. We disagree.
A.
That appellant was not an insider of the companies
whose securities he traded is true, but irrelevant. A finan-
7 Judge Owen’s decision on the motion to dismiss is reported at 450
¥. Supp. 95 (S.D.N.Y. 1978).
Appellant was sentenced to concurrent terms of one year on counts
one through thirteen, to be suspended following one month’s im-
prisonment. Imposition of sentence on the remaining counts was sus-
pended, and he was placed on probation for five years following his
release from prison.
400
A6
cial printer such as Chiarella is as inside the market itself
as one could be.
In practical terms, the services of a financial printing
firm are a prerequisite for the successful execution of a
tender offer. These auxiliaries of the securities industry
are a central, though generaly unheralded, cog in the vital
machinery for disseminating information to. investors.
From his vantage point in the composing room of Pandick
Press, Chiarella had access on\a regular basi3s-to the most
confidential information in the world of finance. Five times
in less than fifteen months he obtained knowledge of facts
that, when released, would have an immediate and dramatic
effect ‘on the Street.” :
For the securities markets to function properly, it is
essential that those who oecupy. such strategic places in
the market mechanism be forbidden to reap personal gains
from information received by virtue of their position. In-
deed, Rule 10b-5 prohibits corporate insiders from trading
on nonpublic corporate information only because their
ready access to the intimate details of their companies’
problems and prospects gives them an unfair advantage
over persons with whom they deal. See, e.g., Texas Guf
Sulphur, supra, 401 F.2d at 848 (“{Tjhe Rule is based in
policy on the justifiable expectation of the securities mar-
ketplace that all investors trading on impersonai exchanges
have relatively equal access to material information.”) ;
Speed v. Transamerica Corp., 99 I’. Supp. $98, 829 (D. Del.
1951); Fleischer, Mundheim & Murphy, An Initial Inquiry
into the Responsibility to Disclose Market Information,
121 U. Pa. L. Rev. 798, 818 (1973). Yet even the most
unscrupulous officer or director could scarcely have a
greater opportunity to reap sure profits than market in-
sider Chiarella had by virtue of the market information
401
at his disposal.* Accordingly, we beli¢ve that the principle
underlying Tezas Gulf Sulphur is not so narrow as
Chiarella contends. In enacting the securities laws, Con-
gress did not limit itself to protecting shareholders from
the pecuiations of their officers and directors. A major
purpose of the antifraud provisions was to “protect the:
integrity of the marketplace in which securities are traded.”
United States v. Brown, 555 F.2d 336, 339 (2d Cir. 1977).
lnyone—corporate insider or not—who regularly receives
material nonpublic information may not use that informa-
ion to trade in securities without incurring an affirmative
“duty to disclose. And if he cannot disclose,? he must
abstain from buying or selling.
The American- Institute’s Federal Securities Code
has suggested a category of “quasi-insiders” that bears a
strong resemblance to the concept of market insider de-
veloped above. See id. § 1603, comment 3(d), at 538-39 —
(Proposed Official Draft 1978). In rejecting a per se dis-
close-or-abstain rule for quasi-insiders, the ALI appeared
primarily concerned with defining the scope of the cate-
gory. Id. It therefore chose not to include these individuals
8 “Market information” refers to information that affects the price
of a company’s securities without affecting the firm’s earning power
or assets. See Fleischer, Mundheim & Murphy, supra, 121 U. Pa. L. Rev.
at 799. Examples include information that an investment adviser will
shortly issue 2 “buy” recommendation or that a large stockholder is
seeking to unload his shares—or that a tender offer will soon be maile for
the company’s stock. Of course, from the point of view of a share-
holder who sells his stock on the day before the price jumps sharply
upward, it matters little whether the cause of the rise was news of an
ore strike, see Tezas Gulf Sulphur, supra, or, as here, the announcement
of = tender offer. See ALI Federal Securities Code § 1693, comment
2(j), at 531-32; Oppenheimer g: Co., Exch. Act Rel. No. 12319, [1975-
1976 Transfer Binder] Fed. See. L. Rep. (CCI£) 30,551, at $6,415
& n.3 (1976).
9 Chiarella, of course, was disabled from disclosing his knowledge of
the tender offers by his duty to his employer not to reveal clients’
confidences.
402
A8
in the “insider trading” section of the Code (§ 1603). But
the Institute specifically indicated that “egregious” cases
would fall under the proscription of § 1602, its recodifica-
tion of Rule 10b-5. Code, supra, at 539. Compare Fleischer,
Mundheim & Murphy, supra, 121 U. Pa. L. Rev. at 819-24.
A test of “regular access to market information” appears
to us to provide a workable rule. There should be no
greater difficulty in resolving close cases than is inherent
in determining who is a “corporate insider” under Tezas
Gulf Sulphur. See Code, supra, § 1603, comment 3(e), at
540. In any event, we believe Chiarella’s conduct was suiffi-
ciently egregious to fit the most restrictive definition of
a quasi-insider who would be barred from trading by the
general provisions of § 1602.
A duty to disclose arising out of regular access to market
information is not a stranger to the world of 10b-5. In
Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972),
the First Security Bank of Utah acted as transfer agent
for shares of the Ute Development Corporation, which was
created by the federal government to hold assets for a
group of mixec-blood Ute Indians. There were effectively
two separate markets for the shares—a primary market
consisting of Indians selling to whites through the Bank,
and a resale market consisting entirely of whites. The
price per share was significantly higher in the resale mar-
ket, but the Indians did not know of the existence of the
resale market nor, of course, of the price differential.
Gale and Haslem, two employees of the Bank, bought from
Indians and sold to whites, thereby realizing sttbstantial
profits. The Supreme Court held that the employees’ posi-
tion at the center of the two markets gave rise to a Rule
-10b-5 affirmative duty to disclose. 406 U.S. at 153."
10 Specifically, the Court applied our decision in Chasins v. Smith,
Barney § Co., 438 F.2d 1167 (2d Cir. 1971), to hold that Gale and
405
A9
C>/
B.
We are not to be understood as holding that no one may
trade on nonpublic market information without incurring
a duty to disclose. Indeed, as Chiarella has persistently.
reminded us, a would-be tender offeror may purchase up
to 5% of the stock of its prospective target without mak-
ing any disclosure at all. General Time Corp. v. Talley
Industries, Inc., 403 F.2d 159, 164 (2d Cir. 1968), cert.
denied, 393 U.S. 1026 (1969); see 15 U.S.C. §78m(d);
Kennecott Copper Corp. v. Curtiss-Wright Corp., No. 78-
7187, slip op. at 4866-70 (2d Cir. Sept. 28, 1978). Because
offerors may trade, and because he obtained his informa-
tion from them, appellant would have us conclude that he,
too, could purchase target stock before the tender offer is
announced, subject only to the 5% limitation of the Wil-
liams Act, 15 U.S.C. 4§ 78m(d), 78n(d). But the offerors
and Chiarella occupy entirely different positions with re-
spect to trading on news of an impending tender offer.
It is clear, at the outset, that an offeror is not a “market
insider” as this term has been defined above. It does not
regularly receive nonpublic information concerning any
Haslem were de facto market makers and obliged to reveal that fact to
the Indians. Both we and the Supreme Court relied exclusively on
Rule 10b-5 to establish the duty, and did not look to Rule 15¢l-4, which
regulates the conduct of broker-dealers, 406 U.S. at 154 n.16; 438 F.2d
at 1172-73. Cf. SEC v. Spectrum, Ltd., 489 F.2d 535, 541-42 (2d Cir.
1973) (“unique and pivotal role” of legal profession in distribution of
securities justifies higher-than-usual standard of conduct).
We disagree with Judge Meskill’s narrow reading of Affiliated Cte
Citizens, It is highly doubtful whether, under the facts of that case,
a mere transfer agent would have had access to the detailed price and
market information available to the bank employees. Accordingly, the
Court’s dictum that a transfer agent would not incur a duty to dis-
close, 406 U.S. at 151-52, should not be interpreted as a holding pre-
eluding liability of Chiarella, who did have regular access to non-
public information of vital concern to investors.
404
Al10
Oo
stock but its own." Indeed, with respect to tender offers,
it does not receive information but creates it.
Moreover, in making a tender offer at a premium above
the pre-offer market price, the offeror is undertaking a
substantial economic risk that his tempting target will
prove to be a “white elephant.” Although it knows that
the price of the target stock will rise when the takeover
bid is announced, the offeror has no alchemic power to
transform this knowledge into a certain profit. The only
reason it can be confident that its purchases will soon
appreciate in value is that it will soon-place a much greater
sum of money at risk. When the price goes up, the offeror
will be buying, not selling. :
The offeror’s pre-offer market purchages thus represent
its willingness to back its judgment that target stock is
undervalued by the market. This course of action is en-
tirely consistent with the principles underlying the securi-
ties laws. The legislative history of the 1934 Act empnha-
$1zeS
{t]he idea of a free and open public market [that]
is built upon the theory that competing judgments of
buvers and sellers as to the fair price of a security
brings about a situation where the market price re-
flects as nearly as possible a just price.
H.R. Rep. No. 1383, 73d Cong., 2d Sess. 11 (1954) ; accord,
S. Rep. No. 1455, 73d Cong., 2d Sess. $1 (1934). Nor are
these principles in any way diminished by the 5% limit on
_ pre-offer market purchases established by the Williams
Act, 15 U.S.C. $§ 7Sm(d), 78n(d). That legislation was
not designed to interfere with an offeror’s exercise of its
11 When it does, of course, it may be liable as an ordinary insider.
Crane Co. v. Westinghouse dir Brake Co., 419 F.ld 737, 796 (20 Cir.
1969), cert. denied, 400 U.S. 822 (1970).
405
All
economic judgment. Rather, its principal purpose was to
prevent the “stampede effect” that the publicity associated
with tender offers has on target shareholders. See, e.g.,
Rondeau v. Mosinee Paper Co., 422 U.S. 49, 58 & n.8 (1975) ;
E. Aranow, H. Einhorn & G. Berlstein, Developments in
Tender Offers for Corporate Control 10-16 (1977).
Let us now consider Chiarella. In stark contrast to the
offerors, he has taken no economic risk whatsoever. In-
deed, his “investments” were less speculative than those
of the defendants in 4.7. Brod & Co. v. Perlow, 375 F.2d
393 (2d Cir. 1967). The Perlows ordered stock from their
broker but refused to pay when the price had not gone up
by settlement date. Chiarella, however, had virtually cer-
‘tain knowledge that he could sell out at a substantial
profit.'* Moreover, as in Perlow, Chiarella’s market ac-
tivity created an artificial demand for target stock that
had a distorting effect on the free play of market forces
envisioned by the securities laws. See id. at 397; Schot-
land, Unsafe at Any Price: A Reply to Manne, Insider
Trading and the Stock Market, 53 Va. L. Rev. 1425, 1448-
52 (1967).
Viewed in this light, Chiarella’s reliance upon General
Time Corp. +. Talley Industries, Inc., supra, is ironic. To
support his assertion that General Time limits the affirma-
tive duty to disclose to outsiders of the issuer, Chiarella
misuses Judge Friendly’s comment that:
We know of no rule of law, applicable at the time, that
_& purchaser of stock, who was not an “insider” and
had no fiduciary relation to a prospective seller, had
12 Appellant’s counsel suggested at oral argument that Chiarella bore
the risk that tender offer plans would collapse between the time he pur-
chased target stock and the date set for the public announcement. We
reject any contention that this remote and nebulous possibility is at
all comparable to the risk borne by the offeror.
Al2
ee Ce See ee ee eee ne en ee mo
any obligation to reveal: circumsiances that might
raise a seller’s demands and thus abort the sale. 403
F.2d at 164 (emphasis added).* — '
Appellant would place himself in the shoes of the offerors,
but the shoes do not fit. Chiarella was not a “tippee” of
Pandick’s clients, with liability derivative only through
them. In clear violation of his duties: as agent, Restate-
ment (2d) Agency § 395, he converted to his personal use
confidential information entrusted to him in the course of
his employment. He may not relieve himself of his market
insider’s duty of disclosure by claiming the ‘protention of
persons he has defrauded.**
Indeed by entering the market for target stock on the
basis of advance knowledge of a tender offer, Chiarella
* exerted upward pressure on the price of the stock. In this
manner, he achieved precisely the result Judge Friendly so
assiduously sought to avoid in General Time. See E. Ara-
13 The allusion to a change in the applicable law refers to enactment
of the Williams Act, which became effective after the transactions ar
issue in General Time. Ag we indicated earlier, that legislation does
not affect the existence of a market insider’s duty to disclose.
l4 This suffices to dispose of appellant’s contention that Judge Owen
erred in permitting the prosecutor to argue that Chiarella’s conduct
defrauded the offerors as well as the sellers. The prosecutor was making
a legitimate response to the principal pillar of the defense theory of the
ease, that Chiarella could trade because the offerors could trade. [In
any event, the indictment fairly charges Chiarella violated Rule 10b-5
by converting offerors’ confidential information to his own use. [It
not only alleged that appellant's activities “operated as a fraud and
deceit upon the sellers of the aforementioned sccuritics,” it also charged
a “scheme to defraud” in general termé. Clearly, violation of an agent’s
duty to respect ciient confidences, 2 coment (2d) Agency § 395, trans-
gresses Rule 10b-5 where, as here, the converted information both con-
cerned securities and was used to purchase and sell securities. C/.
Superintendent of Insurance v. Bankers Life ¢ Cas. Co., 404 U.S. 6,
9-10 & n.7 (1971); United States v. Brown, supra; A.T. Brod ¢ Co.
v. Perlow, supra.
Al3
now, H. Einhorn & G. Berlstein, supra, at 20; Fleischer,
Mundheim & Murphy, supra, 121 U. Pa. L. Rev. at 815."*
We conclude, therefore, that Chiarella’s conduct vio-
lated Rule 10b-5, and the indictment accordingly charges
a crime.’* Congress enacted $10(b) to prohibit conduct
15 We wish to make it clear that we arc not relying on any concept of
“business purpose” in distinguishing Chiarella from Paniick’s clients,
whose confidentia! information appellant vonverted to his own use. In
this respect, we differ with Judge Owen, who relied at least in part
on the offerors’ “presumptively legitimate husiness purpose to pro-
mote economic growth,” 450 F. Supp. at 97. We agree with appel-
lant that “business purpose” cannot be» dispositive of liability under
Rule 10b-5. Santa Fe Inclustries, Inc. Vv. Green, 430 U.S. 462 (1977
But the presence or absence of a business purpose has no Venting
on Chiarella’s liability for defrauding the scilers. That arises. solely
from appellant’s position as a market insider and his breach of his
resulting duty not to trade on market information without disclosure.
With respect to the scilers, the economic analysis adumbrated in the
text serves only to demonstrate why Chiarclla may not claim the hene-
fits of the (icneral Time doctrine. Equally, business purpose is ir-
relerant to Chiarella’s culpability for defrauding the offerors, Ilis guilt
there arises from a conversion of property—Pandick’s clients’ informa-
tion—that is intimatcly connected with the purchase and sale of se-
eurities. See note 14 supra.
In any event, Santa Fe Industries arose on facts entirely different
frum those of the ense at bar. In Santa Fe, the question was whether
lack of business purpose would create liability under Rule 10b-5 even
when all required disclosures were made, 430 U.S. at 474-77. Chiarella, —
of course, made no disclosure whatsoever.
Moreover, Chiarella’s contention that there was no fraud because
the sellers did’ not suffer injury by reason of his conduct is without
merit. Appellant suggests that, even were he to have abstained from
trading, the target sharcholders would still have placed their orders to
sell. Consequently, his failure to abstain was not a “but for” cause of
the losses the sellers incurred by unloading their shares before the
tender offer announcements. This arguinent, however, is weightless. It
would he equally applicable to the shareholders in Trrax Gulf Sulphur,
who would have sold even had the TGS insiders not heen purchasing
on their advance knowledge of the company’s ore strike.
16 We are unpersuaded by our dissenting brother’s argument that
Rule 10b-5 must he construed more narrowly in criminal prosecutions
than in civil enforcement actions. Section 32(u) of the 1934 Act, 15
U.S.C. § 78ff(a), provides criminal penaltivs for willful violations of
“any rule or regulation . . . the violation of which is made unlawful.”
(emphasis added) It is well-established that, excent for issues of intent
408
Al4
that destroyed confidence in the securities markets. Sce,
e.g., 15 U.S.C. § 78h; United States v. Brown, supra. The
section was specifically designed to prohibit “those manipu-
lative and «deceptive practices which “ifive been demon-
strated to fulfill no useful function.” S. Rep. No. 792, 73d
Cong., 2 Sess. 6 (1934). It is diffieult to imagine conduct
less useful, or more destructive of public confidence in the
integrity of our securities markets, than Chiarella’s.
C.
Appellant contends that interpreting Rule 10h-5 to im-
pose an affirmative duty of disclosure on a person other
than a corporate insider would be so novel a construction
of the Rule as to violate the fair notice element of due
process. We helieve, however, that today’s holding is but.
a logical application of the congressional policies under-
lving the rule of Tezras Gulf Sulphur. That no prior liti-
gated case has involved the precise fact pattern at issue
here is not dispositive. United States v. Brown, supra,
555 F.2d at 339-40; United States v. Charnay, 537 F.2d
341, 349-50 (9th Cir.), cert. denied, 429 U.S. 1000 (1976).
All that is necessary is that “a clear and definite statement
of the conduct proscribed” antedate the actions alleged to
be criminal. United States v. Persky, 520 F.2d 283, 288
(2d Cir. 1975).
Under this principle, Chiarella manifestly had adequate
notice that his trading in target stock could subject him
to criminal liability. He was not the first printer to have
felt the wrath of the SEC. On August 12, 1974, the Com-
anl burden of proof, criminal and civil liability under the securities
laws are coextensive. United States v. Peltz, 433 F.2d 48, 13 (2d Cir.
1970) (Friendly, J.), cert. denied, 410 U.S. 955 (1971); United States
v. Charnay, 3535 F.2d 341, 348 nom Cir.) (citing cases), cert. denied,
429 U.S. 1900 (1976).
409
A1L5
mission filed a complaint alleging that various employees
of Sorg Printing Co. had engaged in activities identical to
Chiarella’s. The employees eventually consented to entry
of preliminary injunctions against them. SEC v. Sorg
Printing Co., [1974-1975 Transfer Binder] Fed. Sec. L.
Rep. (CCH) 95,034 (S.D.N.Y. March 28, 1975).
The Sorg decree was well publicized and aroused wide-
spread concern in the financial printing industry. Pandick
undertook to notify its employees that trading orf the basis
of information contained in customers’ copy could violate
the securities laws. “It prepared 8” x 10” signs, in large,
boldface type, reading:
To Ari Exproyers:
The information contained in all type set and print-
ing done by Pandick Press, Inc., is the private and
personal property of the customer.
You are forbidden to use any information learned
‘rom customer’s copy, proofs or printed jobs for your
own or anyone else’s benefits, friend or family or talk-
ing about it except to give or receive instructions.
Any violation of this rule will result in your being
fired immediately and without warning.
In addition, you are liable to criminal penalties of
5 years in jail and $10,000 fine for each offense.
If you see or hear of anybody violating this, report
- it immediately to your supervisor or to Mr. Green or
17 Since Sorg, the SEC has obtained consent devices against three
additiong: printers (not including Chiarellu). SEC v. Manilerano,
(Current] Fed. See. L. Rep. (CCH) 796,357 (D.N.J. March 22, 1973) ;
SEC v. Primar Typographers, Inc., [1976-1977 Transfer Binder] Fed.
See. L. Rep. (CCH) $95,734 (S.D.N.Y¥. 1976); SEC v. Ayoub, [1975-
1976 Transfer Binder] Fed. Sec. L. Rep. (CCH) 95,567 (S.D.N.Y.
1976). Cf. SEC v. Healy, SEC Litigation Rel. No. 6589 (S.D.N.Y. Nov.
13, 1974) (officers of tender offeror).
410
Al6
°
ee
Mr. Fertig. Failure to report violations will result in
vour being fired.
These signs were posted on bulletin boards throughout the
-Pandick shop before September 5, 1975, when. Chiarella
made his first purchase of target stock. During the entire
fifteen-menth period covered by the indictment, the promi-
nent sign over the timeclock where Chiarella punched in
and out glared at him daily. On cross-examination, appel-
lant admitted passing the sign at least 640 times. The
jury need not have believed his testimony that he never
read it. Few malefactors receive such explicit warning
of the consequences of their conduct.
ITI.
We turn now to the second major issue raised on this
appeal—the level of intent necessary to support a con-
viction for criminal violations of Rule 10b-5. Chiarella’s
state of mind was the only significant issue at trial.
Judge Owen charged the jury that it could not convict
Chiarella unless it found that he had acted “knowingly”
and “willfully,” and defined these terms to mean that “the
defendant must be aware of what he was doing and what
he was not doing” and that he must be acting deliberately, |
18 The notice was aiso printed in the union newspaper, om the back of
Chiarella’s timecard, and in separate cards distributed to Pandick
employees. Chiarella testified that he never read any of these, although
he admitted knowing that Sorg employees “violated company policies
and they were discharged.” At the sentencing hearing, Judge Owen
found that Chicreila’s testimony that he had not read the notices
was perjury berond a reasonable doubt.
We did not suggest, of course, that the notices posted by Pandiczk
somehow expanded the scope of liability under § 10(b) and Rule 10b-5.
Our Brother Meskill misreads us on this point. Chiarella’s conduct
was rendered illegal by the language and policy of the statute and rule.
The sign merely informed appellant of the SEC’s riew of the law—
a view we today hold was correct.
411
Al7
and not as a result of “innocent mistakes, negligence, or
inadvertence or other innocent conduct.” He concluded:
All that is necessary for this second element to be
satisfied is that the government establish a realization
on the defendant’s part that he was doing a wrongful
act, assuming that you find that Chiarella’s conduct -
was wrongful under the securities law as I have ex-
plained in the previous element, and that the know-
ingly wrongful act involved a significant risk of effect-
_ ing the violation that occurred. Jt. App. 778a.
This language has been specifically approved for prosecu-
tions brought, like this one, under $32(a) of the 1924
Act, 15 U.S.C. § 78ff(a), which punishes willful violations
of the Act’s substantive provisions or of rules promulgated
under it. United States v. Peltz, 433 F.2d 48, 54-55 (2d
Cir. 1970), cert. denied, 401 U.S. 955 (1971) ; United States
v. Dizon, 536 F.2d 1388, 1395-97 (2d Cir. 1976).
Chiarella does not dispute that Judge Owen’s charge
adequately defines the level of intent required by § 32/a)
itself. Rather, he contends that when the substantive pro-
‘visions are § 10(b) and Rule 10b-5, the Government must
prove the additional element of specific intent to defrand.
In advancing this proposition he cites the statement in
Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), that a
civil action for damages under the antifraud provisions of
the 1934 Act must fail absent proof of “ ‘scienter’—intent
to deceive, manipulate, or defraud,” id at 193.
Courts and commentators alike have noticed, however,
that, read as a whole, the Hochfelder opinion does. not
yield such a clear and ineluctable explication of the méan-
ing of “scienter.” See, e.g., Rolf v. Blyth, Eastman Dillon
¢ Co., 570 F.2d 38, 44-47 (2d Cir. 1978), petition for cert.
filed, 47 U.S.L.W. 3266 (U.S. Oct. 2, 1978) (No. 78-560) ;
412
NA ilies Sp lctitempes its Al om were ee Fa
United States v. Charnay, supra, 537 F.2d at 357-59;
Bucklo, Z'he Supreme Court Attempts to Define Scienter
Under Rule 10b-5, 29 Stan. L. Rev. 213, 216-17 (1977).
The Court was primarily concerned with rejecting Hoch-
felder’s contention that mere negligent omissions sufficed
to establish a claim under Rule 10b-5, and it did not settle
fine points of definition. In particular it left open whether
reckless conduct is sifficient, 425 U.S. at 193 n.12, and
variously described its holding as requiring “some element
of scienter,” id. at 201, and “knowing or intentional mis-
conduct,” id. at 197. A fair reading of Hochfelder indi-
cates that the Court used the term “scienter” only to
contrast negligence and not to establish a standard of
specific intent to defrand.
’ Inded, such fraudulent -intent was not required by any
of the cases or commentators cited by the Hochfelder Court
as favoring a scienter requirement in 10b-5 actions, see .
Bucklo, supra, at 219 & nn.30 & 31, nor was it generally
required at common law, see id. at 228-30. And, since
Hochfelder, we have held that, under some circumstances,
reckless disregard of the trytl will satisfy the scienter
requirement in a private civil action for damages. Jolf
v. Biyth, Eastman Dillon & Co., supra. Finally, the only
eourt to reach the issue has held the Peltz-Dizon charge
to he consistent with Hochfelder. United States v. Char-
nay, supra, 537 F.2d at 357-59 (on petition for rehearing
in light of Hochfelder).
In the case before us, Chiarella was convicted under a
charge requiring the jury to find beyond a reasonable
doubt that ‘he engaged in “knowingly wrongfu!” miscon-
duet.” We do not believe that Hochfelder requirss more
ly There is no question cs to the adequacy of the evidence to support
the verdict. Chiarcila admitted knowing that his actions violatced com-
pany policy and mare him liable to discharge. Ard altuough he testi-
413
ye
=)
wo
than this. Accordingly, Judge Owen correctly refused to
charge the jury that the Government must prove specific
intent to defraud}
IV.
Chiarella’s arguments on the issues of intent, however,
are not limited to his claim under Hochfelder. He asserts
that numerous errors in Judge Owen’s evidentiary rulings
and jury instructions, individually and cumulatively, pre-
vented the jury from fairly considering his contention that
he did not have-a culpable state of mind. Our examination
of the record convinces us that the trial court acted prop-
erly in all respects.
'~“For example, the district judge refused to permit Chi-
arella to testify that he had never heard of anyone being
fied that he thought his conduct was legal (because the offerors had
the right to trade) and that he did not believe that “anything criminal
would come of it,” he admitted on cross-examination that he knew his
conduct was “wrong” and “against the SEC.” Contrary to Chiarella’s
suggestion, he was not convicted for violating company policy. His
knowledge that he was doing so, however, constituted a culpable state
of mind sufficient to satisfy the Peitz-Diron test of willfulness under
§ 32(a).
20 We aiso believe that the district judge did not, as Chiarella sug-
gests, direct a verdict of guilty by charging the jury that “in the contcxt
of this case, assuming you find the requisite state of mind, a failure
by Chiarella to diselose material, nonpublic: information in connection
with his purchase of stock would constitute deceit.” This charge was
given as part of the definition of “scheme to defraud” in Rule 10b-5(a).
Construction of the words of a statute (and, of course, a rulc) is the
court’s function. E.g., United States v. Santiago, 528 F.2d 1130, 1135
(2d Cir.), cert. denied, 425 U.S. 972 (1976). United Statcs v. United
States Gypsum Co., 57 L. Ed.2d 854 (1978), is not to the contrary.
That case held it an impermissible encroachment on the jury’s fact-
finding role to charge that defendants are presumed to have intended
to fix prices if their conduct would have that effect. Id. at 863-75.
Here, the trial judge repeatedly told the jury that it must determine
Chiarella’s state of mind for itself; indeed, the portion quoted as
objectionable specifically so states.
414
A20
a
prosecuted for what he had done. But under the Peltz-
Dizon test, the willfulness requirement of §32(a) is satis-
fied by a general awareness of wrongful conduct, Pe/tz,
supra, at 55, which may exist even if a defendant believes
his chicanery is in technical compliance with the law,
Dizon, sunra, at 1396. Chiarella’s proffered testimony,
therefore, was at best tangentially relevant. Considering
the prejudice to the Government that might arise from a
suggestion that Chiarella was unfairly singled out for
prosecution, Judge Owen did not abuse his broad disere-
tion under Fed. R. Evid. 403 by barring the testimony.
See, e.g., United States v. King, 560 I".24 122, 128 (2d Cir.),
cert. denied, 434 U.S. 925 (1977) Similarly, the trial judge
did not err in excluding, as irrelevant and prejudicial, evi-
dence that appellant disgorged his profits to the sellers of
his target securities. It is difficult to see how Chiarella’s
state of mind during the operation of his scheme wouid
. be illuminated by evidence that afterwards he agreed te
an SEC decree requiring restitution. United Sictes v. Post,
407 F.2d 319, 326-28 (D.C. Cir. 1968), cert. denied, 393
U.S. 1092 (1969) .**
21 We also conelude that it was not error to charge the jury that “the
repeated similar acts or conduct in the indictment muy be considered
eireumstantial evidence of unlawful intent.” Similar acts evidence is
frequently highly probative on issues of intent. Ser, ¢.g., Fed. R. Evid.
404(b); United States v. Grady, 544 F.2d 598, 604-05 (2a Cir. 1975);
United States ¥. Broadway, 477 F.2d 991, 994 (Sth Cir, 1973); United
States v. Deaton, 381 F.2d 114, 117-19 (2d Cir. 1967) (citiag cases).
Although Chiarella did not contend he acted inacvertent'y, or through
mistake, see United States v. Semak, 536 F.cd 1142, 11+4.45 (6th Cir.
1976), the fact that he engaged in five separate transactions over a
period of fifteen months would permit the jury to infer that his mind
was foeused on the nature of his acts, see United States v, Catalano,
$91 P.2d 268, 275-76 (2d Cir.), cert. denied, 419 U.S. 225 (1974).
In L'nited States v. Marcus, 429 F.2d 654, 657-58 (3d Cir. 1970),
relied on by Chiarella, the defendant was charged with knowingly at-
tempting to pledge stolen securities. An instruction permitting the
jury to infer knowledge that the securitics were stolen from evidenre
415
A21
ve
Finally, Chiarella challenges a series of other rulings
below, each of which he claims constituted reversible error.
Only one of these contentions requires extended discussion.
Shortly after he was discharged by Pandick, appellant
sought unemployment benefits from the New York State
Department of Labor. In connection with the application,
he signed a statement admitting that he was discharged _
for misusing confidential information and that “the allega-
tion is true.” When the Government subpoenaed the Labor
Department file for use at trial, Chiarella moved to sup-
press the statement on the ground that it was privileged
under N.Y. Labor Law §537 (McKinney 1977). The stat-
ute provides that statements made in applying for unem-
ployment benefits “shall not ... be used in any court in
any action or proceeding pending therein unless the com-
missioner [of labor] is a party to such action or pro-
ceeding.”
We believe Judge Owen correctly denied the suppres-
sion motion and admitted the statement. State-created
privileges* are not controlling in federal criminal cases
that defendant later sought to pledge other securities was held to be
prejudicial error in the absenee of proof that the latter securities were
themselves stolen. Ji. at 658. In short, the second attempt to pledge
was not a “similar act,” and Varcus is clearly distinguishable from the
ease before us. See id. at 658 n.3.
22 Chiarella contends that the Federal Unemployment Tax Act, 26 U.S.C.
§ 3304(a)(16), (17), providing for federal approval of state unem-
ployment laws, transforms § 537 into aa “Act of Congress” for purposes
of Fed. RB. Evid. 501. We are not inclined to read § 3304 so broadly
heeause, as the Government has pointed out, the Seeretary of Labor
has approved unemployment laws in at least two states— Massachusetts
and Washington—that specifically permit disclosure to prosecutors of
statements such as Chiareila’s. Mass. Ann. Laws ch. 151A, § 46 ( Michie/
Law. Coop. 1976); Wash. Rev. Code §§ 50.13.0060, .070. Im any event,
this ground for excluding the statement was not raised below and is
therefore waived. F.g., United States v. Fuentes, 563 F.2d 327, 531
(2d Cir.), cert. denied, 434 U.S. 959 (1977).
416
A22
except to the extent they reflect “the principles of the com-
mon law as they may be interpreted by the courts of the
United States in the light of reason and experience,” Fed.
R. Evid, 501. £.9., United States v. Craig, 528 F.2d 773,
776 (majority), 781 (Tone, J., concurring on point), aff’d
en banc per curiam on panel concurrence, 537 F.2d 957
(7th Cir.), cert. dented, 425 U.S. 973, 429 U.S. 999 (1976).
To the extent $537 does create a privilege under New
York law, an issue we need not decide, it is one unknown
to the common law. In view of the strong federal policy
favoring acmissibility in criminal cases, see, e.g., United
States v. Niron, 418 U.S. 683, 708-13 & n.18 (1974), the
district court properly held the statement admissible. See
United States v. DiCarlo; 565 F.2d 802, 806 (1st Cir. i977),
cert, denied, 98S. Ct. 1487 (1978) ; United States v. Schoen-
heinz, 548 F.2d 1389 (9th Cir. 1977) (per curiam); Jn re
Grand Jury, 541 F.2d 373, 378-83 (3d Cir. 1976); Craig,
supra. |
We have carefully considered appellant’s remaining eon-
tentions and find them to be without merit. The judgment
is affirmed.
Mesxity, Circuit Judge, dissenting:
I respectfully dissent. Today’s decision expands § 10(b)
drastically, it does so without clear indication in prior law
that this is the next logical step on the path of judicial
development of §10(b), and, alarmingly, it does so in the
context of a criminal case.
Nondisclosure Under §10(b) and Rule 10b-5.
The majority holds that Chiarella committed a § 10(b)
violation by breaking the “disclose or abstain” rule of SEC
v. Texas Gulf Sulphur, 401 F.2d 833, 848 (2d Cir. 1968)
(en banc), cert. denied, 394 U.S. 976 (1969). However,
417
A23
_ we have been cited no case in which even civil liability for
nondisclosure has been imposed under § 10(b) on anyone
other than an insider, the tippee of an insider, or one
standing in a special relationship with other traders. More
specifically, we have been cited no case in which criminal
liability for §10(b) nondisclosure has been imposed on
any purchaser of stock, either insider or outsider. The
-, Majority terms “irrelevant” the fact that Chiarella was
neither an insider of the companies whose securities he
purchased, nor the tippee of an insider. Chiarella’s loca-
tion “inside the market itself” is today held to place him
in a special relationship with all buyers and sellers with
whom he might deal—a relationship which triggers the
duty either to abstain or to disclose material nonpublic
information. I am: sympathetic to the majority’s view that
imposition of ‘the duty to abstain or disclose on those who
ocenpy strategic positions in the securities industry may
further important goals embodied in the securities acts,
such as maintaining investor confidence in the integrity of
the market. However, we must resist the temptation to
redraft legislation, in effect, by reading into it what we
would like to see written there, especially where a criminal
conviction is at issue. )
That today’s application of 4 10(b) is a departure from
prior law cannot be disputed.' ‘In General Time Corp. v.
Talley Industries, Inc., 403 F.2d 159, 164 (2d Cir. 1968),
cert. denied, 393 U.S. 1026 (1969), this Court rejected a
claim that a company acquiring stock in another corpora-
1 Indeed, this Court sitting en bane has stated that “to read Rule 10b-5
as placing an affirmative duty of disclosure on persons who in contrast
to ‘insiders’ or broker-dealers did not occupy a special relationship to
a seller or buyer of securities, would be occupying new ground and
would require most careful consideration.” SEC v. Great American
Industries, Inc., 407 F.2d 453, 460 (2d Cir. 1968) (en banc), cert.
denied, 395 U.S. 920 (1969).
418
A24
ei ieee
BO a es Ss
Ree ne ee
GA Paes ls reece se te Te
tion must disclose to selling shareholders plans for an
eventual merger:
We know of no rule of law, applicable at the time, that
a purchaser of stock, who was not an “insider” and
had no fiduciary relation to a prospective seller, had
any obligation to reveal circumstances that might raise
a seller’s demands and thus abort the sale.
The Williams Act, not yet effective at the time of the trans-
actions at issue in General Time, does impose disclosure
obligations on certain large scale purchasers of stock, but
it is conceded that Chiarella’s trading was not covered by
its provisions. See 15 U.S.C. §§ 78m(d), 78n(d).
As the commentators cited by the majority have ob-
served, “(t]he duty to disclose material, non-public infor-
mation has not been imposed on every person possessing
this type of information. Traditionally, this obligation has
been limited to persons with a special relationship to the
company affected by the information.” Fleischer, Mund-
heim & Murphy, 4x Initial Inquiry into the Responsibility
to Disclose Market Information, 121 U. Pa. L. Rev. 798,
804 (1973) (emphasis added). See also Fleischer, Securi-
ties Trading and Corporate Information Practices: The
Implications of the Texas Gulf Sulphur Proceeding, 51
Va. L. Rev. 1271, 1280 (1965). Commentators on securities
fraud law often discuss persons covered by the Rule 10b-5
disclosure duty without mention of traders other than in-
siders or tippees of insiders. See, e.g., 1 A. Bromberg,
Securities Law: Fraud, §7.4(6)(b), at 179-83 (1977).
Bromherg notes that judicial decisions have generally
adopted the SEC’s own view that anvone is subject to
Rule 10b-5 disclosure obligations if he or she “fas inside
information obtained by reason of access to the issuer.”
Id. at 179.
419
A25
This access formula was first enunciated by the SEC
itself in its leading decision of Cady, Roberts & Co., 40
S.E.C. 907 (1961) :
Analytically,; the obligation [that is, the affirmative
duty to disclose material information] rests on two
principal elements: first, the existence of a relation-
ship giving access, directly or indirectly, to informa-
tion intended to be available only for a corporate pur-
pose and not. for the personal benefit of anyone, and
second, the inherent unfairness involved where a party
takes advantage of such information knowing that it
is unavailable to those with whom he is dealing. In
considering these elements under the broad language
of the anti-fraud provisions we are not to be circum.
scribed by fine distinctions and rigid classifications.
Thus our task here is to identify those persons who
are in a special relationship with a company and privy
to its internal affairs, and thereby suffer correlative
duties in trading in its securities.
Id. at.912 (emphasis added). Eleven years after the Cady,
Roberts decision this approach to Rule 10b-5 had become
so firmly entrenched that this Court remarked: “The essen-
tial purpose of Rule 10b-5, as we have stated time and
again, is to prevent corporate insiders and their tippees
from taking unfair advantage of the uninformed out-
siders.” Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d
876, 890 (2d Cir. 1972).
The majority’s break with this §10(b) tradition is ac-
complished by the creation of the new category of “market
insider,” into which former outsiders will henceforth be
placed. The majority sees in this new category a strong
resemblance to the concept of the “quasi-insider” sug-
420
A26
ee eS SS Se DE
te abide 2
Ae tn ee pe es tole > tid
Pee _" oe:
Wiens dis tet
gested in the comments accompanying the American Law
Institute’s Federal Securities Code (Proposed Official
Draft, March 15, 1978). However, the proposed code quite
clearly imposes an affirmative duty of disclosure only on in-
. Siders (explicitly defined in terms of their relationship’
with or access to the issuer) and tippees of insiders. The
Reporter’s comments indicate that the difficulties that
would be posed by extending this duty to a wider range of
traders were deemed to outweigh the “convenience” of
such an extension. Thus, the drafters of the proposed Code
respectfully rejected the position taken by the three con-
curring judges in SEC v. Great American Industries, Inc.,
407 F.2d 453 (2d Cir. 1968) (en banc), cert. denied, 395
U.S. 920 (1969), who expressed a willingness to catch non-
insiders in the § 10(b) disclosure net. The ALI’s proposed
code, like prior law, explicitly recognizes that some cases
of nondisclosure of material information by non-insiders,
no matter how egregious, do not involve fraud and hence
do not fall within the scope of 4 10(b), the majority’s state-
ment to the contrary notwithstanding.’
Because $10(b) and Rule-i0b-5 apply to “any person,”
it is tempting to view limitations on the class of persons
subject to an affirmative duty either to abstain or to dis-
close nonpublic information as overly technical barriers
to the full pursuit of the goals of the federal securities
laws. But $10(b) prohibits fraud not silence. And it is
hornbook law that silence, unlike active misrepresentation,
is frandulent-only when there is a duty to speak.* Prosser,
See § 1603 and accompanying notes, particulariy comment 3(d).
American Law Institute, Federal Securities Code (Proposed Oficial
Draft, March 15, 1978).
3 This case does not involve the prosecution of a “novel or atypical”
type of traud. See, ¢.g., United States v. Brown, £55 F.2d 336 (2d
Cir. 1977); 4.T. Brod ¢ Co. +. Perlow, 375 F.2d 393 (2d Cir. LyuG7),
Brown anil Perlow involved ingenious schemes which, while novel, were
421
Law of Torts § 106 (4th ed. 1971) ; 3 Loss, Securities Regu-
lation, Chapter 9C (1961); 6 Loss, Securities Regulation,
Chapter 9C (1969).
The majority suggests that the test of “regular access
to market information” is a’workable one for determining -
when such a duty is to be imposed on outsiders. 4d ffiliated
Ute Citizens v. United States, 406 U.S. 128 (1972), a civil
case, is the only precedent cited to buttress the majority’s
assertion that a “duty to disclose arising out of regular
access to market information is not a stranger to the
world of 10b-5.” Afiliated’Ute involved a bank which had
agreed with the Ute Distribution Corporation (UDC) to
act as transfer agent for its stock, which was being sold
by its Indian owners to non-Indians. The bank itself had
acknowledged in a letter to an association representing
the Indian sellers that it would be the bank’s “ ‘duty to see
that these transfers were properly made’” and that “ ‘the
bank would be acting for the individual stockholders.’ ”
Id. at 152. Despite the access of the bank and its employees
to market information which was not known to the sellers,
the Supreme Court explained that if the bank “had func-
tioned merely as a transfer agent, there would have been
no duty of disclosure here.” Id. (emphasis added). It was
because the defendants had devised a plan to induce the
holders of the stock to sell and had developed and encour-
aged a market for their stock that defendants were held
to have assumed an affirmative duty of disclosure. Thus,
clearly fraudulent under any definition of the term fraud. In coutrast,
Chiarella was prosecuted for trading without disclosing nonpublic, non-
inside information. Failure to make such disclosure is fraudulent only
when a duty to disclose is violated. See General Time Corp. v. Talley
Industries, Inc., 403 F.2d 159 (2d Cir. 1968), cert. denied, -393 U.S.
1026 (1969) (permitting company to purchase target stock without
disclosing plans for merger); SEC v. Great dmerican Industries, Inc.,
supra, 407 F.2d at 460.
499
A28
peu Letina intticpn east elles ae
~ ere
ee eee en es
hell S Ai rele tare Bad 90 B61 Be ash 0 tan Ae
it was not the bank’s clearly superior, regular access to mar-
ket information concerning UDC stock but its actions in
undertaking to act for the sellers that rendered its silence
equivalent to a scheme to defraud the selling shareholders.
Chiarella certainly did not undertake to act for the sellers
of the target stock, nor did he enter the type of special
relationship with them which was determinative in 4 fili-
ated Ute.
The majority eee as it must, that the would-be
tender offerors (also outsiders) from whom Chiarella de-
rived his information may themselves purchase up to 5
percent of the target’s stock without making any dis-
closure. See 15 U.S.C. §§78m(d), 78n(d); General Time
Corp. v. Talley Industries, Inc., supra, 403 F.2d 159. The
majority distinguishes purchases by the offeror and pur-
chases by Chiarella on the ground that the offeror takes
an economic risk and Chiarella does not. We have been
cited no case holding that the degrée of risk assumed by
a trader in possession of nonpublic information is determi-
native of the trader’s liability for nondisclosure or renders
his conduct fraudulent.
Chiarella has not been shown to have owed a duty of
disclosure to the sellers of target stock. He owed a duty
to the offeror corporation not to misuse confidential in-
formation entrusted to him. But the term “fraud” in Rule
10b-5 does not bring within the ambit of the rule “all
breaches of fiduciary duty in connection with a securities
transaction.” Santa Fe Industries v. Green, 430 U.S. 462,
472 (1977). In most contexts, “ ‘fraud’ still requires some-,
thing more than ‘unfairness’ or breach of fiduciary duty.”
American Law Institute, Federal Securities Code (Pro-
posed Official Draft, March 15, 1978) $1603, Comment
(3) (b).
423
A29
Section 10(b) as a Criminal Statute.
If §10(b) and Rule 10b-5 were broad enough to cover
every securities-related maneuver that entailed unfairness
or undermined investor confidence there would be no need
for all the other statutes and rules that figure in the com-
plex securities regulation scheme that Congress has been
building since the 1930’s. When a new weak point is iden-
tified—such as abuse of regular access to market informa-
tion by certain participants in the industry—a direct attack
on the problem through congressional legislation or SEC
rulemaking would be a more appropriate response than
the uncomfortable stretching of existing law engaged in by
the majority here to cover the gap.‘ The SEC has been
aware of the potential for abuse of nonpublic information
by financial printers since at least 1971. SEC v. Sorg Print-
ing Co., Inc., C.C.H. Fed. See. L. Rep. 95,034 (S.D.N.Y.
1975). The SEC has sought and obtained several consent
decrees enjoining the same conduct Chiarella engaged in”
4 Because the question is not before us I express no opinion as to
whether the SEC has been delegated the power to regulate printers
engaged in securities work or whether congressional action is required.
Either the legislative or the administrative process would make pos-
sible the imposition of trading restrictions responsive to the different
possibilities for abuse of nonpublic information by vutsiders as opposed
to insiders. Contrary to the majority’s statement, unfair ‘advantage
over other traders is not the only evil that insider trading restrictions
are intended to avoid. The subtle infection of corporate decision-making
by considerations of personal gain and other conflicts of interests
inimical to the insider’s duty to the corporation are also prevented by
~ $10(b) diselosure requirements, as well as by provisions like § 16 of
the 1934 Act (regulating short swing profits). Study of the “market
insider” problem and possible cures might yicld a mechanism more
precisely tailored to prevent the perceived evil without opening the door
to those that the Court has not been given the opportunity to consider.
For example, the impact, if amy, of our decision on the practice of
“warehousing” by tender offerors deserves thought. See, for discussion
of warehousing, Fleischer, Mundheim & Murphy, da Initial Inquiry
into the Responsibility to Disclose Market asians: 121 U. Pa. L.
Rev. 798, 811-815 (1973).
424
A30
Sm
ot er i es =
and ordering disgorgement of profits made in such trans-
actions. See, e.g., Sorg, supra; SEC vy. Ayoub, C.C.H. Fed.
Sec. L. Rep. 795,567 (S.D.N.Y. 1976); SEC v. Primar
Typographers, Inc., C.C.H. Fed. Sec. L. Rep. f 95,734 (S.D.
N.Y. 1976). Apparently the government is of the view that
imprisonment will succeed where other sanctions have
failed. This may be. But whatever the wisdom of an ex-
tension of the “civil incarnation” of §10(b) to cover the
situation presented here, our lawmaking function is severe-
ly restricted in the criminal area. As the majority notes,
we caunot uphold a conviction unless “a clear and definite
statement of the conduct proscribed” antedates the actions
alleged to be criminal. Chief Judge Kaufman in United
States v. Persky, 520 F.2d 283, 287 (2d Cir. 1975), most
perceptively identified the novel issue raised by the appli-
eation of due process-vagueness-notice principles to § 10(b)
criminel prosecutions.
Perhaps the most interesting [issue] is the apparent
dissonance between the general rule that criminal stat-
utes are to be strictly construed in favor of the ac-
cused ... and the realization that the civil incarnations
of the anti-fraud provisions have, as remedial legisla-
tion, been openly and avowedly construed broadly.
(citations omitted).’ In Persky, this same panel concluded
that, as applied to Persky, it could not be said that “the
3 Compare the Supreme Court’s cautious and restrictive interpretation
of the Sherman Act in a recent criminal price fixing case in light of
the fact that “the Act has not been interpreted as if it were primarily
a criminal statute” but rather has been construed with great flexibility.
United States v. Cnited Stctes Gypsum Co., 46 U,S.L.W. 4937, 4942
(June 29, 1978). The same accommodaticn of crimina! and remedial!
sanctions is necessitated by the structure and history of the securities
acts. See also United States v. Winston, 558 F.2d 105, 103 (2d Cir.
1977), overturning a conviction under the Railway Labor Act: “The
paucity of criminal proceedings under [45 U.S.C. $152], when con-
A31
expansive civil interpretations of Rule 10b-5 have so
stretched the Rule that he was not provided fair warning
that his conduct was fraudulent by the standard of strict
construction due criminal statutes.” Id. Persky, a securi-
ties lawyer and an officer of Microthermal Applications,
Inc., engaged in a series of maneuvers, including filing false
SEC reports, issuing misleading press releases, and making
misrepresentations to Microthermal’s shareholders, all cal-
culated to cover up the president’s misappropriation of
company funds. Not only was Persky an insider owing a
clear common law duty to the shareholders of his company,
but his actions, designed to use his position of trust to
further his own interests at the shareholders’ expense,
would fall within the most restrictive definition of “fraud.”
We specifically left open the possibility that 4 10(b) might
be unconstitutionally vague, in a criminal context, as ap-
plied to other behavior when we noted that Persky had no
standing to challenge the law “on behalf of those whose.con-
duct would be more ambiguous but who are not before us.”
Id. at 288.
I believe that the “clear and definite statement of the
conduct proscribed” to which the majority concedes a defen-
dant is entitled, must emanate from the language of the
statute itself, from prior judicial interpretation, or from
established custom and usage. Thus I fail to see the rele-.
vance to this issue of the warning signs posted by Pandick.
While they would be most relevant to questions of willful-
ness, knowledge, or intent, signs posted by a private party
trasted with the active pursuit of civil relief thereunder, strongly sup-
ports appellants’ contention that Congress intended criminal sanctions
to apply only to the more egregious violations. Although the failure to
enfores a statute over an extended period of time does not result in
its repeal, .. . the ‘gloss which life has written upon it’. . . indicates
in this instance that strict construction of its terms is appropriate.”
(footnotes and citations omitted).
426
A32
a .- ee ee ee ee
SOE ag Poo + ee ne a Oe nn
pen Putin Di niet cilisib tai asian rece elt nite Caaiattaed ee aa it w
can hardly transform conduct otherwise not covered by a
particular statute into conduct prohibited by that statute.
Under our system only the legislature, not the private citi-
zen, has this power.*
The majority has failed to uncover a sufficiently clear
statement prohibiting Chiarella’s actions to warrant impo-
sition of a criminal sanction.’ I wholeheartedly endorse the
majority’s explanation of the desirability and necessity of
curbing the ability of those with access to nonpublic infor-
mation to trade without making disclosure. And I recog-
nize that as a civil, remedial statute §10(b) has been and
should be interpreted in a flexible fashion by the courts.
Yet we cannot be deaf to recent caveats issued by the Su-
preme Court in slowing down the expansion of § 10(b) lest
it take over “the whole corporate universe.” Santa Fe, Inc.
v. Green, supra, 430 U.S. at 480. We have been urged to
turn first to the language of §10(b) in ascertaining con-
gressional intent. Ernst & Ernst vy. Hochfelder, 425 U.S.
185, 197 (1976). We have been chided for relying on “the
term ‘fraud’ in Rule 10b-5 to bring within the ambit of
the Rule all breaches of fiduciary duty in connection with a
securities transaction” lest we add a gloss to the statute
“quite different from its commonly accepted meaning.’ ”
Santa Fe, Inc. v. Green, supra, 430 U.S. at 472. The brakes
have been applied in the context of private causes of action
under §10(b). Surely we should be even more fastidious
6 Nor would Chiarella’s subjective view that his conduct was violative
of the securities laws transform his actions, no matter how worthy of
condemnation, into conduct criminal under §§ 10(b) and 32(a). See
United States v. Zacher, slip op. 49, 58-59 (2d Cir. Oct. 17, 1978).
For the same reason, civil consent decrees, entered into by parties
who may want to avoid further litigation for any number of reasons,
cannot transform behavior denounced by the SEC into criminal conduct.
7 As Chief Judge Kaufman has observed, the “exact nature and scope”
of the federal law governing tippee trader liability “remain in a forma.
tive stage.” Schein v. Chasen, 478 F.2d $17, 828 (2d Cir. 1973) (Kaud?-
man, J., dissenting), racated on other grounds, 416 U.S. 386 (1974).
£27
A33
in our construction of the statute when we are asked to
review a criminal conviction. Here, Chiarella was sentenced
to a one year term of imprisonment, suspended except for
one month, and a five year term of probation.
Conclusion.
Despite some dicta concerning the purpose behind the
securities laws, see, e.g., SEC v. Tezas Gulf Sulphur Co.,
supra, 401 F.2d at 847-48, “no case has held that there must
be parity of material information between the parties to a
securities transaction.” Fleischer, Mundheim & Murphy,
supra, 121 U. Pa. L. Rev. at 806. The disclosure duty has
been imposed on insiders, broker-dealers, Chasins v. Smith,
Barney & Co., 438 F.2d 1167 (2d Cir. 1970), and those un-
dertaking a special relationship with buyers or sellers of
stock, Affiliated Ute Citizens v. United States, supra, 406
U.S. 128. “The problem in the silence cases is to identify
the circumstances which trigger a duty to come forward
with information.” Fleischer, Mundheim & Murphy, supra,
121 U. Pa. L. Rev. at 803. To identify judicially a new trig-
gering circumstance—regular receipt of market informa-
tion—if appropriate at all, is not appropriate here. The
criminal aspects of 10b-5 have been neither extensive nor
significant prior to today. 3 Bromberg, supra, 410.3 at
241. The ability of the SEC to function will not be severely
hampered if it must await congressional action or action
by its own rulemakers to correct any market distortion
caused by wayward printers. As would any agency, the
SEC would like to keep as many weapons in its arsenal as
possible. But there are rules of combat, and our job is to
see that the amenities are observed when the SEC embarks
on a new crusade.
I would reverse the judgment of conviction and remand
with instructions to dismiss the indictment.
498
A34
APPENDIX B
UNITED STATES of America,
v. :
Vincent CHIARELLA, Defendant.
No. 78 Cr. 2.
United States District Court,
S. D. New York.
March 29, 1978.
Defendant charged with criminal viola-
tion of statute prohibiting use of manipula-
tive and deceptive devices in connection
with sale or purchase of sccurities moved to
dismiss indictment. The District Court,
Owen, J., held that indictment which a!-
leged that defendant, who was employed by
financial printing house, received, in. the
course of his emp!oyment, materials from
various corporations from which he learned
of prospective tender offers, and that «e-
fendant then purchased for his own account
shares of commun stock of target companies
without disclosing material, nonpublic in-
formation concerning tender offers, suffi-
ciently alleged criminai violation of statute
prohibiting use of manipulative and decep-
tive devices in connection with sale or pur-
chase of securities; defendant’s criminal li-
ability was not contingent upon a finding
that offering companics were similarly !ia-
ble for pretender offer purchases of target
companies’ shares without disclosure of
their intent.
Motion to dismiss denied.
1. Section 10 provides in relevant part:
It shall be unlawful for any person, directly
or indirectly, by the use of any means or
instrumentality of interstate commerce or of .
the mails, or of any facility of any nationa
securities exchange—
(d) To use or employ, in connection with
the purchase or sale of any secunty reyis-
Bl
Securities Regulation 195
Indictment which alleged that defend-
ant, who was employed by financial print-
ing house, received, in the course of his
employment, matcrials from various corpo-
rations from which he learned of prospec-
tive tender offers, and that defendant, then
purchased for his own account shares of
common stock of target companies without
disclosing material, nonpublic information
concerning tender offers, sufficiently al-
leged criminal violation of statute prohibit-
ing use of manipulative and deceptive de-
vices in connection with sale or purchase of
securities; defendant's criminal liability
was not contingent upon a finding that
offering companies were similarly liable for
pretender offer purchases of target compa-
nies’ shares without disciosure of their in-
tent. Securities Exchange Act of 1934,
§§ 10, 10(b), 15 US.C.A. §§ 78j, 78j(b).
Stanley S. Arkin, New York City, for
movant Chiarella; Mark S. Arisoha, New
: York City, on the brief.
Robert B. Fiske, Jr., U. S. Atty., S.
Y., by John S. Siffert, Asst. U. S.
New York City, for the U. S.
D. N.
ut
vy
Yo
tered on a national securities exchange or
any security not so registered, any manipula-
tive or deceptive device or contrivance in
contravention of such rules and regulations
as the Commission may prescribe as neces-
sary or appropriate in the public interest or
for the protection of investors.
and Rule 10b-5 thereunder, 17 C.F.R. anyone so that he had no duty of disclosure
§ 240.10b-5,? moves for an order, pursuant prior to purchasing shares in the target
to Fed.R.Cr.P. 12(b)(2), dismissing the in- companies, and that, accordingly, his ac-
dictment upon the ground that it fails to tions did not constitute even a civil viola-
state an offense and, alternatively, for an tion of § 10(b)}—and Rule 10b—S—much less
order dismissing the indictment in the in- 4 criminal violation. ‘
terest. of justice. The vy a
: a government, recognizing that this is
The allegations of the indictment—taken 4 novel application of § 10(b), urges that
as true for purposes of this motion—are under the law Chiarella could not trade in
’ essentially that between September 1975 4), shares of the target corporations at all.
and December 1976, Chiarella, a printerem- 1+ contends that on the one hand, the feder-
ployed in the composing room of Pandick 4) ..ourities laws required him to disclose
Press, Inc.,> in the course of his employ- 41. material. non-public inf :
; : : " -public information prior
ment, received materials from various ax er while on the other, the confiden-
porations to set in type. From these he ti yotureof the information, by virtue of
would learn of prospective tender offers— the pu in ahh Cadi Drake ron
resumably at prices above the market—by a Marg . ‘
ssrnoratines pi the stock of others or that pat i rene Se arin oa cad ait
a corporate merger was in prospect. He ae 8 :
would then purchase for his own account Crediting the indictment, there is no
shares of the common stock of the target question that Chiarella wrongfully took cor-
companies without disclosing the material, porate information—unquestionably mate-
non-public information he had thus learned. ial and non-public—entrusted to him by
After each tender offer or proposed merger offering corporations, and used it solely for
was announced, Chiarella would sell the personal profit, which information was “in-
shares in the target companies, at an aggre- tended to be available only for a corporate
gate profit of some $30,000. In all, the purpose and not for the personal benefit of
indictment alleges the use of such informa- anyone .. . .” Cady, Roberts & Co.,
tion on five different occasions.‘ 40 S.E.C. 907, 912 (1961). The analogy of
Chiarella claims that since the source of embezzlement by a bank employee immedi-
the information he failed to disclose was ately springs to mind, and, of course, em-
from outside the target corporations whose bezzlement imiplies fraudulent conduct. E.
stock he purchased, ke did not trade on g., Grin v. Shine, 187 U.S. 181, 189-00, 2
“inside” information within the meaning of S.Ct. 98, 47 L.Ed. 130 (1902). Chiarella can,
the securities laws. Further, he claims he therefore, hardly claim that the acts alleged
was not in a fiduciary relationship as to did not operate as a fraud. See United
2. Rule 10b-5 provides:
Employment of manipulative and deceptive (c) To engage in any act, practice or course
devices. of business which operates or would operate
It shall be unlawful for any reason, directly as a fraud or deceit upon any person, in
or indirecily, by the use of any means or connection with the purchase or sale of any
instrumentality of interstate commerce, or of security.
nerfhes hed sles facility of any national 3. Pandick Press is a financial printing house
‘ . : ‘ that prints, among other things, tender offer
(a) To employ any device, scheme, or arti materials for filing with the SEC and for distri-
fice to defraud, :
(b) To make any untrue statement of a bution to shareholders.
material fact or to omit to state a material .
fact necessary in order to make the state- 4. Chiarella’s use of the mails in furtherance of
ments made, in the light of the circumstances his purchases .tisfies the statutory require-
under which they were made, not misleading, ment of § 10 for federal jurisdiction.
or
R?
States v. Persky, 520 F.2d 283, 287-88 (2d
Cir. 1975). Chiarella’s purchases further
acted as a fraud upon the acquiring corpo-
rations whose plans and information he
‘took while he was setting them in type,
because his purchases might possibly have
raised the price of the target companies’
stock, increasing the cost of legitimate mar-
ket purchases by such acquiring corpora-
tions, and thus constituted “a manipulative
or deceptive device or contrivance” within
the prohibition of § 10(b) and Rule 10b-5.
See A. T. Brod & Co. ¥. Periow, 375 F.2d
393 (2d Cir. 1967).
Looking in the other direction, Chiarella’s
failure to disclose his purloined information
to the sellers whose stock he purchased
constituted an “inherent unfairness,” Cady,
Roberts & Co., supra, 40 S.E.C. at 912, and a
“deceptive device” in connection with his
“purchases.
_ practices
As to those from whom he purchased,
however, Chiarella urges that he is crimi-
nally liable on these facts only if the offer-
ing companies are similarly liable for pre-
.tender offer purchases of target companics’
shares without disclosure of their intent.
The clear answer to this, as I perceive it, is
that such corporate purchases have a pre-
sumptively legitimate business purpose to
promote economic growth and are appropri-
ately made without disclosure * so as not to
“raise a seller's demands and thus abort the
sale.” General Time Corp. v. Talley Indus-
tries, Inc., 403 F.2d 159, 16+ (2d Cir. 1968),
cert. denied, 393 U.S. 1026, 89 S.Ct. 631, 21
L.Ed.2d 570 (1969). Chiarella’s alleged mis-
use of information, in contrast, was solely
for personal profit, serving no business pur-
pose. It thus falls within the intent of
Congress in the enactment of §° 1%(b) to
punish “those manipulative and deceptive
{that} fulfiil no useful
function.” S.Rep.No.792, 73d Cony., 2d
Sess., 6 (1934).
The motion to dismiss is denied.
- So Ordered.
5. Subject to the require:nents of the Williams
Act, §§ 13(d) & I4{d) of the Securities Ex-
450 F.Supp.—3
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‘
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3 : J ‘ APPENDIX C
Apvendix C
Constitutional Provisions,
Statutes and Regulations
Involved
Constitutional Provisions:
Constitution of the United States,
Amendment 5
No person shall be held ‘to answer for
a capital, or otherwise infamous crime, un-
less on a presentment or indictment of a
Grand Jury, except in cases arising in the
land or naval forces, or in the Militia,
when in actual service in time of War or |
public danger; nor shall any person be
subject for the same offence to be twice
put in jeopardy of life or limb; nor shall
be compelled in any criminal case to be a
witness against himself, nor be deprived of
life, liberty, or property, without due
process of law; nor shall private property
be taken for public use, without just com-
pensation.
Statutes:
15 U.S.C. §78]j (b)
§78j. Manivoulative and deceptive
devices
It shall be unlawful for any person,
directly or indirectly, by the use of any
means or unstrumentality of interstate
commerce or of the mails, or of any
facility of any national securities ex-
change
Cl
(b) To use or employ, in connection
with the purchase or’sale of any security
registered on a national securities ex-
change or any security not so registered,
any manipulative or deceptive device or con-
trivance in contravention of such rules and
‘regulations as the Commission may prescribe
as necessary or appropriate in the public
interest or for the protection of investors.
§1S 0.S.C. §78£f
§78ff. Penalties
(a) Any person who willfully violates
any provision of this chapter (other than
section 78dd-1 of this title), or any rule
or regulation thereunder the violation of
which is made unlawful or the observance
of which is required under the terms of this
chapter, or any person who willfully and
knowingly makes, or causes to be made, any
statement in any application, report, or
document required to be filed under this
chapter or any rule or regulation there-
under or any undertaking contained in a
registration statement as provided in sub-
section (d) of section 780 of this title
or by any self-regulatory organization in
connection with an application for member-
ship or participation therein or to become
associated with a member thereof, which
statement was false or misleading with
respect to any material fact, shall upon
conviction be fined not more than $10,000,
or imprisoned not more than five years, or.
both, except that when such person is an
exchange, a fine not exceeding $500,000 may
be imposed; but no person shall be subject
to imprisonment under this section for the
violation of any rule or regulation if he
proves that he had no knowledge of such
rule or regulation.
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joa h i eh ee ee ae se
initia a
Rule 501, Federal Rules of Evidence
Except as otherwise required by the
Constitution of the United States or pro-
vided by Act of Congress or in rules
prescribed by the Supreme Court pursuant
to statutory authority, the privilege of
a witness, person, government, State, or
political subdivision thereof shall be
governed by the principles of the common
law as they may be interpreted by the courts
of the United States in the light of reason
and experience. However, in civil actions
and proceedings, with respect to an element
of a claim or defense as to which State
law supplies the ruie of decision, the
privilege of a witness, person, government,
State, or political subdivision thereof
shall be determined in accordance with
State law.
New York Labor Law, §537
§537.. Disclosures prohibited
1. Use of information. Information
acquired from employers or employees pur-
suant to this Article shall be for the ex-
clusive use and information of the commis-
sioner in the discharge of his duties
hereunder and shall not be opén to the
public nor be used in any court in any
action or proceeding pending therein un-
less the commissioner is a party to such
action or proceeding, not withstanding any
other provisions of law. Such information
insofar as it is material to the making and
determination of a claim for benefits shall
be available to the parties affected and,
in the commissioner's discretion, may be
made available to the parties affected in
connection with effecting placement.
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2. Penalties. Any officer or employee
of the state, who, without authority of the
commissioner or as otherwise required by law,
shall disclose such information shall be
guilty of a misdemeanor.
Regulations:
17 C.F.R. §240.10b=-5
It shall be unlawful for any person,
directly or indirectly, by the use of any
means or instrumentality of interstate
commerce or of the mails, or of any facility
of any national securities exchange
(1) to employ any device, scheme,
Or artifice to defraud,
(2) to make any untrue statement of a
material fact or to omit to state a
material fact necessary in order to
make the statements made, in the light
of circumstances under which they
were made, not misleading, or
(3) to engage in any act, practice or
course of business which operates or
would operate as a fraud or deceit
upon any person,
in connection with the purchase or sale of
any security.
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SS ee
emt es
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.