Petition — Newman v. United States

Office-$

8 ») pa l 6 5 3 " ‘oR ar US.

No. APR 8 1983

hintihbiineMel STEVAS,

CLERK

IN THE

Supreme Court of the United States

OCTOBER TERM, 1982

JAMES MITCHELL NEWMAN,

Petitioner,

V.

UNITED STATES OF AMERICA,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

ARTHUR F.. MATHEWS *

LOUIS R. COHEN

MICHAEL R. KLEIN

ANDREW B. WEISSMAN

THOMAS W. WHITE

WILMER, CUTLER & PICKERING

1666 K Street, N.W.

Washington, D.C. 20006

(202) 872-6000

Counsel for Petitioner

* Counsel of Record

April 8, 1983

—=

QUESTIONS PRESENTED

1. May a conviction of mail fraud be based solely on

an employee’s unauthorized use of confidential informa-

tion learned in the course of his employment without any

allegation that pecuniary harm was either contemplated

or caused?

2. May a conviction of securities fraud under Sec-

tion 10(b) of the Securities Exchange Act of 1934 be

based, notwithstanding Chiarella v. United States, 445

U.S. 222 (1980), solely on the unauthorized use of non-

public “outside” information, without any allegation that

the defendant owed any duty of disclosure to any person

who purchased or sold securities, or that any such person

suffered pecuniary harm?

8. Did petitioner have fair notice that securities trad-

ing based on unauthorized use of nonpublic “outside” in-

formation was unlawful under federal law where pertinent

judicial decisions and Securities and Exchange Commis-

sion pronouncements prior to his acts indicated such

trades were lawful?

(i)

TABLE OF CONTENTS

QUESTIONS PRESENTED ...0.0.......:cccccccceccesseeeeeeeeeeseees

SE A MRR EPIEE BRIIMD wocncaseccsccsossesccnsccaseccceccsecsesces

soc sasderesseassacnessessaecensscdsssseesscassoncsnssese

ee nsiccssnsssceesecesessesasnasenessnceccssosensee

STATUTORY PROVISIONS AND REGULATION

Sia nctdasansdepeovaresusecsensssocsencecnnccececocese

STATEMENT OF THE CASE .....0........:ccccccccsssseesesseeeees

REASONS FOR GRANTING THE WRIT ....................

I.

II.

ITI.

The Decision Below Radically Extends the Fed-

eral Crime of Mail Fraud to Private Misuse of

Information Without Any Actual or Contem-

plated Pecuniary Injury to the Victim ................

The Court Below Improperly Resolved the Issue

Left Open in Chiarella v. United States by Fed-

eralizing Breaches of Duty Wholly Within the

Province of State Law Which Had No Effect on

Persons Involved in Securities Transactions......

A. The Rule Adopted Below Improperly Ex-

tends the Federal Securities Law To Reach

Conduct Traditionally Governed by State

as nanavanenosancnenanccccse

B. Determination of the Validity of the Govern-

ment’s “Misappropriation” Theory Is Vital

to the Securities Industry ....0.0...0..00000.......

Petitioner’s Conviction Violates Due Process of

Law Because He Was Indicted and Convicted

Under Section 10(b) for Conduct Never Before

Held To Be a Crime, and at the Time Reason-

ably Believed To Be Lawful |... ..

CONCLUSION ........... SEE aiteiiblshatierseneicessecetessseceeeess

(iii)

13

14

19

21

iv

TABLE OF AUTHORITIES

CASES Pape

Blue Chip Stamps v. Manor Drug Stores, 421 U.S.

Ak « RRURS PIRI Oris es Cherent Onin De prt erters Nel 18

Bouie v. City of Columbia, 378 U.S. 347 (1964)... 23

Chiarella v. United States, 445 U.S. 222 (1980) ....passim

Connally v. General Construction Co., 269 U.S. 386

A, RRSRER SEA EERE VT ec eiad grok PD IIs Ca Ws OH Ne 23

Diamond v. Oreamuno, 24 N.Y.2d 494, 248 N.E.2d

BE AID cvastnecsacesstanaci visdasceacuntraveceuecmcns Ginetcnabacnien 1¢

Dirks v. SEC, No, 82-276 (argued March 21,

I ee a Ueicdatesicie ds euch ecsittet tied ken. iceachadeatusigtonahindes . 4

Dunn v. United States, 442 U.S. 100 (1979) ...... 23

Durland v. United States, 161 U.S. 306 (1896)...... 9

Eason v. General Motors Acceptance Corp., 490

F.2d 654 (7th Cir. 1973), cert. denied, 416 U.S.

RP: I cctsacncscsecceraaciasadicasccdetacesucent Actsmpbinussy 18

Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976)... 12

General Time Corp. v. Talley Industries, Inc., 403

F.2d 159 (2d Cir. 1968), cert. denied, 393 U.S.

REA EN Rie aad Mant lama, RATES LS 23

Grayned v. City of Rockford, 408 U.S. 104 (1972). 22

Hammerschmidt v. United States, 265 U.S. 182

5 SAREE ET ae SRO Ra 2 ORT ara Gathers Rael Rees 8,9, 12

Ketchum v. Green, 557 F.2d 1022 (3d Cir. 1977),

cert. denied, 484 U.S. 940 (1977) ................ccc eee 18

Lanzetta v. New Jersey, 306 U.S. 451 (1989)........ 23

Mallis v. Bankers Trust Co., 615 F.2d 68 (2d Cir.

1980), cert. denied, 449 U.S. 1123 (1981) ........... 16

Morrison v. National Broadcasting Co., 226 N.Y.S.

2d 406 (Sup. Ct. 1965), rev'd, 280 N.Y.S.2d 641

COPD vckictaccoeeaateteeen 16

Radiation Dynamics, Ine. v. . Goldmunts, 464 F.2d

876 (2d Cir. 1972) . 23

Santa Fe Industries, Ine. v. Green, 430 US. 462

(1977) Ne Pink 12, 15, 16, 17

SEC v. Great American Industries, Ine., 407 F.2d

453 (2d Cir. 1968) (en banc), cert. denied, 395

U.S. 920 (1969) 23

SEC v. Texas Gulf Sulphur Co., 401 F.2d 883 (2d

Cir. 1968), cert. denied, 404 U.S. 1006 ................ 18

¥

TABLE OF AUTHORITIES—Continued

Page

Shushan v. United States, 117 F.2d 110 (5th Cir.),

cert. denied, 818 U.S. 574 (1941) .........00 10

Superintendent of Insurance v. Bankers Life &

Casualty Co., 404 U.S. 6 (1971) ..........cccccccseccceees. 17,18

United States v. Bronston, 658 F.2d 920 (2d Cir.

1981), cert. denied, 456 U.S. 915 (1982) .......... 11

United States v. Bryza, 522 F.2d 414 (7th Cir.

1975), cert. denied, 426 U.S. 912 (1976) .......... 11

United States v. Bush, 522 F.2d 641 (7th Cir.

1975), cert. denied, 424 U.S. 977 (1976) ............. 11

United States v. Chiarella, 588 F.2d 1358 (2d Cir.

1978), rev'd, 445 U.S. 222 (1980) ...........0. 19, 24

United Stutes v. Dixon, 586 F.2d 1888 (2d Cir.

I aki ns cussica datedichtusbapehisuaandatrsgdsdutadaain teatiepinhasinmnitis 10, 11

United States v. George, 477 F.2d 508 (7th Cir.),

cert. denied, 414 U.S. 827 (1978) ..........0. 11

United States v. Harriss, 347 U.S. 612 (1954)...... 23

United States v. Isaacs, 493 F.2d 1124 (7th Cir.),

cert. denied, 417 U.S. 976 (1974) ...........ccccceeeeeeeee 10

United States v. Mandel, 591 F.2d 1347 (4th Cir.),

on rehearing en bane, 602 F.2d 653 (4th Cir.

1979) (per curiam), cert. denied, 445 U.S. 961

Cael GRE RL Ieee ae Lee PRET On Set Wee eee 10

United States v. Naftalin, 441 U.S. 768 (1979)...... 18

United States v. Regent Office Supply Co., Inc.,

ME TBE BUTE. CE Cae, FOTO ovsiccnrcccdessavccsovcsssnces 9

United States v. States, 488 F.2d 761 (8th Cir.

1973), cert. denied, 417 U.S. 909 (1974) ........... 10

United States v. Von Barta, 635 F.2d 999 (2d Cir.

1980), cert. denied, 450 U.S. 998 (1981) ......... ; 11

Vincent v. Moench, 473 F.2d 430 (10th Cir. 1973) .. 18

Walton v. Morgan Stanley & Co., 628 F.2d 796 (2d

AIRES SECURE nie et ate Ov 20

STATUTES AND REGULATIONS

Securities Exchange Act of 1984, §10(b), 15

i lance ata puuasmiasennbind passim

18 U.S.C. § 371 y uigalbssedekababuaataiodaa 1

I a Dasara pbicbtane 1,2,8

vi

TABLE OF AUTHORITIES—Continued

- gis 25 ae E | ; FS enenep nN eRe ae SE care oe

N.Y. PENAL LAW §§ 155.00(1), (2), (3), 155.05,

and 165.07 (McKinney 1975) ......... sciciuiiaumcunameies

N.Y. PENAL LAW $190.60 (McKinney Supp.

MD i necedatssesis uicthctaincelcsiederusdaupcsciuacauancclabieaimaaeieae

Oe ee se IIE incessceniecdnecieuntnncteptnsmnaatael

Oe ae i Ae I icin sciccencssucichtecoacncnatussucdeneuseanans

ADMINISTRATIVE RULINGS

Tender Offers, Sec. Act Rel. No. 6329, [1980 Trans-

fer Binder] Fed. Sec. L. Rep. (CCH) " 82,626

COE GRID on esticeccnisecscedcccescchaccsoumsdonanemnats

In Re Dirks, Exch. Act Rel. No. 17380, [1981

Transfer Binder) Fed. Sec. L. Rep. (CCH)

" 82,812 (January 22, 1981), a/ff’d, 681 F.2d 824

(D.C. Cir.), cert. granted, 108 S. Ct. 371 (1982)..

MISCELLANY

Barry, The Economics of Outside Information and

Rule 10b-5, 129 U. Pa. L. REV. 1807 (1981)........

Brudney, /nsiders, Outsiders, and Informational

Advantages Under the Federal Securities Laws,

OB TEARY. La. REV. BEB (IGT) ........cccerccosccceccccsscesccns

Coffee, From Tort to Crime: Some Reflections on

the Criminalization of Fiduciary Breaches and

the Problematic Line Between Law and Ethics,

19 AM. Crim. L. REV. 117 (1981) .....0....0000000000....

Comment, The Intangible Rights Doctrine and

Political Corruption Prosecutions Under the

Federal Mail Fraud Statute, 47 U. Cut. L. REV.

BE IID vs snstasincisanmteachnciceniessmticadaiacasen ta rare

Fleischer, Mundheim & Murphy, A» Initial Inquiry

into the Responsibility to Disclose Market In-

formation, 121 U. PA. L. REv. 798 (1978) ...........

Hurson, Limiting the Federal Mail Fraud Stat-

ute—A Legislative Approach, 20 AM. CRIM. L.

STEED ccsniocinssnceinmtnindecgumichamanamasamiaas

16

passim

19

21

8,9

vii

TABLE OF AUTHORITIES—Continued

Koelt]l & Kuock, Chiarella and Market Information,

13 REV. OF SEC. REG. 903 (1980) ...........000c.

Morano, The Mail Fraud Statute: A Procrustean

Bed, 14 J. MAR. L. REV. 45 (1980) ...000000000000cc..

Note, Trading on Confidential Infornation—

Chiarella Takes an Encore: United States v.

Newman, 56 ST. JOHN’S L. REV. 727 (1982)........

Note, 13 SETON HALL L. REV. 178 (1982) ..............

Rakoff, The Federal Mail Fraud Statute (pt. 1),

Be ey Bile Rs CED CID vececticcceccctencnecncesnelevenence

Recent Decisions, 58 NOTRE DAME L. REV. 132

ee

Recent Developments, 27 VitL. L. REV. 1329

SID edahadbedsissiaschsdesateidenichieighguticbohboalcabccmoncenascecocnsasstadtons

Page

IN THE

Sigreme Court of the United States

OCTOBER TERM, 1982

No.

JAMES MITCHELL NEWMAN,

> Petitioner,

UNITED STATES OF AMERICA,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Petitioner James Mitchell Newman prays that a Writ

of Certiorari issue to review the judgment of the United

States Court of Appeals for the Second Circuit entered in

this case.

OPINIONS BELOW

The United States Court of Appeals for the Second

Circuit affirmed petitioner’s conviction of mail fraud, 18

U.S.C. § 1841, securities fraud, 15 U.S.C. § 78j(b) and

17 C.F.R. § 240.10b-5, and conspiracy to commit mail

fraud and securities fraud, 18 U.S.C. § 371. The court of

appeals’ order, which is unreported, is set forth in the

Appendix (“App.”) at la-3a. A previous opinion of the

court of appeals arose on the United States’ appeal of the

dismissal of the indictment. The district court’s opinion

dismissing the indictment is set forth at App. 4a-39a.

The court of appeals’ opinion reinstating the indictment

is reported at 664 F.2d 12 (2d Cir. 1981) and is set

forth at App. 40a-54a.

2

JURISDICTION

Jurisdiction to review the court of appeals’ February

8, 1988, judgment is vested in this Court by 28 U.S.C.

§ 1254(1).

STATUTORY PROVISIONS AND

REGULATION INVOLVED

The federal mail fraud statute, 18 U.S.C. § 1341, pro-

vides:

$1341. Frauds and swindles

Whoever, having devised or intending to devise any

scheme or artifice to defraud, or for obtaining money

or property by means of false or fraudulent pre-

tenses, representations, or promises, or to sell, dis-

pose of, loan, exchange, alter, give away, distribute,

supply, or furnish or procure for unlawful use any

counterfeit or spurious coin, obligation, security, or

other article, or anything represented to be or inti-

mated or held out to be such counterfeit or spurious

article, for the purpose of executing such scheme or

artifice or attempting so to do, places in any post of-

fice or authorized depository for mail matter, any

matter or thing whatever to be sent or delivered by

the Postal Service, or takes or receives therefrom, any

such matter or thing, or knowingly causes to be de-

livered by mail according to the direction thereon, or

at the place at which it is directed to be delivered by

the person to whom it is addressed, any such matter

or thing, shall be fined not more than $1,000 or im-

prisoned not more than five years, or both.

Section 10(b) of the Securities Exchange Act of 1934

(the “1934 Act”), 15 U.S.C. § 78j(b), provides:

§ 78}. Manipulative and deceptive devices

It shall be unlawful for any person, directly or in-

directly, by the use of any means or instrumentality

3

of interstate commerce or of the mails, or of any fa-

cility of any national securities exchange—

(b! To use or employ, in connection with the pur-

chase or sale of any security registered on a national!

securities exchange or any security not so registered,

any manipulative or deceptive device or contrivance

in contravention of such rules and regulations as the

Commission may prescribe as necessary or appropri-

ate in the public interest or for the protection of in-

vestors.

Rule 10b-5 of the Securities Exchange Commission

(“S.E.C."), 17 C.F.R. § 240.10b-5, provides:

$ 240.10b-5 Employment of manipulative and decep-

tive devices.

It shall be unlawful for any person, directly or in-

directly, by the use of any means or instrumentality

of interstate commerce, or of the mails or of any fa-

cility of any national securities exchange,

(a) To employ any device, scheme, or artifice to

defraud,

(b) 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 the

circumstances under which they were made, not mis-

leading, or

(ec) 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 pur-

chase or sale of any security.

4

STATEMENT OF THE CASE

The decision below broke new ground in the law of

both mail fraud and securities fraud. It held for the first

time that the mail fraud statute encompasses an employ-

ee’s unauthorized use of information belonging to his em-

ployer even if there was no intended or actual pecuniary

loss to the employer. It also is the first decision finding

civil or criminal liability under S.E.C. Rule 10b-5 for

unauthorized use of nonpublic “outside” information by

persons not alleged to have owed any duty to any party to

a securities transaction or to the issuer of the securities.’

Petitioner James Mitchell Newman has been a profes-

sional securities trader for more than 10 years. During

part of the period covered by the indictment, petitioner

was employed as a securities trader and manager of the

' This case, like Chiarella ». United States, 445 U.S. 222 (1980),

and Dirks v. S.E.C., No. 82-276 (argued March 21, 1983), involves

the expansion of liability under Section 10(b) of the 1934 Act and

S.E.C. Rule 10b-5 beyond its traditional scope. Because the court

below extended Section 10(b) beyond its commonly understood

prohibition against “insider trading” to proscribe trading while

in possession of nonpublic “outside” information, it is crucial to

understand the terminology used here and in the literature. “In-

side” information is “nonpublic information that belongs to and

emanates from the corporation whose securities are traded.”

Barry, The Economics of Outside Information and Rule 10b-5, 129

U. Pa. L. Rev. 1307, 1309 (1981). Inside information generally

concerns the internal business affairs of the issuer. An “insider”

is a person with a relationship to the issuer “affording access to

inside information intended to be available only for a corporate

purpose... .” Chiarella, 445 U.S. at 227. “Outside” information

is “nonpublic information created by and belonging to sources out-

side the issuer.” Barry, supra, at 1309. Outside information often

is not about the internal affairs of the issuer, but may nevertheless

be of interest to investors in its securities. See also Brudney, /n-

siders, Outsiders, and Informational Advantages Under the Fed-

eral Securities Laws, 93 Harv. L. REV. 322, 329 (1979); Fleischer,

Mundheim & Murphy, An Initial Inquiry into the Responsibility To

Disclose Market Information, 121 U. Pa. L. REv. 798, 799 (1973) ;

Koelt] & Kubek, Chiarella and Market Information, 18 REV. oF SEC.

REG. 903, 904 (1980).

5

over-the-counter trading department of a securities

broker-dealer; he later left to engage in trading for his

own account.

Petitioner and three co-defendants, E. Jacques Courtois,

Jr. (“Courtois”), Franklin Carniol, and Constantine

Spyropolous,? were indicted for mail fraud, securities

fraud, and conspiracy to commit mail, wire and securities

fraud arising out of certain purchases of stock between

1974 and 1978. App. 55a-78a. The indictment charged

that Courtois and Adrian Antoniu (“Antoniu”), an un-

indicted co-conspirator," “misappropriated” * confidential

information entrusted to their employers, Morgan Stanley

& Co., Inc. (“Morgan Stanley”) and Kuhn Loeb & Co.

(“Kuhn Loeb”), by their respective clients regarding the

plans of those clients to acquire other companies.’ Since

the information originated with the prospective acquirers

rather than the prospective targets, it was “outside” in-

formation—information of interest to securities traders

but not obtained from sources within the issuer. The in-

dictment alleged that Courtois and Antoniu obtained such

*Courtois and Carniol reside outside of the United States and

have not been extradited for prosecution under the indictment.

After petitioner's conviction, Spyropolous entered into a plea bar-

gain with the Government.

* Antoniu, apparently the central figure in the alleged conspiracy,

entered into a plea bargain with the Government and cooperated in

the prosecution of petitioner.

‘ Although the indictment uses the term “misappropriate,” it does

not allege that information was “taken” in the sense that its

“owners” were deprived of that information. Instead, the in-

dictment uses the terra “misappropriation” as the equivalent of

“misuse” of information, that is, use of information by employees

in a manner contrary to that intended by their employers.

5 Morgan Stanley and Kuhn Loeb are investment banking firms

which, among other things, represented companies engaged in cor-

porate mergers, acquisitions, tender offers, or other takeovers. App.

55a-56a. For convenience, they are sometimes hereinafter referred

to together as the “investment bankers” or the “employers.” Simi-

larly, Courtois and Antoniu are sometimes referred to as the

“employess.”

6

information, that Antoniu communicated it to petitioner

and others who purchased stock in the target companies,

and that Courtois and Antoniu concealed these facts

from their employers. Petitioner was the only person

tried under the indictment."

The indictment charged that by misappropriating in-

formation and failing to disclose the securities purchases

to their employers the employees “violated and caused

each other to violate the fiduciary duties of honesty, loy-

alty and silence which each owed” to the employers. App.

60a-61la. Petitioner and the others allegedly “aided, par-

ticipated in and facilitated Courtois and Antoniu in vio-

lating” these fiduciary duties. App. 61a.

The indictment did not assert that Morgan Stanley,

Kuhn Loeb, or any of their clients—the alleged victims of

the fraud—-suffered any economic harm, nor that the al-

leged scheme contemplated any pecuniary loss on their

part. Nor did the indictment charge that any purchaser

or seller of securities, or any other participant in any

securities transaction, was misled, deceived or defrauded,

or suffered any pecuniary loss. The indictment alleged

only that p itioner aided two employees in their respec-

tive breaches of a duty owed their employers of honesty,

loyalty and silence, and that he indirectly used the mails.

District Judge Haight granted petitioner’s pretrial mo-

tion to dismiss the indictment. Judge Haight found: (i)

the Section 10(b) counts failed to state a prosecutable

offense because they alleged only a breach of duty owed

to persons who were not securities purchasers, sellers or

® Another person who traded on the same information as peti-

tioner, Eruce Steinberg, was not indicted and was advised by the

Government that he had not c mmitted any crime. Steinberg testi-

fied for the Government under a grant of immunity. Although he

testified that he joined petitioner in the purchase of securities of

target companies, he was twice told by the Government—on June

20, 1978, and again on April 15, 1981 (after several extensive inter-

views by prosecutors revealing his activities) —that the prosecution

“is not presently possessed of information that Bruce Steinberg has

committed a crime.” App. 150a-153a.

7

investors, and such breaches of duty are governed by

state law, not the federal securities laws ‘App. 25a);

(ii) the theory of Section 10(b) liability pursued by the

Government was so novel that it “does not charge New-

man with acts that were proscribed by the securities

laws then in force” (App. 27a); and (iii) the mail fraud

counts failed to state a prosecutable offense because they

were “devoid of any allegation of economic loss, actual

or contemplated, on the part of the investment banks or

their clients,” and that without such allegations “|t]he

conduct alleged in the indictment cannot be brought with-

in the mail fraud statute without stretching its terms

beyond the degree permitted by basic principles of crimi-

nal law.” App. 37a-38a.

A divided panel of the Court of Appeals for the Second

Circuit reversed the decision of the district court and re-

manded the case for trial. The majority held that the

charges in the indictment “could be found to constitute

a criminal violation of section 10(b) despite the fact that

neither Morgan Stanley, Kuhn Loeb nor their clients was

at the time a purchaser or seller of the target company

securities in any transaction with any of the defendants.”

App. 44a. The majority also summarily rejected Judge

Haight’s dismissal on the ground of fair notice and due

process. App. 49a-50a. The full panel reinstated the mail

fraud counts, finding that: “The district court erved in

holding that, in every mail fraud case based upon a

breach of fiduciary duty by a private employee, there

must be proof of ‘direct, tangible, economic loss to the

victim, actual or contemplated.’”’ App. 52a.

Following a five-week trial, petitioner was convicted of

one count of conspiracy, seven counts of securities fraud

and seven counts of mail fraud, all arising out of the

breaches of duty by Courtois and Antoniu alleged in the

indictment. Petitioner was sentenced to imprisonment

for one year and one day, probation for three years there-

after, and a fine of $10,000. Petitioner’s second appeal to

the Court of Appeals reasserted his argument that the

8

indictment violated due process and failed to charge

crimes under Section 10(b) and the mail fraud statute,

and objected to the jury instructions which aliowed a

conviction under the theories pursued in the indictment.

On February 8, 1983, the Court of Appeals for the Second

Circuit affirmed petitioner’s conviction. App. la-3a.

REASONS FOR GRANTING THE WRIT

I. THE DECISION BELOW RADICALLY EXTENDS

THE FEDERAL CRIME OF MAIL FRAUD TO PRI-

VATE MISUSE OF INFORMATION WITHOUT

ANY ACTUAL OR CONTEMPLATED PECUNIARY

INJURY TO THE VICTIM.

This petition presents a novel and important question

concerning the federal crime of mail fraud. The court be-

low held that an employee’s breach of his duty of “honest

and faithful service” to his private employer constitutes

mail fraud even if the employee neither intends nor

causes economic injury to his employer. App. 52a.’

This Court declared long ago that mail fraud is “con-

fined to pecuniary or property injury inflicted by a scheme

to use the mails for the purpose.” Hammerschmidt v.

United States, 265 U.S. 182, 188-89 (1924).* This Court

7The Second Circuit’s theory was well-stated in the district

court’s charge to the jury:

“(I]t is not necessary, in a mail fraud case based upon a breach

of fiduciary duty by a private employee, for the Government to

prove direct, tangible, economic loss to the victim, actual or

contemplated ... Schemes designed to deprive its [sic] victims

of intangible rights also violate the mail fraud statute.” App.

128a.

The district court further charged the jury, in effect, that any

deprivation of the employee’s “honest services” was sufficient to

convict. Jd.

’ A recent comprehensive examination of the language and his-

tory of the mail fraud statute likewise concluded that Congress in-

tended to incorporate the common law rule that fraud was action-

able only where the perpetrator intended to deprive the victim of

his money or property. Comment, The Intangible Rights Doctrine

9

has never sustained a mail fraud conviction in the ab-

sence of such pecuniary harm.

Until recently, prosecutors and courts generally re-

spected the limits on the mail fraud statute articulated

in Hammerschmidt.’ Over the past decade, however,

prosecutions under the mail fraud statute have steadily

expanded to cover an ever-wider range of activities not

before subject to the federal criminal law. “In recent

years, ... the federal mail fraud statute... has been

expansively interpreted to invite federal prosecution of

virtually every type of untoward activity known to

man,” '°

and Political Corruption Prosecutions Under the Federal Mail

Fraud Statute, 47 U. Cut. L. REV. 562, 566-78 (1980). The statute

proscribes a “scheme or artifice to defraud, or for obtaining money

or property by means of false or fraudulent pretenses, representa-

tions, or promises.” 18 U.S.C. § 1341. The reference to “money or

property” in one phrase does not mean that the term “scheme or

artifice to defraud” encompasses non-pecuniary injuries. The

“money or property” phrase was added in 1909, to codify the hold-

ing of Durland v. United States, 161 U.S. 306 (1896), that the

statute extended to false promises, in addition to fraudulent mis-

representations of fact. See Comment, /ntanyible Rights, supra,

at 570-72. Nothing in Durland suggests that the statute extends

to schemes or artifices not involving actual or contemplated eco-

nomic injury.

”E.g., United States v. Regent Office Supply Co., Inc., 421 F.2d

1174, 1180 (2d Cir. 1970) (the Government cannot “escape the

burden of showing that some actual harm or injury was contem-

plated by the schemer”) (emphasis in original).

10 Hurson, Limiting the Federal Mail Fraud Statute—A Legisla-

tive Approach, 20 AM. CRIM. L. REV. 423, 424 (1983). The pace

and troublesome thrust of this recent trend is reflected in the

volume and tenor of this and other recent learned commentary. See,

e.g., Coffee, From Tort to Crime; Some Reflections on the Criminali-

zation of Fiduciary Breaches and the Problematic Line between Law

and Ethics, 19 AM. CRIM. L. REV. 117 (1981); Rakoff, The Federal

Mail Fraud Statute (pt. 1), 18 Dug. L. Rav. 771 (1980) ; Comment,

Intangible Rights, supra note 8; Morano, The Mail Fraud Statute:

A Procrustean Bed, 14 J. MAR. L. REV. 45 (1980).

10

The first step in this growth occurred in the area of

public official corruption.'' As Judge Friendly later

stated, the “doctrine of the deprivation of honest and

faithful services . . . developed to fit the situation in

which a public official avails himself of his public position

to enhance his private advantage, often by taking bribes.”

United States v. Dixon, 586 F.2d 1388, 1400 (2d Cir.

1976). This extension of the crime of mail fraud rested

on the perception that public officials should be held to

higher standards of conduct than other individuals: “No

trustee has more sacred duties than a public official and

any scheme to obtain an advantage by corrupting one

must in the federal law be considered a scheme to de-

fraud.” Shushan v. United States, 117 F.2d 110, 115

(5th Cir.), cert. denied, 313 U.S. 574 (1941).

Prosecutors, particularly in the Second Circuit, soon

attempted to extend these principles to private conduct.

In the beginning they were unsuccessful. In United

States v. Dixon, Judge Friendly recognized that the mail

fraud statute did not encompass all violations of duty in

the commercial context. He noted that while breaches of

private fiduciary obligations violated the mail fraud stat-

ute when the purpose of the scheme was “‘to obtain direct

pecuniary gain,” a corporate officer’s failure to make dis-

closures to shareholders mandated by S.E.C. rules was not

actionable as mail fraud on the theory that the failure to

disclose deprived shareholders of the officer’s “honest and

faithful services.” 566 F.2d at 1399-1400." Four years

11 In United States v. States, 488 F.2d 761 (8th Cir. 1973), cert.

denied, 417 U.S. 909 (1974), for example, a court of appeals for the

first time upheld a mail fraud conviction where the only injury

alleged was the deprivation of “intangible” political and civil rights.

States was soon applied to other cases involving government offi-

cials. E.g., United States v. Mandel, 591 F.2d 1347 (4th Cir.), on

rehearing en banc, 602 F.2d 653 (4th Cir. 1979) (per curiam),

cert. denied, 445 U.S. 961 (1980); United States v. Isaacs, 493 F.2d

1124 (7th Cir.), cert. denied, 417 U.S. 976 (1974).

'2 The Dizon opinion noted that it was unnecessary to determine

whether the principle of the political corruption cases that a show-

11

later, however, in a case involving an alleged actual loss

to the victim of two million dollars, the Second Cir-

cuit declared in dictum that “the object of the fraudulent

scheme need not be the deprivation of a tangible interest,”

but could include an employer’s right to the honest and

faithful services of his employees. United States v. Von

Barta, 635 F.2d 999, 1006 (2d Cir. 1980), cert. denied,

450 U.S. 998 (1981). The Second Circuit the very next

year held that a breach of fiduciary duty was actionable

even though it was not causally related to the contem-

plated injury to the victim. United States v. Bronston,

658 F.2d 920 (2d Cir. 1981), cert. denied, 456 U.S. 915

(1982). Even in Bronston, however, the court recognized

that the scheme at issue “was designed to inflict actual

economic harm on [the victims] and was capable of doing

so.” Id. at 928 (emphasis added).

The line drawn in Dixon was abandoned in the present

case. Here the Second Circuit upheld the conviction of a

private citizen for aiding a purported “fiduciary breach”

consisting solely of secret unauthorized use of information

in violation of an employee’s duty of “honest and faithful

service” without requiring the jury to find any contem-

plated or actual pecuniary harm to the employer.’® This

ing of economic harm was not necessary “should be carried over to

the private field,” e.g., where an element of corruption, such as

bribery, was involved. 536 F.2d at 1401.

13 In cases involving kickbacks or other payments to employees by

suppliers, the courts have invoked the deprivation of honest and

faithful services rationale. E.g., United States v. George, 477 F.2d

508 (7th Cir.), cert. denied, 414 U.S. 827 (1973); United States

v. Bryza, 522 F.2d 414 (7th Cir. 1975), cert. denied, 426 U.S. 912

(1976). Those cases, however, involve economic injury to the

employer because the scheme contemplates that the employer will be

deprived of discounts that the supplier would presumably otherwise

be willing to offer to the employer, but instead pays to the employee.

See United States v. George, 477 F.2d at 513; United States v. Bush,

522 F.2d 641, 648 (7th Cir. 1975), cert. denied, 424 U.S. 977

12

case, in effect, federalizes and criminalizes as “fraud” any

violation of a company policy, any employee peccadillo, so

long as the bare jurisdictional requirement of a mailing is

satisfied.

In marked contrast to this unrestrained lower court ex-

pansion of the meaning of “fraud” in the mail fraud con-

text, this Court has in other contexts sought to define

with some precision the boundaries of the concept of

fraud in federal statutes. In Ernst & Ernst v. Hoch-

felder, 425 U.S. 185 (1976), this Court held that the fed-

eral securities law references to fraud incorporated the

common law understanding that “fraud” actions require

proof of scienter. Then, in Santa Fe Industries, Inc. v.

Green, 480 U.S. 462 (1977), a civil action, the Court re-

jected the notion that federal securities law fraud em-

braced every breach of duty touching a securities trans-

action—exactly the same breadth that the Second Circuit

would now give the crime of mail fraud where there is

any use of the mails.

If this Court is to prevent the trivialization of the

criminal process, it must impose limitations on the mail

fraud law akin to those imposed on civil actions under

similar federal statutes. As this Court concluded in

Hammerschmidt, supra, in the area of private conduct

such limitations are found in the requirement of pecu-

niary harm.

(1976) (in kickback case, no need to express opinion on whether

pecuniary injury must be shown to establish mail fraud violation,

because pecuniary injury was present).

13

II. THE COURT BELOW IMPROPERLY RESOLVED

THE ISSUE LEFT OPEN IN CHIARELLA ov.

UNITED STATES BY FEDERALIZING BREACHES

OF DUTY WHOLLY WITHIN THE PROVINCE OF

STATE LAW WHICH HAD NO EFFECT ON PER-

SONS INVOLVED IN SECURITIES TRANSAC-

TIONS.

This petition presents the “misappropriation” issue ex-

pressly left open by this Court’s recent interpretation of

Section 10(b) of the 1934 Act in Chiarella v. United

States, 445 U.S. 222 (1980). In Chiarella, the Court held

that Section 10(b) does not impose a duty to “disclose

or refrain from trading” on an individual who comes

into possession of nonpublic information but is not a

corporate insider and has no “special relationship” to the

seller of securities... The Court left open the question

whether the individual’s breach of duty to his employer—

from whom he obtained access to material outside infor-

mation—could provide the basis for a Section 10(b)

conviction.”®

4 The Court said that “a purchaser of stock who has no duty to a

prospective seller because he is neither an insider nor a fiduciary

has been held to have no obligation to reveal material facts.”’ 445

U.S. at 229. The opinion stated that a conviction required proof of

a breach of a duty to disclose “arising from a relationship of trust

and confidence between parties to a transaction.” Jd. at 230.

15The Court found that “[wje need not decide whether this

theory has merit for it was not submitted to the jury.” 445 U.S.

at 236. Chief Justice Burger, however, wrote in dissent that:

“T would read §10(b) and Rule 10b-5 . . . to mean that a person

who has misappropriated nonpublic information has an absolute

duty to disclose that information or to refrain from trading.” 445

U.S. at 240. The prosecutors in this case, by focusing on a failure

to disclose the misappropriation to the employers, pursued a mis-

appropriation theory different from the Chief Justice’s, which

creates a duty to disclose to the sellers of securities information

gained by means of misappropriation.

14

The Government framed the indictment in this case in

order to test the issue left open in Chiarella.’ Its theory

below was that a breach of an employee’s duty to his em-

ployer, not alleged to cause any harm to any person

involved in a securities transaction, was nonetheless

prosecutable under Section 10(b)."’

A. The Rule Adopted Below Improperly Extends the

Federal Securities Laws To Reach Conduct Tradi-

tionally Governed by State Law.

The breach of duty alleged by the Government involves

only contractual or fiduciary obligations of employees to

their employers, not duties created by the federal securi-

ties laws. The victims of the conduct—the investment

bankers and their clients—were not involved in any of

the securities transactions described in the indictment.

See App. 44a.

The Government did not charge that the use of non-

public outside information of impending takeover bids

was itself unlawful. That is because under Chiarella,

there being no relationship of trust and confidence be-

tween petitioner or the employees and the sellers of secu-

16 For this reason, the decision below has been the subject of

considerable commentary. E.g., Note, Trading On Confidential In-

formation—Chiarella Takes An Encore: United States v. Newman,

56 ST. JOHN’S L. REV. 727 (1982); Recent Developments, 27 VILL.

L. REV. 1829 (1982); Note, 13 SETON HALL L. REV. 178 (1982);

Recent Decisions, 58 NOTRE DAME L. REV. 132 (1982).

17 Accordingly, the jury was charged by the district court as

follows:

“The Government does not charge in this case that the persons

from whom Mr. Newman purchased stocks in the target com-

pany were themselves defrauded. ... This indictment charges

that Mr. Newman and the other individuals referred to de-

frauded, not the sellers of the target companies’ stock but

rather Morgan Stanley, Kuhn, Loeb and their corporate

clients.” App. 120a-121a.

15

rities, petitioner had no duty to disclose material non-

public information or refrain from trading. See 445

U.S. at 228. Petitioner’s prosecution rested solely on

the allegation that the use of this information for secu-

rities purchases had not been authorized by the em-

ployers, and that his colleagues had failed to disclose

that use to them. See App. 137a. No person engaging in

a securities transaction was alleged to have been misled

by this breach of duty to the employers; there was no

contention that had there been disclosure of the unau-

thorized transactions to the employers, any market trade

would have been affected.

The misappropriation of information alleged here is

the type of conduct that traditionally has been the prov-

ince of state law governing employee-employer relation-

ships and commercially sensitive information. The rule

adopted below would change this. It would impose, under

Section 10(b), a federal securities law standard of con-

duct for such matters.'* The federalization of these rela-

tionships merely because after the alleged breach of duty

the information was used in otherwise lawful securities

transactions is clearly beyond the intended scope of the

securities laws.

This Court declared in Santa Fe Industries, Inc. v.

Green, 430 U.S. 462 (1977), that even breaches of fiduci-

ary duty directly affecting securities transactions regis-

tered under the 1934 Act do not constitute violations of

Section 10(b) when the breach is of a type that falls

within the traditional framework of state law. In Santa

Fe, the Court reasoned that applying Rule 10b-5 under

these circumstances “would be to bring within the Rule

a wide variety of corporate conduct traditionally left to

18 See Note, Trading On Confidential Information—Chiarella

Takes An Encore: United States v. Newman, 56 ST. JOHN’S L. REV.

727, 735 (1982) (“the Second Circuit has transformed an employ-

ee’s fiduciary obligations into the status of a new federal securities

law duty”).

16

state regulation,” and that “the extension of the federal

securities laws would overlap and quite possibly interfere

with state corporate law.” 430 U.S. at 478-79. Accord-

ingly, “[a]bsent a clear indication of congressional in-

tent,” the Court was “reluctant to federalize’” state cor-

poration law, “particularly where established state poli-

cies of corporate regulation would be overridden.” Jd. at

479,”

The Sante Fe decision has direct application here. The

conduct at issue here involves matters traditionally gov-

erned by state law—here the law of the State of New

York. The court below circumvented the limitations of

state law * by adopting the strained theory that Section

19 The district court’s original dismissal of the indictment relied

in part on this point. The court stated:

“While the acquiring corporations and investment bankers were

damaged ... insofar as they were deprived of their agent’s

duty of loyalty and ethical behavior, they were not damaged in

their role as future investors in the target companies. While

injury of the latter type falls generally within the domain of

federal law, the former category is more appropriately gov-

erned by state law.” App. 25a.

*? The New York Penal Law makes it unlawful (1) to engage in

a course of conduct with intent to defraud persons or to obtain

property from persons by false or fraudulent pretenses, and (2) to

obtain property by such means from these persons. N.Y. PENAL

LAW § 190.60 (McKinney 1982 Supp.). It is unlikely that the em-

ployees violated this or any other New York Penal Law governing

theft of property because they did not “obtain property” as defined

under the statute, nor did they intend to “deprive” the employers

of property as required to commit larceny. See N.Y. PENAL LAW

§§ 155.00(1), (2), (3), 155.05, and 165.07 and comments thereon

(McKinney 1975). Neither would the employees’ alleged breach of

duty constitute actionable civil fraud. See, e.g., Mallis v. Bankers

Trust Co., 615 F.2d 68, 80 (2d Cir. 1980); Morrison v. National

Broadcasting Co., 266 N.Y.S. 2d 406, 410 (S. Ct. 1965), rev’d on

other grounds, 280 N.Y.S. 2d 641 (1967). The investment bankers

and their clients could, of course, pursue state law causes of

action other than fraud or deceit, including claims for breach of

contract or an equitable accounting for profits obtained through the

use of confidential corporate information. See, e.g., Diamond v.

Oreamuno, 24 N.Y.2d 494, 248 N.E.2d 910 (1969).

17

10(b) applied because the “proceeds” of the employees’

misappropriation—information—were used to determine

which securities petitioner bought. In so holding, Judge

Van Graafeiland, writing for a divided panel, reversed

the district court’s finding “that fraud perpetrated upon

purchasers or sellers of securities is a ‘requisite element

under the securities laws.’” App. 46a.*' Citing this

Court’s decision in Superintendent of Insurance v. Bank-

ers Life & Casualty Co., 404 U.S. 6 (1972), the majority

ruled that any fraud on a person not engaged in securi-

ties trading becomes a Section 10(b) violation if the

fraudulent activity “touches” upon the purchase or sale

of securities. App. 48a-49a. This conclusion both mis-

construes Superintendent and ignores this Court’s subse-

quent admonitions in Santa Fe against federalizing state

law.**

In Superintendent, this Court found Section 10(b) li-

ability where a seller of Government bonds was “duped”

through deceit by its fiduciary into making a sale because

it was fraudulently misrepresented that the seller would

receive the proceeds. 404 U.S. at 9. Liability attached in

Superintendent because the seller “was injured as an in-

*! Judge Dumbauld dissented from this aspect of the court's

opinion, noting “a trend to confine the scope of § 10(b) to practices

harmful to participants in actual purchase-sale transactions.” App.

58a.

“Judge Van Graafeiland also erred by equating the alleged

misappropriation with fraud. Pressed by this Court's statement

in Chiarella that “Section 10(b) is aptly described as a catchall

provision, but what it catches must be fraud,” 445 U.S. at 234-35,

he assumed without discussion that an employee's misuse of confi-

dential corporate information, like embezzlement of corporate

property, was fraud. App. 46a-47a. But this Court made it clear

in Santa Fe that the term “fraud” in Rule 10b-5 cannot be used

“to bring within the ambit of the Rule all breaches of fiduciary

duty in connection with a securities transaction.” 430 U.S. at 472.

The acts of the employees in this case were at most—even if they

had fiduciary rather than mere contractual obligations—breaches

of fiduciary duty.

18

vestor through a deceptive device which deprived it of

any compensation for the sale of its valuable block of

securities.” Jd, at 10 (emphasis added). The Court con-

cluded that “[t]he crux of the present case is that [the

seller] suffered an injury as a result of deceptive prac-

tices touching its sale of securities as an investor.” Id.

at 12-13 (emphasis added). Clearly, Superintendent did

not set forth an expansive “touch” test of the type

adopted by the Second Circuit here. Nor does it other-

wise support a finding of Section 10(b) liability where,

as in this case, the Government scrupulously avoided any

allegation that the fraud ever deceived any person with

an investment interest or participation in the securities

transactions that followed the alleged misappropriation.*"

Indeed, neither this nor any other court has ever

held Section 10(b) applicable where the victim did not

participate in, or have any investment interest in, an af-

fected securities transaction.”

*3 See Recent Developments, 27 VILL. L. REV. 1829, 1346 (1982)

(“a careful reading of [Superintendent] indicates that the fraud

must result from deceptive practices ‘touching’ the purchase or

sale of securities of the defrauded party”) (emphasis in original).

*4 See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723,

737-88 (1975); United States v. Naftalin, 441 U.S. 768 (1979). In

Naftalin, referenced by the court below (App. 49a), this Court

reaffirmed the view that a prerequisite for “securities” fraud is

deceit of a person in connection with his or her participation in

securities trading, when it held that Naftalin violated Section

17(a) (1) of the Securities Act of 1933 because the terms of the

statute were “expansive enough to encompass the entire selling

process, including the seller/agent transaction.” 441 U.S. at 773.

See also Ketchum v. Green, 557 F.2d 1022 (3d Cir.), cert. denied,

434 U.S. 940 (1977); Eason v. General Motors Acceptance Corp.,

490 F.2d 654, 659 (7th Cir. 1973), cert. denied, 416 U.S. 960 (1974)

(opinion of Stevens, J.) ; Vincent v. Moench, 473 F.2d 480, 434-35

(10th Cir. 1978); SEC v. Texas Gulf Sulphur Co., 401 F.2d 8383,

860 (2d Cir. 1968), cert. denied, 404 U.S. 1005 (1971) (Congress

intended Section 10(b) to apply to deceit “of a sort that would

cause reasonable investors to rely thereon, and, in connection there-

with, so relying, cause them to purchase o” sell a corporation’s

securities”).

19

In sum, the rule of law adopted below gave Section

10(b) and Rule 10b-5 unprecedented breadth to cover

conduct traditionally governed by state law. This Court

should review the fundamental question it raises regard-

ing the appropriate scope of federal securities fraud

prosecutions.

B. Determination of the Validity of the Government’s

“Misappropriation” Theory Is Vital to the Securi-

ties Industry.

The Government’s contention is that “a stock purchase

on misappropriated information is in itself a form of

fraud and deception as against the rightful owner of

the information” creating liability under Section 10(b)

and Rule 10b-5.% That theory represents a broadening

of Section 10(b) liability which is of grave import

to the securities industry. The concept of the misuse of

information can be so elusive, both in the definition of

information covered and the determination of its appro-

priate use, that the expansion of Section 10(b) liability

on the misappropriation theory could have the counter-

productive effect on the securities industry of chilling le-

gitimate and productive information-gathering activities.

In the normal course of their employment, many per-

sons in the industry routinely have access to nonpublic

outside information. Investment bankers, for example,

gain access to information in the course of providing

professional services relating to the full range of corpo-

*> See Brief for the United States of America in United States v.

Newnan, Docket No. 81-1225, at 27. See aiso Tender Offers, Sec.

Exch. Act Rel. No. 6239, [1980 Transfer Binder] Fed. Sec. L. Rep.

(CCH) { 82646 at 83456 (Sept. 4, 1980) (“. .. persons who unlaw-

fully obtain or misappropriate material, nonpublic information

violate Rule 10b-5 when they trade on such information”). The

Court of Appeals for the Second Circuit has adopted this theory

See App. 44a; United States v. Chiarella, 588 F.2d 1358, 1368 n.14

(2d Cir. 1978), rev'd on other grounds, 445 U.S, 222 (1980).

20

rate finance transactions. Likewise, the job of securi-

ties analysts is constantly to seek nonpublic information

regarding publicly-traded companies. Often they gather it

by pressing company personnel and other industry sources

for nonpublic news of general applicability or pertaining

to the prospects of particular businesses. Such research

is crucial to the effectiveness of the securities market-

place. Their inquiries are hardly limited to information

of potential or impending takeover efforts, as in this

case. Other areas of obvious interest include such infor-

mation as changes in the levels of orders for certain

products or services; price forecasts for various com-

modities; impending awards of major commercial con-

tracts; changes in key personnel; breakthroughs in re-

search and development; and so forth.” In addition to

such analysis, the market role of some persons requires

that they trade on nonpublic outside information, e.g.,

the stock exchange specialist. See Chiarella, supra, 445

U.S. at 233-34 n.16.

The Government’s misappropriation theory, particularly

when applied in a prosecution for aiding and abetting,

26 See Walton v. Morgan Stanley & Co., 623 F.2d 796 (2d Cir.

1980), where it was held that an investment banker may trade

on nonpublic inside information obtained at arm's length from the

issuer.

27 See Barry, The Economics of Outside Information and Rule

10b-5, 129 U. Pa. L. Rev. 1807, 1314 n.48 (1981):

“Corporations, their associates, and their employees continu-

ously create or receive from countless outside sources informa-

tion that may affect dramatically the fortunes of competitors,

customers, and suppliers. Advance information accessible to

even the itinerant salesman about new products, new con-

tracts, accidents, bankruptcies, and other events may have

great value to someone trading in the stock of companies only

indirectly affected.”

Accord, Brudney, Insiders, Outsiders, and Informational Advan-

tages Under the Federal Securities Laws, 93 HARV. L. REV. 322, 331

(1979).

21

creates a new risk of prosecution for securities analysts,

specialists and other professional traders performing their

proper role in the market: ascertaining, disseminating,

and utilizing market information.** By creating disin-

centives for these activities, a rule of this breadth could

seriously impair the ability of market intermediaries to

disseminate pertinent market information. It should be

reviewed by this Court before it has widespread

application.

III. PETITIONER’S CONVICTION VIOLATES DUE

PROCESS OF LAW BECAUSE HE WAS INDICTED

AND CONVICTED UNDER SECTION 10(b) FOR

CONDUCT NEVER BEFORE HELD TO BE A

CRIME, AND AT THE TIME REASONABLY BE-

LIEVED TO BE LAWFUL.

District Judge Haight, declaring that “man’s free

choice must be guided and informed by legislative pro-

hibitions which are clear, definite and precise” (App. 9a-

10a), initially dismissed the indictment against petitioner

because “there was no ‘clear and definite statement’ in

the federal securities laws which both antedated and pro-

scribed the acts alleged ....” App. 25a. In so conclud-

ing, Judge Haight took special note of Chiarella, in which,

as noted above, this Court made clear that the “misap-

propriation” theory, under which petitioner was subse-

quently indicted and convicted, represented a novel ap-

28 The S.E.C. stated in Jn re Dirks, Sec. Exch. Act Rel. No. 17480,

[1981 Transfer Binder] Fed. Sec. L. Rep. (CCH) % 82,812 at 83,945

(Jan. 22, 1981), aff'd, 681 F.2d 824 (D.C. Cir. 1982), cert. granted,

103 S. Ct. 871 (1982), that securities analysts “actively seek out

bits and pieces of corporate information not generally known to the

market for the express purpose of analyzing that information and

informing their clients who, in turn, can be expected to trade on

the basis of the information conveyed. The value to the entire

market of these efforts cannot be gainsaid; market efficiency in

pricing is significantly enhanced by such efforts to ferret out and

analyze information, and thus the analyst’s work redounds to the

benefit, of all investors.”

22

plication of Section 10(b) the propriety of which was ex-

pressly not addressed by the Court. App. 10a-lla.*’ Jus-

tice Stevens, while agreeing that the Court should not

reach the issue, found that “|[rljespectable arguments

could be made in support of either position’ for or

against the criminal application of Section 10(b) to an

employee’s breach of the duty of silence owed to his em-

ployer. 445 U.S. at 238.

The Court in Chiarella also responded to Justice Black-

mun’s dissenting argument for adoption of a broad stand-

ard of liability for trading on nonpublic outside informa-

tion as follows:

“TA] judicial holding that certain undefined activi-

ties ‘generally are prohibited’ by § 10(b) would raise

questions whether either criminal or civil defendants

would be given fair notice that they have engaged in

illegal activity. Cf. Grayned v. City of Rockford, 408

U.S. 104, 108-09 (1972).” 445 U.S. at 235 n.20.”

Grayned is but one of many cases which uniformly

hold that penal statutes not providing reasonable notice

to men of common intelligence of the unlawfulness of

their acts violate the fundamental constitutional guar-

antees of due process.*' Under this same standard, novel

29In Chiarella, because “[t|he jury was not instructed on the

nature or elements of a duty owed... to anyone other than the

sellers,” this Court declined to “speculate upon whether such a duty

exists, whether it has been breached, or whether such a breach

constitutes a violation of §10(b).” 445 U.S. at 236-37.

80 The Court also took note of the fact that Chiarella’s prosecu-

tion was “apparently the first case in which criminal liability has

been imposed on a purchaser for § 10(b) nondisclosure.” 445 U.S.

at 235 n.20. After the Court’s reversal in Chiarella, petitioner

stands in Chiarella’s position as a test case for a new Government

theory of Section 10(b) criminal liability.

‘In Grayned, the Court declared that “|i|t is a basic principle

of due process that au enactment is void for vagueness if its pro-

hibitions are not clearly defined ... {Blecause we assume that

man is free to steer between lawful and unlawful eonduct, we

insist that laws give the person of ordinary intelligence a rea-

23

applications of valid statutes to new and unpredictable

circumstances equally transgress the due process require-

ment of fair notice of illegality.”

Petitioner, of course, was indicted and convicted for

stock purchases which occurred between 1974 and 1978,

well before the Court’s introduction to this novel issue in

Chiarella, and well before any court had found Section

10(b) applicable to trading on misappropriated outside

information.” Indeed, to this date the only court that

sonable opportunity to know what is prohibited, so that he may act

accordingly.” 408 U.S. at 108. Accord, Dunn v, United States, 442

U.S. 100, 112-13 (1979); United States v. Harriss, 347 U.S. 612,

617 (1954); Lanzetta v. New Jersey, 306 U.S. 451, 453 (1939);

Connally v. General Construction Co., 269 U.S. 385, 391 (1926).

"2 See Bouie v. City of Columbia, 378 U.S, 347, 250 (1964). The

due process issue is not, as the S.E.C. argued in its amicus brief

to the Second Circuit, whether or not petitioner or his alleged co-

conspirators knew that their conduct was on the borderline of the

law and therefore took actions to maintain the secrecy of their

activities. See Brief for the Securities and Exchange Commission,

Amicus Curiae, Docket No. 81-1225 at 12-13 (June 29, 1981).

This Court wrote in Bowie that “[t|)he 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.” 378 U.S. at 355-56 n.5.

“’ Previous judicial pronouncements on the issue of “insider”

trading reflected, if anything, a general view that petitioner’s trad-

ing on nonpublic outside information did not constitute a Section

10(b) violation. See General Time Corp. v. Talley Industries, Inc.,

403 F.2d 159, 164 (2d Cir. 1968), cert. denied, 393 U.S. 1026

(1969) (‘We know of no rule of law... that a purchaser of stock,

who was not an ‘insider’ and had no fiduciary relation to a prospec-

tive seller, had any obligation to reveal circumstances that might

raise a seller’s demands and thus abort the sale”); Radiation

Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 890 (2d Cir. 1972)

(“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 outsider’); SE v. Great

American Industries, Inc., 407 F.2d 453, 460 (2d Cir. 1968) (en

banc), cert. denied, 395 U.S. 920 (1969) (“to read Rule 10b-5 as

placing an affirmative duty of disclosure on persons who in contrast

24

has approved this application of Section 10(b) is the

Second Circuit Court of Appeals when it decided peti-

tioner’s appeal. Moreover, as Judge Haight’s district

court opinion explained at some length, contemporaneous

analyses of the law in this area by the securities bar and

even the S.E.C. itself during the years preceding petition-

er’s purchases reveal that no one then contemplated that

trading on material nonpublic outside information was

prohibited by Section 10(b). See App. 15a-25a. It was

not until 1980, after a decade of consideration, that the

S.E.C. prohibited the conduct addressed in petitioner’s

indictment. See 17 C.F.R. § 240.14e-3.

Based upon these considerations, the district court

concluded that:

“{T] here was no ‘clear and definite statement’ in the

federal securities laws which both antedated and pro-

scribed the acts alleged in this indictment. As of the

times alleged, neither courts, commentators, nor the

SEC in its rulemaking or enforcement capacities had

stated that Rule 10b-5 extended to a noninsider’s

breach of a fiduciary duty owed to the acquiring cor-

poration in a tender offer. To the extent the question

was addressed at all, the indications . . . were quite

to the contrary. While the SEC has concerned itself

with the general subject of tender offers at least since

the enactment of the Williams Act in 1968, the con-

duct sought here to be prosecuted was not proscribed

until 1980, when Rule 14e-3 was promulgated. Prior

to that time, the absence of such a rule, particularly

when viewed in the context of the SEC’s inquiry to

the industry as to whether one should be adopted, pre-

cludes criminal prosecutions for what is, in effect,

unproscribed conduct.” App. 25a."

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”).

“Compare United States v. Chiarella, 588 F.2d at 1876-77

(Meskill J., diss.).

25

The court of appeals barely addressed the key due

process issue raised in Judge Haight’s district court

opinion. Its sole discussion of the issue of fair notice was

its conclusory finding that “Rule 10b-5’s proscription of

fraudulent and deceptive practices upon any person in

connection with the purchase or sale of a security pro-

vided clear notice to appellee that his fraudulent conduct

was unlawful.” App. 49a-50a.

In view of the cursory consideration apparently given

this issue by the court of appeals, and petitioner’s im-

pending imprisonment, this Court should grant certiorari

to provide review befitting the grave issue of due process

of law that is presented.

CONCLUSION

For the reasons set forth above, certiorari should be

granted to review the judgment of the court of appeals.

Respectfully submitted,

ARTHUR F.. MATHEWS *

Louis R. COHEN

MICHAEL R. KLEIN

ANDREW B. WEISSMAN

THOMAS W. WHITE

WILMER, CUTLER & PICKERING

1666 K Street, N.W.

Washington, D.C. 20006

(202) 872-6000

Counsel for Petitioner

* Counsel of Record

April 8, 1983