Appendix — United States v. O'Hagan

FILED

O 6 842 NOV 2 6 1996

In the Supreme Court of He United States

, OCTOBER TERM, 1996

UNITED STATES OF AMERICA, PETITIONER

U.

JAMES HERMAN O’HAGAN

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

APPENDIX TO

PETITION FOR A WRIT OF CERTIORARI

WALTER DELLINGER

Acting Solictor General

RICHARD H. WALKER JOHN C. KEENEY

General Counsel Acting Assistant Attorney

PAUL GONSON General

Solictor MICHAEL R. DREEBEN

JACOB H. STILLMAN Deputy Solicitor General

Associate General Counsel pa. R.Q. WOLFSON

ERIC SUMMERGRAD Assistant to the Solicitor

Principal Assistant General

General Counsel JOSEPH C. WYDERKO

RANDALL W. QUINN Attorney

Senior Litigation Counsel Department of Justice

ADAM C. PRITCHARD Washington, D.C. 20530-0001

Attorney (202) 514-2217

Securities and Exchange

Commission

Washington, D.C. 20549

git

TABLE OF CONTENTS

Page

Appendix A (court of appeals’ opinion

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Appendix B (magistrate's opinion dated

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Appendix C (district court opinion

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Appendix D (court of appeals’ order

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Appendix E (statutory and regulatory

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APPENDIX A

UNITED STATES COURT OF APPEALS

FOR THE EIGHTH CIRCUIT

Nos. 94-3714, 94-3856

UNITED STATES OF AMERICA,

PLAINTIFF-APPELLEE/CROSS-APPELLANT

*.

JAMES HERMAN O’HAGAN,

DEFENDANT-APPELLANT/CROSS-APPELLEE

Submitted: October 17, 1995

Decided: Aug. 2, 1996

Before: FAdd, LAY, and HANSEN, Circuit Judges.

HANSEN, Circuit Judge.

James Herman O’Hagan appeals his convictions of

all counts in a 57-count indictment for mail fraud,

securities fraud, and money laundering. The govern-

ment cross-appeals, contending that the district court

erroneously calculated O’Hagan’s sentence. Al-

though O’Hagan raises a whole host of issues, we find

merit in two particular claims. First, neither the

statutory language of section 10(b) of the Securities

Exchange Act of 1934, 15 U.S.C. § 78j(b), nor Supreme

Court precedent interpreting it, will support the use

of the “misappropriation theory,” the theory which

formed the basis for O’Hagan’s § 10(b) securities

fraud convictions. Second, the Securities and Ex-

change Commission (SEC) exceeded its rulemaking

(la)

2a

authority under section 14(e) of the Securities Ex-

change Act of 1934, 15 U.S.C. § 78n(e), when it pro-

mulgated Rule 14e-3(a), 17 C.F.R. § 240.14e-3(a), and

omitted therefrom the requirement that a breach of a

fiduciary duty must be shown in order to violate the

rule. The mail fraud counts are structured in the

indictment to hinge on the validity of the securities

fraud counts, and the money laundering counts in

turn are dependent upon the mail fraud or securities

fraud counts. Accordingly, we vacate all of O’Hagan’s

convictions. The government’s cross-appeal is dis-

missed as moot.

James Herman O’Hagan was a partner in the

Dorsey & Whitney law firm in Minneapolis, Minne-

sota. In approximately July of 1988, Grand Met PLC

(Grand Met), a large diversified company based in

London, England, retained Dorsey & Whitney as local

counsel because Grand Met was interested in acquir-

ing the Pillsbury Company (Pillsbury), a Minneapo-

lis, Minnesota, company. Throughout the remainder

of the summer and into the fall of 1988, Grand Met

maintained a continued interest in acquiring Pills-

bury, but before moving forward with an actual tender

offer, it first had to sell a subsidiary company in order

to have sufficient capital to finance the purchase of

Pillsbury.

On August 18, 1988, O’Hagan began purchasing call

options for Pillsbury stock that had a September 17,

1988, expiration date. He subsequently purchased

1 A call option gives the holder the right to purchase a

specified number of shares of stock by a certain date at a

specific price. If the shares are not purchased by that date, the

3a

call options that had October 22, 1988, and November

19, 1988, expiration dates. By the end of September

1988, O’Hagan had amassed 2,500 Pillsbury call opticn

contracts.” He also held approximately 5000 shares of

Pillsbury common stock which he had purchased on

September 10, 1988.

On October 4, 1988, Grand Met publicly announced

its tender offer for Pillsbury stock. Pillsbury stock

immediately rose from $39 per share to almost $60 per

share.’ Shortly thereafter, O’Hagan exercised his

options, purchasing the Pillsbury stock at the lower

option price, and then liquidating the stock, along

with the previously purchased 5000 shares of common

stock, for the higher market price generated by the

tender offer. He realized a profit of over $4,000,000

from these securities transactions.

The Securities and Exchange Commission (SEC)

subsequently commenced an investigation of O’Hagan

and others who had heavily invested in Pillsbury se-

curities shortly before its takeover by Grand Met.

This investigation, which was later joined by other

option expires and along with it the right to purchase the

specified number of shares. For instance, on August 18, 1988,

O’Hagan purchased 100 Pillsbury call options. Each call option

gave him the right to purchase 100 shares of Pillsbury stock.

Each call option also expired on September 17, 1988, if the op-

tion was not exercised.

2 O’Hagan purchased 3,000 Pillsbury call option contracts

during August and September 1988. At the end of September

of 1988, he held only 2,500 of those contracts because 500 con-

tracts had a September 17, 1988, expiration date.

When a tender offer is announced, usually the price of

the target company rises and the price of the offeror falls or

— SEC v. Maio, 51 F.3d 623, 628 n.3 (7th Cir.

4a

federal law enforcement authorities, culminated with

O’Hagan being charged in the instant 57-count in-

dictment. Counts 1-20 charged him with mail fraud in

violation of 18 U.S.C. § 1341. Counts 21-37 charged

him with securities fraud in violation of § 10(b) and

Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated there-

under. Counts 38-54 charged O’Hagan with securities

fraud in violation of § 14(e) and Rule 14e-3, 17 C. F. R.

§ 240.14e-3(a), promulgated thereunder. Counts 55-57

alleged various violations of the federal money laun-

dering statutes, 18 U.S.C. §§ 1956(a)(1)(B)(i) and 1957.

The case proceeded to trial, and a jury convicted

O’Hagan on all 57 counts. The district court sen-

tenced O’Hagan to 41 months of imprisonment.

O’Hagan appeals.

II.

Because we resolve the issues in this case solely on

legal grounds, our standard of review is de novo.

United States v. Hang, 75 F.3d 1275, 1279 (8th Cir.

1996).

A.

O’Hagan challenges his § 10(b) securities fraud con-

victions, arguing that the theory of liability under

which the government prosecuted him, known as the

“misappropriation theory,” is, as a matter of law, an

impermissible basis upon which to impose § 10(b)

liability. Before outlining the misappropriation the-

ory, however, we first turn to the language of § 10(b)

and its SEC-created counterpart, Rule 10b-5.

Section 10(b) of the Securities Exchange Act of

1934 provides:

5a

It shall be unlawful for any person, directly or

indirectly, by the use of any means or instru-

mentality of interstate commerce or of the mails,

or of any ‘acility of any national securities ex-

change—

(b) To use or employ, in connection with the

purchase or sale of any security, any

manipulative or deceptive device or contrivance in

contravention of such rules and regulations as the

[Securities and Exchange] Commission may pre-

scribe as necessary or appropriate in the public

interest or for the protection of investors.

15 U.S.C. § 78j(b). The touchstones of § 10(b) liability

then, are “manipulation” and “deception” “in connec-

tion with the purchase or sale of any security.” Id.

Our focus in this case is on the deception element of

1005).

The other prong of § 10(b) liability, manipulation“ is

virtually a term of art when used in connection with securi-

ties markets’” referring to practices “such as wash sales,

matched orders, or rigged prices, that are intended to mislead

investors by artificially affecting market activity.” Santa Fe

Indus. v. Green, 430 U.S. 462, 476 (1977) (quoting Ernst &

Ernst v. Hochfelder, 425 U.S. 185, 199 (1976)). The govern-

ment does not contend, and the record does not show, that

O’Hagan’s conduct constituted any of these prohibited acts. In

any event, the misappropriation theory thus far has been used

only as a vehicle to prosecute acts that constitute deception

under § 10(b) and that was the government’s approach in this

case.

6a

Acting pursuant to the authority granted to it

under § 10(b), the SEC promulgated Rule 10b-5, which

provides in relevar Hart:

It shall be unlawful for any person, directly or

indirectly, by the use of any means or instru-

mentality of interstate commerce, or of the mails

or of any facility of any national securities ex-

change,

(a) [t]o employ any device, scheme, or artifice

to defraud, [or]

(e) [t]o 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.

17 C.F.R. § 240.10b-5. The SEC thus enacted Rule

10b-5 to include a prohibition on “fraud” as a means of

defining the scope of conduct proscribed by the term

deception under § 10(b). Significantly, however, fraud

under Rule 10b-5 cannot be construed more broadly

than its statutory enabler, deception; in other words,

Rule 10b-5 fraud cannot prohibit conduct that does not

amount to § 10(b) deception. See Central Bank of

Denver v. First Interstate Bank of Denver, 114 S. Ct.

1439, 1446 (1994) (“We have refused to allow 10b-5

challenges to conduct not prohibited by the text of the

statute.”); Santa Fe Indus. v. Green, 430 U.S. 462,

472 (1977) (“in deciding whether [challenged conduct

constitutes] ‘fraud’ under Rule 10b-5, ‘we turn first to

the language of § 10(b),’”) (quoting Ernst & Ernst v.

Hochfelder, 425 U.S. 185, 197 (1976)). Thus, although

§ 10(b) has been described as a broad catchall provi-

7a

sion, the fraud that must be caught must also con-

stitute deception within the meaning of the statute.

United States v. Chiarella 445 U.S. 222, 234-35 (1980)

(“Section 10(b) is aptly described as a catchall pro-

vision, but what it catches must be fraud.”).

In construing the scope of conduct that may be

regulated under § 10(b), the Supreme Court has de-

finitively ruled that the text of the statute is disposi-

tive. See Central Bank, 114 S. Ct. at 1446 (“With re-

spect ... to... the scope of conduct prohibited by

§ 10(b), the text of the statute controls our decision.”);

see also Chiarella, 445 U.S. at 234 (“As we have em-

phasized before, the 1934 Act cannot be read more

broadly than its language and the statutory scheme

reasonably permit.”’” (citation omitted)). This point

could not have been made in clearer terms than in

Central Bank, the Court’s most recent exposition of

the reach of § 10(b). There, concluding that a § 10(b)

aiding and abetting cause of action was not viable, the

Court stated:

We reach the uncontroversial conclusion, ac-

cepted even by those courts recognizing a § 10(b)

aiding and abetting cause of action, that the text of

the 1934 Act does not itself reach those who aid

and abet a § 10(b) violation. Unlike those courts,

however, we think that conclusion resolves the

case. It is inconsistent with settled methodology

in § 10(b) cases to extend liability beyond the scope

of conduct prohibited by the statutory text.

Because this case concerns the conduct pro-

hibited by § 10(b), the statute itself resolves the

ae

Central Bank, 114 S. Ct. at 1448. This is because

“(tlhe language of § 10(b) gives no indication that

Congress meant to prohibit any conduct not involving

manipulation or deception.” Santa Fe, 430 U.S. at

473. In sum, in determining whether conduct falls

within § 10(b) deception and Rule 10b-5 fraud, we are

confined to what the term deception under § 10(b) will

reasonably bear. See United States v. Bryan, 58 F.3d

933, 945 (4th Cir. 1995) (“For at least two decades,

however, the Supreme Court has repeatedly warned

against expanding the concept of fraud in the securi-

ties context beyond what the words of the Act will

reasonably bear.”). It is against this backdrop that we

now turn to the two theories of liability which have

been created under § 10(b)’s proscription of deception.

The first theory is what has been termed the

“classical theory.“ See SEC v. Clark, 915 F.2d 439,

443 (9th Cir. 1990). It was outlined by the Supreme

Court in the germinal case of Chiarella, 445 U.S. at

226-35, and later refined in Dirks v. SEC, 463 U.S.

646, 653-667 (1983). “Under the classical theory, a

person violates [Rule 10b-5] when he or she buys or

sells securities on the basis of material, non-public

information and at the same time is an insider of the

corporation whose securities are traded.” SEC v.

Cherif, 933 F.2d 403, 408 (7th Cir. 1991), cert. denied,

502 U.S. 1071 (1992). The gravamen of the classical

theory is that the “insider owes a fiduciary duty to

the corporation’s shareholders not to trade on inside

information for his personal benefit.” Jd. at 409. In

sum, the classical theory deals with corporate “in-

siders,” i.e., those who owe a fiduciary obligation to

the shareholders of the corporation whose shares are

traded. This theory, however, does not reach those

9a

individuals who trade securities based on material,

nonpublic information and who owe no fiduciary duty

to the shareholders of the company whose securities

are traded; these persons are the so-called “out-

siders.” See Clark, 915 F.2d at 443.

The misappropriation theory addresses those not

Te the reach of the classical theory. Specifically,

it:

extends the reach of Rule 10b-5 to outsiders who

would not ordinarily be deemed fiduciaries of the

corporate entities in whose stock they trade. [It]

focuses not on the insider’s fiduciary duty to the

issuing company or its shareholders but on

whether the insider breached a fiduciary duty

to any lawful possessor of material non-public

information.

Cherif, 983 F.2d at 409. The misappropriation theory

has been held to impose § 10(b) and Rule 10b-5 liability

for fraud on an individual who “‘(1) misappropriates

material nonpublic information (2) by breaching a

duty arising out of a relationship of trust and con-

fidence and (3) uses that information in a securities

transaction, (4) regardless of whether he owed any

duties to the shareholders of the traded stock.’”

Bryan, 58 F.3d at 944 (quoting Clark, 915 F.2d at 443).

Under the misappropriation theory, the requirement

that the information be used “in connection with the

purchase and sale of any security” is satisfied simply

because the misappropriated information is used in a

subsequent securities transaction. See id. at 944-45.

The misappropriation theory thus focuses on whether

the securities trader breached a fiduciary obligation

to the party from whom the material nonpublic infor-

mation was obtained, notwithstanding whether that

10a

party had any connection to, or even an interest in,

the securities transaction, and also without concern

as to whether a party who did care about the securi-

ties transaction was defrauded. Id.

In this case, the government proceeded against

O’Hagan on the § 10(b) and Rule 10b-5 counts under

the misappropriation theory, although the theory has

never been recognized in this circuit. The govern-

ment contended that O’Hagan breached a fiduciary

duty to Dorsey & Whitney and Grand Met when,

through his employment at Dorsey & Whitney, he

obtained confidential, material, and nonpublic infor-

mation concerning Grand Met’s interest in acquiring

Pillsbury, and subsequently used that information as

a basis for trading in Pillsbury securities.’ O’Hagan

contends that the misappropriation theory is an im-

permissible basis upon which to impose § 10(b) liabil-

ity. Specifically, he argues that the theory cannot be

squared with either the plain text of § 10(b) or the

5 The government did not prosecute O’Hagan under the

classical theory, nor could it, because O’Hagan was not an

“insider” of Pillsbury, the corporation in whose shares he

traded. The government conceded before the magistrate judge

that O’Hagan could not be prosecuted under Rule 10(b)-5 for

failure to disclose the inside information to Pillsbury stock-

holders because he had no preexisting fiduciary duty to them

and had done nothing to induce the officers and directors of

Pillsbury to place their trust or confidence in him. Report and

Recommendation of Magistrate Judge Cudd (Sept. 10, 1993),

App. at 672-73. The magistrate judge’s report and recommen-

dation, adopted by the district court, concluded that Jals far as

Pillsbury stockholders were concerned, Defendant was free

under Chiarella and Dirks to use the alleged inside information

as he saw fit.” Jd. at 673. Thus, our attention is focused solely

on the misappropriation theory.

lla

Supreme Court’s teachings regarding the scope of

conduct that may be regulated under that statute.

Neither the Supreme Court nor this court has yet

determined whether the misappropriation theory is a

permissible basis upon which to impose § 10(b) liabil-

ity. After carefully studying the Supreme Court’s

teachings on the scope of conduct reachable under

§ 10(b), however, coupled with the recent Central

Bank ruling that the plain text of the statute

controls this issue, we hold that § 10(b) liability

cannot be based on the misappropriation theory. We

reach this conclusion because, contrary to § 10(b)’s

explicit requirements, the misappropriation theory

does not require “deception,” and, even assuming that

it does, it renders nugatory the requirement that the

“deception” be “in connection with the purchase or

sale of any security.”

We first turn our attention to the meaning ascribed

to § 10(b) by the Supreme Court. That Court has re-

peatedly held that the deception prohibited under

§ 10(b) consists of the making of a material misrep-

resentation or the nondisclosure of material informa-

® In Carpenter v. United States, 484 U.S. 19, 24 (1987), an

evenly divided Court affirmed a § 10(b) criminal conviction

premised on the misappropriation theory, without expressing

any views on the validity of the theory. Further, in Chiarella,

445 U.S. at 235-36, the Court declined to consider ne govern-

ment’s argument that the misappropriation theory was a

permissible basis upon which to affirm the defendant’s § 10(b)

conviction because such a theory had not been submitted to the

jury. ;

With respect to this court, as far as we can tell, this is the

only case in which the misappropriation theory of § 10(b)

liability has been presented to us.

12a

tion, in violation of a duty to disclose. See, e.g., Cen-

tral Bank, 114 S. Ct. at 1446-48; Santa Fe, 430 U.S. at

470, 476. The Santa Fe Court, in fact, explicitly re-

jected the lower court’s reading of § 10(b) which re-

quired no misrepresentation or nondisclosure. Santa

Fe, 430 U.S. at 470-76. The Central Bank Court con-

firmed that misrepresentation or nondisclosure are

requirements for § 10(b) liability. See Central Bank,

114 S. Ct. at 1448 (“As in earlier cases considering

conduct prohibited by § 10(b), we again conclude that

the statute prohibits only the making of a material

misstatement (or omission) or the commission of a

manipulative act.”).

Additionally, the Court has left no doubt that § 10(b)

deception cannot be premised on the mere breach of a

fiduciary duty, without an accompanying misrepre-

sentation or lack of disclosure. See id. at 1446 (“de-

ception” under § 10(b) does not encompass “ ‘breaches

of fiduciary duty . . . without any charge of mis-

representation or lack of disclosure. (quoting Santa

Fe, 430 U.S. at 470)). See also Santa Fe, 430 U.S. at

472 (to interpret “fraud” under Rule 10b-5 to extend

to all breaches of fiduciary duty that are linked to a

securities transaction would “add a gloss to the

operative language of the statute quite different from

its commonly accepted meaning.”) (internal quota-

tions omitted); Dirks, 463 U.S. at 654 (“Not all

breaches of fiduciary duty in connection with a secu-

rities transaction . . . come within the ambit of Rule

10b-5. There must also be manipulation or decep-

tion.”) (internal quotations omitted).

We reject the misappropriation theory, in part,

because it permits the imposition of § 10(b) liability

based upon the mere breach of a fiduciary duty

13a

without a particularized showing of misrepresenta-

tion or nondisclosure. As previously stated, the mis-

appropriation theory bases liability upon the mere

misappropriation of material nonpublic information in

breach of a fiduciary obligation and subsequent use of

that information in a securities transaction. Clark,

915 F.2d at 443. By its very definition then, it does

not require either a material misrepresentation or

nondisclosure. Thus, the misappropriation theory

runs counter to the Santa Fe and Central Bank

holdings that the mere breach of a fiduciary obliga-

tion, without misrepresentation or nondisclosure, is

not deception within the meaning of & 10(b). See

Bryan, 58 F.3d at 949 (breach of fiduciary obligation

without misrepresentation or nondisclosure does not

constitute deception and thus conflicts with Central

Bank and Santa Fe).

We need not tarry long on this point, however, be-

cause the misappropriation theory fails on another,

more obvious, basis. The language of § 10(b) requires

that the fraud be “in connection with the purchase or

sale of any security.” The misappropriation theory,

however, permits liability for a breach of duty owed to

individuals who are unconnected to and perhaps unin-

terested in a securities transaction, thus rendering

meaningless the “in connection with . . .” statutory

language. As noted by the Fourth Circuit, “The

[Supreme] Court has left no doubt that the principal

concern of section 10(b) is the protection of pur-

chasers and sellers of securities.” Bryan, 58 F.3d at

946-47. We agree. A careful reading of the Supreme

Court’s decisions in Chiarella, Dirks, and Centra!

Bank reveals that only a breach of a duty to parties to

the securities transaction or, at the most, to other

14a

market participants such as investors, will be suf

ficient to give rise to § 10(b) liability.

This principle was explicitly stated in Chiarella.

There, relying upon common law fiduciary principles,

the Court held that one commits Rule 10b-5 fraud by

failing to disclose material non public information in

violation of a duty to disclose. Chiarella, 445 U.S, at

228. This duty to disclose, however, arises only “from

a relationship of trust and confidence between parties

to a transaction.” Id. at 230 (emphasis added). The

Court reiterated this point later in the opinion,

stating that liability could be founded only on the

breach of a fiduciary duty by “a person in whom the

sellers had placed their trust and confidence.” Id. at

232.

The Dirks Court reaffirmed this principle, stating

“that Ja] duty [to disclose] arises from the relation-

ship between parties . . . and not merely from one’s

ability to acquire information because of his position

in the market.’” Dirks, 463 U.S. at 657-58 (quoting

Chiarella, 445 U.S. at 282-33). Although the Court

referred only to “parties,” rather than “parties to a

transaction,” as in Chiarella, the Court gave no indi-

cation that it intended to retreat from Chiarella’s

holding. To the contrary, the Dirks Court stated

early in its opinion that the duty to disclose crafted in

Chiarella was applicable only to the corporation

whose securities were being traded. See id. at 654

(“We were explicit in Chiarella in saying that there

can be no duty to disclose where the person who has

traded on inside information ‘was not [the corpora-

tion’s] agent, . . . was not a fiduciary, [or] was not a

person in whom the sellers [of the securities] had

placed their trust and confidence.’” (quoting Chia-

15a

rella, 445 U.S. at 232). The Court did indicate,

however, that if § 10(b) was to be construed to reach

beyond parties to the securities transaction, at the

very most it extended to market participants, namely

investors. See id. at 664 n.23 (“a violation [of § 10(b)]

may be found only where there is ‘intentional or will-

ful conduct designed to deceive or defraud investors.

(quoting Ernst & Ernst, 425 U.S. at 199)).

Finally, the Central Bank Court clearly placed the

focus of § 10(b) on purchasers and sellers of securi-

ties: “Any person or entity, including a lawyer,

accountant, or bank, who employs a manipulative

device or makes a material misstatement (or omis-

sion) on which a purchaser or seller of securities

relies may be liable as a primary violator under 10b-5,

assuming all of the requirements for primary liability

under Rule 10b-5 are met.” 114 S. Ct. at 1455 (em-

phasis added). The Court also reaffirmed the princi-

ple it had set forth in Dirks that, if construed to reach

beyond the purchasers and sellers to a securities

transactions, § 10(b) at the very broadest can be read

to reach only market participants. See id. at 1446

(stating that “the broad congressional purposes be-

hind the [Securities] Act” is “to protect investors

from false and misleading practices that might injure

them.”). See also Bryan, 58 F.3d at 948, 950 (if con-

strued to reach beyond purchasers and sellers of

securities, outer boundary of § 10(b) reaches no fur-

ther than other market participants).

Against this venerable body of law, the misap-

propriation theory, which allows the imposition of

§ 10(b) liability even though no market participant

was deceived or defrauded, cannot be defended. By

evading the statutorily required nexus that the fraud

l6a

be “in connection with the purchase or sale of any

security,” the misappropriation theory essentially

turns § 10(b) on its head, “transforming it from a rule

intended to govern and protect relations among

market participants” into an expansive “general

fraud-on-the-source theory” which seemingly would

apply to an infinite number of trust relationships.

Bryan, 58 F.3d at 950; see also id. at 951 (observing

that courts have applied the misappropriation theory

to a wide variety of trust relationships and if taken to

its logical conclusion would apply to case of simple

theft by an employee). Such a wide ranging

application of § 10(b) liability simply cannot be

reconciled with the Central Bank holding that the

text of § 10(b) governs the scope of conduct which may

be regulated under that provision, coupled with the

focus in Chiarella, Dirks, and Central Bank on

parties to the securities transaction or, at most,

other market participants. See also id. at 950 (the

misappropriation theory “artificially divides into two

discrete requirements—a fiduciary breach and a

purchase or sale of securities—the single indivisible

requirement of deception upon the purchaser or seller

of securities, or upon some other person intimately

linked with or affected by a securities transaction.”).

The government contends that It he in connection

with element is met whenever a fraud touches the

purchase or sale of a security, a standard which has

been described as being very tenuous indeed.” Gov.

Br. at 48 n.37 (inner quotations omitted). This

“touch” test stems from a passage in Superintendent

of Ins. v. Bankers Life & Casualty Co., 404 US. 6,

12-13 (1971), where the court stated, “The crux of the

present case is that [the victim] suffered an injury as

17a

a result of deceptive practices touching its sale of

securities as an investor.” (emphasis added). Accord-

ing to the government, the Court’s use of “touch”

demonstrates that the fraud need not be upon a party

interested in a securities transaction.

_ We decline to ascribe such broad meaning to this

single passage from Bankers Life. Such a sweeping

interpretation appears to be inconsistent with the

Court’s statement in the immediately previous para-

graph of Bankers Life that “we read § 10(b) to mean

that Congress meant to bar deceptive devices and

contrivances in the purchase or sale of securities.”

Bankers Life, 404 U.S. at 12 (emphasis added). More

importantly, the victim of the fraud in Bankers Life

was a seller of securities who was “injured as an

investor.” Id. at 10; see also Bryan, 58 F.3d at 950

n.17 (same). Finally, if this passage held the all-

encompassing meaning the government attributes to

it, then we cannot fathom how the defendants in the

subsequent Chiarella, Dirks, and recently Central

Bank cases escaped § 10(b) liability because each en-

gaged in acts that “touched” the securities trans-

on.

The government pointed out in oral argument that we

have cited Bankers Life and employed its “touch” in several

cases. See Harris v. Union Elec. Co., 787 F.2d 355, 368 (8th

Cir.), cert. denied, 479 U.S. 823 (1986); United States v.

Gruenberg, 989 F. 2d 971, 976 (8th Cir.) (quoting Harris), cert.

denied, 114 S. Ct. 204 (1993). From this, the government con-

tends that we have held that only a tenuous connection need be

established between the fraud and the securities transaction,

and applying that reasoning to this case, we must uphold

O’Hagan’s § 10(b) convictions. We have not held, however, nor

could we in the face of the Supreme Court authority cited

above, that the person defrauded need not be an individual who

18a

Several of our sister circuits have concluded that

§ 10(b) liability may be predicated on the misappro-

priation theory, while the Fourth Circuit recently

reached the opposite conclusion, — outright

the misappropriation theory as a basis for imposing

§ 10(b) liability. See Bryan, 58 F.3d at 933. We find

the analysis from Bryan persuasive and have bor-

rowed heavily from it in arriving at our conclusion.

Therefore, we adopt that court’s analysis in its

entirety as our own."

has an interest or stake in a securities transaction. We simply

held in these cases that the “touch” test is easily satisfied as

long as the party defrauded is a market participant.

8 Bryan was decided after the briefing had been completed

in this case but prior to oral argument. The parties addressed

the applicability of Bryan at oral argument. The government

contends that Bryan holds that when information is misap-

propriated from a nonmarket participant, no fraud occurs

under § 10(b); conversely when information is misappropriated

from a market participant, fraud for the purposes of § 10(b)

has occurred. In making this argument, the government

contends that Bryan did not really depart from the holdings of

other circuits and that no split in the circuits is present. We

decline to read Bryan in the narrow fashion urged by the gov-

ernment. The Bryan court’s ne eee 1

in terms. Bryan,

— aes eae the language of section 10(b), Rule

10b-5, the Supreme Court authority interpreting these provi-

sions, nor the purposes of these securities fraud provisions, will

support convictions resting on the particular theory of mis-

appropriation adopted by our sister circuits.”). It did not,

contrary to the government’s contention, make a distinction

between market v. nonmarket participants. In fact, had it

done so, there would have been no need to explicitly disagree

with the holdings from other courts which have adopted the

misappropriation theory because the overwhelming majority of

those cases has involved market participants.

19a

We have read with care the cases in which our

sister circuits, namely the Second,’ the Seventh,” the

Ninth,” and, arguably, the Third,” have adopted the

misappropriation theory. With all due respect to

these courts, for the most part, they seem to adopt the

misappropriation theory without conducting a rigor-

ous analysis of the text of § 10(b) and Supreme Court

precedent. The genesis of the misappropriation

theory, the Second Circuit’s holding in United States

v. Newman, 664 F.2d 12, 16-19 (2d Cir. 1981) (sub-

sequent case history omitted), is emblematic. There,

the court held that “deceitful misappropriation of con-

fidential information by a fiduciary” was fraudulent

under Rule 10b-5 and was “in connection with the

purchase or sale of any security” because his “sole

purpose in participating in the misappropriation of

confidential takeover information was to purchase

shares of the target companies.” Jd. at 18. However,

See, e. g., United States v. Libera, 989 F. 2d 596, 599-600 (2d

Cir.), cert. denied sub nom. Sablone v. United States, 114 S. Ct.

467 (1993); United States v. Chestman, 947 F.2d 551, 564 (2d

Cir. 1991) (en banc), cert. denied, 503 U.S. 1004 (1992); United

States v. Newman, 664 F.2d 12, 16-19 (2d Cir. 1981) (subse-

quent case history omitted).

” See Sec v. Maio, 51 F.3d 623, 631 (7th Cir. 1995); Cherif,

933 F.2d at 410.

1 See SEC v. Clark, 915 F.2d at 453.

2 See Rothberg v. Rosenbloom, 771 F.2d 818, 822 (3d Cir.

1985), rev'd after remand, 808 F.2d 252 (1986), cert. denied, 481

U.S. 1017 (1987). Courts that have discussed the

priation theory posit that the Third Circuit embraced it in

Rothberg. We believe this is fairly debatable however, because

the court devoted a mere paragraph to the principles under-

lying the theory, coupled with a citation to Newman. Id. at

822. In any event, we will assume for the purposes of this case

that the Rothberg court adopted the theory.

20a

the Newman court did not quote or discuss the

language of § 10(b), did not cite Santa Fe, and only

mentioned in passing the majority opinion in Chia-

rella. The court validated the misappropriation

theory on the language of Rule 10b-5, Chief Justice

Burger’s dissent in Chiarella, and other areas of law

in which the misappropriation of property has been

held to be criminal. We take pause to note that the

language of § 10(b), not Rule 10b-5, determines the

scope of conduct the statute reaches. Additionally,

Chief Justice Burger’s position in Chiarella was

espoused in a dissent and not the majority opinion.”

Finally, the Santa Fe Court made clear that in con-

struing § 10(b) resort could not be had to analogous

federal statutes. See Santa Fe, 430 U.S. at 471-72

(court of appeals erred in relying on definition of

fraud from other contexts in defining term in § 10(b)

context); see also Carpenter, 484 U.S. at 24 (unani-

mously affirming defendant’s mail fraud and wire

fraud convictions based on same facts which divided

the Court on § 10(b) conviction based on misappropria-

tion theory).

Other courts that have recognized the misappro-

priation theory have either relied heavily on New-

man or utilized interpretational methods which con-

flict with the Supreme Court’s teachings on inter-

preting the scope of conduct encompassed by § 10(b).

See Rothberg, 771 F.2d at 822 (relying solely on

Newman); Cherif, 933 F.2d at 410 n.5 (relying on

Newman and stating “[tJhe more precise issues of

statutory construction and legislative history have

8 As we noted above, the Chiarella Court declined to address

whether a misappropriation theory was valid because such a

basis was not submitted to the jury.

21a

been treated exhaustively elsewhere, and we decline

to revisit them.“), Clark, 915 F.2d at 443-53 (relying

in part on Newman and also utilizing the meaning of

fraud in other contexts). We note that neither Cherif

nor Clark acknowledge Santa Fe in conducting their

analysis. In essence, the courts which recognize the

misappropriation theory seem to have validated it on

the basis of the assumed unfairness of allowing an

individual to trade securities on the basis of infor-

mation which is not available to other traders. See

United States v. Carpenter, 791 F.2d 1024, 1029 (2d

Cir. 1986) (misappropriation theory permissible to

give “legal effect to the commonsensical view that

trading on the basis of improperly obtained informa-

tion is fundamentally unfair. ) (citation and

quotations omitted), aff’d in part by evenly divided

Court and rev'd in part, 484 U.S. 19, 24 (1987).

However, the Supreme Court has repeatedly held that

the mere possession of material nonpublic informa-

tion does not automatically create a duty to disclose.

See Chiarella, 445 U.S. at 232 (“not every instance of

financial unfairness constitutes fraudulent activity

under § 10(b)”); id. at 235 (“We hold that a duty to

disclose under § 10(b) does not arise from the mere

possession of nonpublic market information.”); Dirks,

463 U.S. at 658 (“Imposing a duty to disclose or ab-

stain solely because a person knowingly receives

material nonpublic information from an insider and

trades on it could have an inhibiting influence on the

role of market analysts, which the SEC itself recog-

nizes is necessary to the preservation of a healthy

market.”). The Bryan court undertook an exhaustive

review of the opinions from these courts and con-

cluded that these courts simply had given insufficient

weight to the text of § 10(b) and improperly construed

22a

the Supreme Court’s pronouncements on the reach of

that provision. We agree fully with that observation

and, therefore, we respectfully decline to follow the

holdings of our sister circuits which have adopted the

misappropriation theory.

As the Supreme Court has said, the securities

industry generally, and § 10(b) specifically, is “‘an

area that demands certainty and predictability’” and

“decisions ‘made on an ad hoc basis, offering little

predictive value’ to those who provide services to

participants in the securities business’” are to be

avoided. Central Bank, 114 S. Ct. at 1454 (quoting

Pinter v. Dahl, 486 U.S. 622, 652 (1988)). The mis-

appropriation theory undermines this interest by

permitting liability to be imposed in a wide variety of

circumstances involving a breach of fiduciary duty,

presumably including a simple employee theft. See

Bryan, 58 F.3d at 951-52 (outlining myriad of fiduci-

ary situations in which the misappropriation theory

has been applied). In essence, the theory creates “‘a

shifting and highly fact-oriented disposition of the

issue of who may [be liable for] a damages claim for

violation of Rule 10b-5.’” Central Bank, 114 S. Ct. at

1454 (quoting Blue Chip Stamps v. Manor Drug

Stores, 421 U.S. 723, 755 (1975)). See also Blue Chip

Stamps, 421 U.S. at 737 (Court described burgeoning

of liability in § 10(b) area as “a judicial oak which has

grown from little more than a legislative acorn.”);

United States v. Chestman, 947 F.2d 551, 564 (2d Cir.

1991) (en banc) (Winter, J., concurring in part and

dissenting in part) (describing liability under § 10(b)

for insider trading and stating that “caselaw estab-

lishes that some trading on material nonpublic infor-

mation is illegal and some is not. The line between

23a

the two is less than clear.”), cert. denied, 508 U.S.

1004 (1992). In this light, we think the misappropria-

tion theory cannot be countenanced.®

“Perhaps the paradigmatic example of the attenuated

circumstances in which a § 10(b) conviction based on the mis-

appropriation theory has been obtained is United States v.

Willis, 787 F. Supp. 269 (S.D.N.Y.), appeal dismissed, 778 F.

Supp. 205 (S.D.N.Y. 1991). There, the government charged

that the defendant, a psychiatrist, breached a physician-patient

duty of confidentiality when he traded securities based on

material, nonpublic information supplied by a patient that her

husband was interested in becoming the CEO of BankAmerica.

737 F. Supp. at 270-72. In sustaining the defendant’s convic-

tion, the court held that under the misappropriation theory,

§ 10(b) liability was not limited only to situations in which the

breach of the fiduciary relationship implicates the securities

markets. 778 F. Supp. at 208-09.

“The misappropriation theory has also been criticized by

commentators, primarily for the very reasons we reject the

theory today. See Michael P. Kenny & Teresa D. Thebaut,

Misguided Statutory Construction to Cover the Corporate

Universe: The Misappropriation Theory of Section 10(b), 59

Alb. L. Rev. 139 (1995); David C. Bayne, The Insider’s Natural

Law Duty: Chestman and the “Misappropriation Theory”, 43

U. Kan. L. Rev. 79 (1994). See also John R. Beeson, Comment,

Rounding the Peg to Fit the Hole: A Proposed Regulatory Re-

form of the Misappropriation Theory, 144 U. Pa. L. Rev. 1077,

1138 (1996). The Beeson article gives a perfect example of the

ad-hoc basis on which the theory is employed, offering by way

of example two individuals who obtain material, nonpublic

information, on which they subsequently trade securities. One

two individuals call to mind the Supreme Court's statement in

Chiarella that “a duty to disclose under § 10(b) does not arise

24a

Accordingly, we hold that the misappropriation

theory is not a valid basis upon which to impose

criminal liability under § 10(b). Thus, because

O’Hagan’s convictions for securities fraud under

§ 10(b) and Rule 10b-5 in Counts 21-37 were prem-

ised solely on the misappropriation theory, these

convictions must be vacated.

O’Hagan also challenges his securities fraud con-

victions under § 14(e) of the Securities Exchange Act

and Rule 14e-3. Section 14(e) provides:

It shall be unlawful for any person to make any

untrue statement of a material fact or omit to

state any material fact necessary in order to make

the statements made, in the light of the circum-

stances under which they are made, not mis-

leading, or to engage in any fraudulent, deceptive,

or manipulative acts or practices, in connection

with any tender offer. . . . The [SEC] shall, for

the purposes of this subsection, by rules and regu-

lations define, and prescribe means reasonably

designed to prevent, such acts and practices as are

fraudulent, deceptive, or manipulative.

15 U.S.C. § 78n(e). The first sentence in § 14(e) was

enacted in 1968 as part of the Williams Act. Chest-

man, 947 F.2d at 564. The purpose of the Williams

Act is to insure that public shareholders who are

confronted by a cash tender offer for their stock will

not be required to respond without adequate infor-

mation.“ Schreiber v. Burlington Northern, Inc.,

472 U.S. 1, 8 (1985) (quoting Rondeau v. Mosinee

from the mere possession of nonpublic market information.”

445 U.S. at 235.

25a

Paper Corp., 422 U.S. 49, 58 (1975)). See also Piper v.

Chris-Craft Indus., 430 U.S. 1, 35 (1977) (“The legis-

lative history thus shows that the sole purpose of the

Williams Act was the protection of investors who are

confronted with a tender offer.”). Thus, the focus of §

14(e) is on the shareholders of the company who are or

will be confronted with a tender offer. The purpose of

§ 14(e) is to “add[{] a broad antifraud prohibition

modeled on the antifraud provisions of § 10(b) of [the

Securities Exchange Act of 1934] and Rule 10b-5.

Schreiber, 472 U.S. at 10 (inner quotations and

citations omitted).

The second sentence of § 14(e) is a rulemaking

provision that was enacted in 1970, two years after

the original Williams act. Chestman, 947 F.2d at 564.

Accordingly, the SEC promulgated Rule 14e-3(a) in

1980, which provides:

(a) If any person has taken a substantial step

or steps to commence, or has commenced, a tender

offer (the “offering person”), it shall constitute a

fraudulent, deceptive, or manipulative act or prac-

tice within the meaning of section 14(e) of the

[Securities Exchange] Act for any other person

who is in possession of material information re-

lating to such tender offer which information he

knows or has reason to know is nonpublic and

which he knows or has reason to know has been

acquired directly or indirectly from:

(1) The offering person,

(2) The issuer of the securities sought or to be

sought by such tender offer, or

— ä —jä — — —

26a

(3) Any officer, director, partner, or employee

or any other person acting on behalf of the

offering person or such issuer,

to purchase or sell or cause to be purchased or

sold any of such securities or any securities

convertible into or exchangeable for any such

securities or any option or right to obtain or to

dispose of any of the foregoing securities,

unless within a reasonable time prior to any

purchase or sale such information and its

sources are publicly disclosed by press release

or otherwise.

17 C. F. R. § 240.14e-3(a).

“Rule 14e-3(a) is a disclosure provision.“ Chest-

man, 947 F.2d at 557. An individual violates the rule

when “he trades on the basis of material nonpublic

information concerning a pending tender offer that he

knows or has reason to know has been acquired

‘directly or indirectly’ from an insider of the offeror

or issuer, or someone working on their behalf.” Id.

(quoting Rule 14e-3(a)). Thus, the rule creates a duty

to disclose this information, or to abstain from

trading, “regardless of whether such information was

obtained through a breach of fiduciary duty.” SEC v.

Maio, 51 F.3d 623, 631 (7th Cir. 1995); see also SEC v.

Peters, 978 F.2d 1162, 1166-67 (10th Cir. 1992) (holding

breach of fiduciary relationship not required to

establish violation of Rule 14e-3); Chestman, 947 F.2d

at 557 (Rule 14e-3(a) “creates a duty in those traders

who fall within its ambit to abstain or disclose, with-

out regard to whether the trader owes a pre-existing

fiduciary duty to respect the confidentiality of the

information.”).

27a

_O’Hagan contends that his securities fraud con-

victions under § 14(e) and Rule 14e-3(a) must be

vacated because the SEC exceeded its rulemaking

authority when it promulgated Rule 14e-3(a). Specifi-

cally, O’Hagan claims that the SEC impermissibly

redefined fraud in Rule 14e-3(a) by omitting the

requirement that a breach of a fiduciary duty must be

shown because the term fraud under § 14(e) requires a

breach of fiduciary duty.

An administrative rule exceeds its statutory man-

date if it is “inconsistent with the statutory mandate

or... frustrate[s] the policy that Congress sought

to implement.” Securities Indus. A’ssn v. Board of

Governors, 468 U.S. 137, 143 (1984) (inner quotations

and citation omitted). To date, three courts have con-

sidered whether the SEC exceeded its rulemaking

authority when it promulgated Rule 14e-3 without the

requirement of a breach of a fiduciary duty. See

Maio, 51 F.3d at 634-35; Peters, 978 F.2d at 1165-67;

Chestman, 947 F.2d at 556-63. These courts have all

concluded that the SEC did not exceed its authority.

After carefully reviewing these decisions and consid-

ering them in light of the text of § 14(e) and the Su-

preme Court’s holdings in Chiarella and Schreiber,

we conclude that we must depart from the holdings of

our sister circuits and hold that the SEC exceeded its

rulemaking authority by enacting Rule 14e-8(a) with-

out including the requirement of a breach of a fiduci-

ary duty.

Because this issue turns on the scope of conduct

that may be regulated by § 14(e), once again the plain

language of the statute is controlling. See Central

Bank, 114 S. Ct. at 1446-48 (with respect to deter-

mining the scope of conduct prohibited by § 10(b), “the

28a

text of the statute controls our decision”). Although

the Central Bank Court dealt with scope of conduct

prohibited by § 10(b), the Court stated unequivocally

that its textual analysis applied to all provisions in

the Securities Act. See id. at 1447 (“Adherence to the

text in defining the conduct covered by § 10(b) is

consistent with our decisions interpreting other pro-

visions of the securities Acts.”). This methodology is

in line with that employed by the Schreiber Court

where, in the context of interpreting the term “man-

pulative” under § 14(e), the Court turned to the lan-

guage of the statute. See 472 US. at 6 (At he start-

ing point is the language of the statute.”).

We thus turn our attention to the text of § 14e).

Specifically, we focus on the second sentence of that

provision, the enabling provision. It provides in perti-

nent part: “The Commission shall, for the purposes of

this subsection, by rules and regulations define, and

prescribe means reasonably designed to prevent, such

acts and practices as are fraudulent. . . .” Eliminat-

ing those words having no bearing to our inquiry, the

statute empowers the SEC to “define” and “prescribe

means reasonably designed to prevent” “acts and

practices” which are “fraudulent.” Thus, by dis-

secting the language and structure of the statute, it

becomes clear that the terms “define” and “prescribe”

relate to “acts and practices” meeting the statutory

definition of “fraudulent,”

A straightforward exercise in statutory construc-

tion then affords no basis for concluding that § 14(e)

authorizes the SEC to create its own definition of

fraud in implementing the statute. Simply put, the

enabling provision of § 14(e) permits the SEC to

identify and regulate those “acts and practices”

29a

which fall within the § 14(e) legal definition of

“fraudulent,” but it does not grant the SEC a license

to redefine the term. See Chestman, 947 F.2d at 584

(Mahoney, J., concurring in part and dissenting in

part) (“the plain meaning of the dispositive language

is that the SEC is empowered to identify and re-

gulate, in this (then) novel [tender offer] context, the

‘acts and practices’ that fit within the existing legal

categories of the ‘fraudulent, deceptive, or manipulat-

ive,’ but not to redefine the categories themselves.”).

The government takes issue with this reading of

§ 14(e), claiming that the plain language is a broad

delegation to the SEC of rulemaking powers and,

when properly read, it empowers the SEC to “define”

and means reasonably designed to prevent”

“fraudulent conduct” in the tender offer context. In

essence, the government conflates the language of the

statute into a broad empowerment to the SEC to

“define” and “prescribe” “fraud.” As we point out

above, however, this is not what the plain language of

§ 14(e) delegates to the SEC; the enabling provisions

simply permit the SEC to “define” and “prescribe”

“acts and practices” which meet § 14(e)’s meaning of

“fraudulent.”

We thus must ascertain the meaning of “fraudu-

lent” in § 14(e). The Congress gave no indication that

the term was to have a meaning different from its

common legal definition. See id. (“Furthermore.

these venerable terms are used in their normal,

accepted definitions.”). The Schreiber Court looked

to the common law and dictionary definitions in

defining manipulation. See Schreiber, 472 U.S. at 7

(court construed “manipulative” in manner con-

sistent with its common law and dictionary defini-

ee ee

30a

tion). Black’s Law Dictionary provides certain defini-

tions of “fraud” which are entirely consistent with

the breach of a fiduciary duty, while other definitions

would impose no such requirement. Compare Black’s

Law Dictionary 660 (6th ed. 1990) (“concealment of

that which should have been disclosed,” and “acts,

omission, and concealments involving a breach of a

legal or equitable duty”) with id. (“An intentional

perversion of truth for the purpose of inducing

another in reliance upon it,” “A false representation

of a matter of fact,” and “A generic term, embracing

all multifarious means which human ingenuity can

devise”). Thus, the dictionary definitions provide

little assistance in resolving this problem. However,

the analytic model created by the Supreme Court’s

holdings in Schreiber and Chiarella, cases drawing

heavily on common law principles, leads to the in-

escapable conclusion that fraudulent under § 14(e)

must be read to include a breach of a fiduciary duty.

In Schreiber, the Court explicitly held that § 14(e)

is modeled after the broad antifraud provisions of

§ 10(b) and Rule 10b-5. 472 U.S. at 10 & n.10. Moreo-

ver, in the course of interpreting manipulation, the

Court turned to the meaning that term had been given

under § 10(b), noting that “Congress used the phrase

‘manipulative or deceptive’ in § 10(b) as well, and we

have interpreted ‘manipulative’ in that context to

require misrepresentation.” Id. at 7-8 & n.6. The

Court went on to note that “{ajll three species of

misconduct, i.e., ‘fraudulent, deceptive, or manipulat-

ive,’ listed by Congress are directed at failures to

disclose.” Id. at 8. Accordingly, the definition that

fraudulent has been given under § 10(b) and Rule 10b-5

guides our interpretation of the term under § 14(e).

3la

As we observed during our discussion of § 10(b), the

Chiarella Court drew upon common law concepts in

defining fraud under § 10(b), holding that the term

encompassed a failure to disclose information but only

if there was a duty to speak. 445 U.S. at 222, 235.

This duty to speak, in turn, arises out of a “ ‘fiduciary

or other similar relation of trust and confidence.’”

Id. at (quoting Restatement (Second) of Torts §

551(2)(a) (1976)).

Reading Schreiber and Chiarella together leads to

the conclusion that “fraudulent” under § 14(e) in-

cludes the breach of a fiduciary obligation. Initially,

we note that § 10(b) and § 14(e) are contained in the

same statutory enactment, the Securities Exchange

Act of 1934—strong evidence that the terms are to be

given the same meaning. See Gustafson v. Alloyd

Co., Inc., 115 S. Ct. 1061, 1067 (1995) (term “prospec-

tus” construed to have the same meaning in § 10 of

the 1933 Securities Act as in § 12 of that same Act);

see also id. (in holding that “identical words used in

different part of the same act are intended to have

same meaning,” Court stated It he Securities Act of

1933, like every Act of Congress, should not be read as

a series of unrelated provisions.”). That § 10(b) does

not specifically include the term fraud is of no

moment because it is beyond cavil that that provision

is a powerful antifraud provision. Chiarella, 445 U.S.

at 234-35. Further, the Schreiber Court turned di-

rectly to § 10(b) to define terms in § 14(e), and Chia-

rella held that fraudulent under § 10(b) requires the

breach of a fiduciary obligation. Of added import, the

Schreiber Court held that “fraudulent” under § 14(e)

was directed at nondisclosure of information, while

the Chiarella Court detailed the circumstances

32a

under which nondisclosure is fraudulent under §

10(b). Additionally, we also think it significant that

the Chiarella Court turned to common law concepts

in giving meaning to fraudulent under § 10(b), as did

the Schreiber Court in interpreting manipulative

under § 14(e).

Finally, we also find telling that, in the quote from

Chiarella in the above paragraph, the Supreme Court

quoted the Restatement (Second) of Torts and then

stated that the American Law Institute views this

rule as applicable to “securities transactions.” See

Chiarella, 445 U.S. at 228 n.9 (“As regards securities

transactions, the American Law Institute recognizes

that ‘silence when there is a duty to . . speak may

be a fraudulent act.’” (quoting ALI, Securities Code

§ 262(b) (Prop. Off. Draft 1978)). It is inexplicable to

us why this Restatement rule, should have definitive

force in the § 10(b) context but not in the § 14(e) con-

text, especially in light of the fact that the two

sections are part of the same statutory scheme. See

Chestman, 947 F.2d at 586-87 (Mahoney, J., con-

curring in part and dissenting in part). Accordingly,

we hold that Schreiber and Chiarella mandate that

“fraudulent” under § 14(e) must be interpreted to re-

quire the breach of a fiduciary obligation or similar

trust relationship.”

% Additionally, some commentators have indicated that the

rationale from Bryan, 58 F.3d at 943-59, with respect to the

misappropriation theory under § 10(b), also calls into doubt the

validity of Rule 14e-3(a). Richard M. Phillips & Gilbert C.

Miller, Litigation Reform in the Courts: Limiting Section 12(2)

Liability, The Bespeaks Caution Doctrine and the Misappro-

priation Theory, CA28 ALI-ABA 487, 527 (February 16, 1996)

Indeed, under the [Bryan] court’s rationale, it is by no me- ns

clear that SEC Rule 14-3 would be upheld to prec!nde transac-

33a

The government does not explicitly address the

force of Chiarella and Schreiber on this issue, in-

SEC does not have the authority to define fraud;

rather, the plain language of § 14(e) permits the SEC

to define and prescribe preventive measures for acts

and practices which are fraudulent. Moreover, this

grant of authority to the SEC, even without the

power to define fraud, remains a very powerful tool

because the SEC has broad latitude in regulating acts

The government also points out that the language

in § 14(e), granting the SEC rulemaking authority, is

different from that in § 10(b), arguing that the § 14(e)

language grants the SEC much broader rulemaking

powers than under § 10(b). We believe, however, the

government makes too much of what in reality are

simply minor discrepancies in language between the

two provisions. Section 10(b) permits the Commis-

sion to create “rules and regulations” which are

“necessary or appropriate in the public interest or for

the protection of investors,” while § 14(e) empowers

the Commission to enact “rules and regulations”

which “define” and “prescribe means reasonably de-

tions in the securities of target companies by insiders of tender

offerors.”).

ee ee ee . . eee eee eee

34a

signed to prevent“ acts and practices“ which are

“fraudulent.” In the end, although perhaps 5 14e) is

the product of clearer legislative draftsmanship, the

authority granted to the SEC under both provisions

is fundamentally the same. See Chestman, 947 F.2d

at 587 (Mahoney, J., concurring in part and dissenting

in part) (positing that minor discrepancies in statu-

tory language of § 10(b) and § 14(e) are of no signifi-

cance).

Finally, the government contends that the meaning

of “fraudulent” under § 14(e) is irrelevant in deciding

this issue because of the statutory language authoriz-

ing the SEC “to prescribe means reasonably designed

to prevent” the acts and practices which are fraudu-

lent. The government argues that under this lan-

guage, the SEC may regulate conduct which is not

fraudulent in order to prevent the commission of a

fraudulent act. The government points to a passage

from a footnote in Schreiber, where the Court stated

that the enabling provision in § 14(e) empowered the

We also note that to the extent that the Chestman

majority relied on the statements of a subsequent Congress in

interpreting § 14(e), such a method of interpretation was con-

demned by the Supreme Court in Central Bank. There, the

court made clear that using statements of a later Congress to

interpret a statute enacted by an earlier Congress is to be

avoided, at least in the area of securities law. See Central

Bank, 114 S.Ct. at 1452 ([The interpretation given by one

Congress (or committee or Member thereof) to an earlier

statute is of little assistance in discerning the meaning of that

statute.”). As the government correctly observes, however,

the Chestman majority first relied on the text of the statute to

reach its conclusion, and thus it is unclear how much weight

the majority gave to this evidence. See Chestman, 947 F.2d at

558.

35a

SEC to “regulate nondeceptive activities as a ‘rea-

sonably designed’ means of preventing manipulative

acts. .” 472 U.S. at 11 n. 11. However, the govern-

ment fails to include the remainder of this sentence

from Schreiber, which states, “without suggesting

any change in the meaning of the term ‘manipulative’

itself.“ Jd. Properly read, this provision means

simply that the SEC has broad regulatory powers in

the field of tender offers, but the statutory terms have

a fixed meaning which the SEC cannot alter by way of

an administrative rule.

We take pause to observe, as the government points

out, that “[blecause Congress has expressly granted

the SEC authority to promulgate rules which will

implement section 14(e), rules promulgated under

that section have ‘legislative effect’ and are ‘entitled

to more than mere deference. . . .’” (Gov’t’s Br. at 53

(quoting Batterton v. Francis, 482 U.S. 416, 425-26

(1977).) Thus, the government continues, we may not

set aside these-rules simply because we would have

interpreted § 14(e) in a manner different from the

SEC, but only if the rule is inconsistent with the

statutory mandate or frustrates the Congressional

policy sought to be implemented.

While the government’s point is well made,

nonetheless, an administrative agency’s interpreta-

tion of a statute under which it has been given rule-

making authority is not wholly beyond reproach. In

this vein, the Supreme Court observed in IBT v.

Daniel, 439 U.S. 551, 566 n.20 (1979), that “[TJhis

deference is constrained by our obligation to honor

the clear meaning of a statute, as revealed by its

language, purpose, and history. On a number of occa-

sions in recent years this Court has found it neces-

36a

sary to reject the SEC’s interpretation of various

provisions of the Securities Acts.” See also Aaron v.

SEC, 446 U.S. 680, 694 n.11 (1980) (rejecting SEC’s

view that scienter is not required in § 10(b) injunctive

proceedings); Business Roundtable v. SEC, 905 F.2d

406, 407 (D.C. Cir. 1990) (holding that SEC exceeded

its statutory authority in promulgating Rule 19c-4 to

bar national securities exchange and associations

from listing stocks violative of one share/one vote

principle). We conclude that, in this instance, the

SEC has once again acted in excess of its statutory

authority.

We hold that the SEC exceeded its rulemaking

authority under § 14(e) when it promulgated Rule

14e-3(a) without including a requirement of a breach

of a fiduciary obligation. Accordingly, we must vacate

O’Hagan’s securities fraud convictions under these

provisions.

C.

O’Hagan was also convicted on a number of counts

of mail fraud and money laundering. The essential

elements of the crime of mail fraud are: (1) a scheme

to defraud, or to obtain money or property by false

pretenses, and (2) use of the mails to further the

scheme. United States v. Wicker, 80 F.3d 263, 267

(8th Cir. 1996). The mere fact that O’Hagan’s securi-

ties convictions have been reversed does not as a

matter of law require that the mail fraud convictions

likewise be reversed. See Carpenter, 484 U.S. at 24

(unanimously affirming mail and wire fraud convic-

tions based on the same facts that evenly divided the

Court on the defendant’s securities fraud convic-

tions); Bryan, 58 F.3d at 936 (affirming mail fraud and

wire fraud counts but reversing on securities fraud

37a

counts). However, in the present case, the indictment

was structured in such a manner as to premise the

fraud for the mail fraud charges on the acts allegedly

constituting the securities fraud. (See R. at 697-706.)

Because O’Hagan’s conduct did not constitute securi-

ties fraud for the reasons we have noted above, there

was no fraud upon which to base the mail fraud

charges. Accordingly, we reverse O’Hagan’s mail

fraud convictions.

With regard to the money laundering counts, they

were predicated on the securities fraud or mail fraud

counts. Because we have vacated all of the securities

fraud and mail fraud counts, there no longer remain

any convictions to serve as the predicate conduct

upon which to base the money laundering counts. We

therefore must reverse these convictions as well. See

18 U.S.C. §§ 1956-1957 (requiring the property in-

volved in the transaction to be derived from or the

proceeds of unlawful activities).

Our ruling today should in no manner be under-

stood as condoning O’Hagan’s conduct. From the

record, it appears as though O’Hagan, then an attor-

ney at law, engaged in at least some transactions in

Pillsbury securities after learning privileged, con-

fidential information that his law firm was repre-

senting a client intending a takeover of Pillsbury.

Such conduct is certainly unethical and immoral and

must be condemned, which we make haste to do. We

note that O’Hagan was disbarred in Minnesota, and

served a 30-month sentence after being convicted in

Minnesota state court for invading clients’ trust

funds. However, it is a fundamental principle of the

criminal law that not every ethical or moral trans-

38a

gression falls within its realm. This case is a prime

example of that principle. Accordingly, for the rea-

sons enumerated above, we reverse O’Hagan’s securi-

ties fraud, mail fraud, and money laundering convic-

tions and remand this case to the district court for

dismissal of the indictment.

Face, Circuit Judge, dissenting.

My colleagues have carefully analyzed both sides of

the relevant legal coins and selected the sides that

nullify O’Hagan’s convictions. Contrary to their

well-reasoned views, I would recognize and adopt the

misappropriation theory like the Second, Seventh,

Ninth, and Third Circuits, see ante at 620 & nn. 9-12,

and thus uphold O’Hagan’s convictions for securities

fraud under § 10(b) and Rule 10b-5. United States v.

Libera, 989 F. 2d 596, 599-600 (2d Cir.), cert. denied

sub nom. Sablone v. United States, 114 S. Ct. 467

(1993); SEC v. Maio, 51 F.3d 623, 631 (7th Cir. 1995);

SEC v. Clark, 915 F.2d 439, 453 (9th Cir. 1990);

Rothberg v. Rosenbloom, 771 F.2d 818, 822 (3d Cir.

1985), rev’d after remand, 808 F.2d 252 (1986), cert.

denied, 481 U.S. 1017 (1987). Also, like the Second,

Seventh, and Tenth Circuits, see ante at 623-24, I

would hold the Securities Exchange Commission did

not exceed its rulemaking authority when it enacted

Rule 14e-3(a) without the requirement of a breach of a

fiduciary duty, and thus uphold O’Hagan’s securities

fraud convictions under § 14(e) and Rule 14e-3(a).

United States v. Chestman, 947 F.2d 551, 556-63 (2d

Cir. 1991) (en banc), cert. denied, 508 U.S. 1004 (1992);

Maio, 51 F.3d at 634-35; SEC v. Peters, 978 F.2d 1162,

1165-67 (10th Cir. 1992). Having adopted these views,

I find no basis to reverse O’Hagan’s convictions for

mail fraud and money laundering. See ante at 31-32.

39a

Because I would affirm all of O’Hagan’s convictions, I

would also consider the merits of the government’s

appeal from O’Hagan’s sentences.

a eee el i ee eS ie et

40a

APPENDIX B

UNITED STATES DISTRICT COURT

DISTRICT OF MINNESOTA

FOURTH DIVISION

Crim. No. 4-92-219

UNITED STATES OF AMERICA, PLAINTIFF

v.

JAMES HERMAN O’HAGAN, DEFENDANT

Filed: Sept. 10, 1993]

REPORT AND RECOMMENDATION

Defendant was present in court with his counsel,

Charles Hawkins. The government was represented

by Assistant United States Attorneys Lynn Zentner

and Christopher Bebel. Attorneys Jan Struumans,

Terrence Fruth and Vincent Louwagie, who all have

represented Defendant, testified on his behalf.

Before the Court are Defendant’s motion to dismiss

the indictment and his supplemental motion to dis-

miss the indictment. Defendant is charged with mis-

appropriation of material, non-public information

concerning the acquisition of The Pillsbury Company

by Grand Metropolitan, PLC and subsequently mak-

ing a series of purchases on the securities markets

based on this insider information. The indictment

alleges in:

4la

a) Counts 1-20 tnat Defendant committed mail

fraud in violation of 18 U.S.C. § 1341 by receiving

through the mail twenty confirmation slips;

b) Counts 21-37 that Defendant committed securi-

ties fraud in violation of the Securities Exchange Act

of 1934, 15 U.S.C. §§ 78j(b) and 78ff(a) and 17 C.F.R. §

240.10b-5, by breaching his duty of trust and

confidence owed to Grand Met and the Dorsey &

Whitney law firm by misappropriating information

concerning Grand Met’s tender offer for Pillsbury

stock and trading on that information in the securi-

ties market;

e) Counts 38-54 that Defendant committed securi-

ties fraud in violation of the Securities Exchange Act

of 1934, 15 U.S.C. §§ 78n(e) and 78ff(a) and 17 C.F.R. §

240.14e-3(a), by trading in Pillsbury stock after

substantial steps were taken by Grand Met in its

takeover attempt, while in possession of material,

non-public information concerning the tender offer;

and

d) Counts 55-57 that Defendant engaged in money

laundering in violation of 18 U.S.C. § 1957 (Count 55),

and 18 U.S.C. § 1956(a)(1)(B)(i) (Counts 56-57) by the

wire transfer of funds derived from mail fraud and

fraud in the sale of securities, and by obtaining cash-

ier’s checks to replace embezzled funds, which sums

involved the proceeds from the mail and securities

fraud perpetrated by Defendant, all with the intent to

conceal and disguise the proceeds of Defendant’s

unlawful activity.

Defendant moves to dismiss all Counts, 1-57, of the

indictment on the grounds that:

a) The Counts are barred on the grounds of double

jeopardy by his civil case, pending in this Court;

42a

b) The Counts violate principles of federalism and

the “Petite Policy” oi Petite v. United States, 36)

U.S. 529 (1960), which counsels against bringing a

federal prosecution following a state prosecution

based on substantially the same act or acts unless

there is a compelling federal interest;

e) The Counts are the result of prosecutorial

vindictiveness;

d) There has been preindictment delay; and

e) The information obtained by Defendant was

public and immaterial as a matter of law.

Defendant moves to dismiss Counts 1-20 on the

grounds that these Counts fail to state an offense

because: 1) the indictment fails to allege that either

Dorsey & Whitney or Grand Met were deprived of any

property as required by the mail fraud statute, 18

U.S.C. § 1341; and 2) because the confirmation slips

Defendant received from his brokers were not mail-

ings in furtherance of the alleged fraud.

Defendant moves to dismiss Counts 21-37 on the

grounds that these Counts fail to state an offense

because: 1) Section 10(b) of the Securities Exchange

Act of 1934 does not criminalize insider trading; and

2) the indictment alleges only a breach of a duty of

trust and confidence owed to Grand Met and the

Dorsey & Whitney law firm, not a duty owed to Pills-

bury shareholders.

Defendant moves to dismiss Counts 21-54 on the

grounds that: 1) these Counts are barred by the ap-

plicable statute of limitations; and 2) these Counts are

multiplicitous and should be consolidated into two or

three Counts.

Defendant moves to dismiss Counts 38-54 on the

grounds that: 1) the SEC exceeded its rulemaking

authority in promulgating Rule 14e-8 under which

43a

Defendant is charged; and 2) these Counts fail to state

an offense because they do not allege that Grand Met

took substantial steps toward the takeover of

Pillsbury.

Defendant moves to dismiss Counts 55-56 for

failure to state an offense because neither mail fraud

nor securities fraud were defined as “specified un-

lawful activity” in 1988, pursuant to the money laun-

dering statutes under which Defendant is charged.

BACKGROUND

The indictment charges that Defendant violated

federal laws against insider trading, mail fraud and

money laundering. It is alleged that Defendant, while

a partner at the Dorsey & Whitney law firm, misap-

propriated material, non-public information concern-

ing the acquisition of The Pillsbury Company by

Grand Metropolitan, PLC and subsequently made a

series of purchases on the securities markets based

on this insider information. Defendant denies these

allegations.

At the hearing, Defendant’s former attorneys in

the SEC civil suit testified concerning essentially

two subjects. First, the attorneys testified that they

believed Defendant would be indicted perhaps as much

as two years earlier than he was indicted. However,

they admitted that the government made no such

affirmative representations. Second, the attorneys

testified that glob[al] settlement negations were con-

ducted, but failed, and that attempts to have the

government forego prosecution in light of Defen-

dant’s state conviction had not been successful. In

this regard, the testimony was that the prosecutor

had stated that Defendant had been an attorney, had

enjoyed societ[y’s] benefits and his crimes were many

14a

and involved millions of dollars. The prosecuting

attorney is reported to have noted that, compared to

less privileged members of society, who might rob a

bank, gain only $500.00 and yet be sentenced to 15 to

20 years in prison, Defendant had little to complain

about.

DOUBLE JEOPARDY

Defendant argues that all Counts, 1-57, are barred

by double jeopardy. Defendant contends his SEC civil

case, pending in this Court, bars his criminal pros-

ecution. This Court is not persuaded.’

The double jeopardy clause bars further pros-

ecution only if jeopardy attached in the initial pro-

ceeding. See Serfass v. United States, 420 U.S. 377,

388, 391 (1975). Jeopardy does not attach until a jury

is empaneled and sworn or in a non-jury trial, when

the court begins to hear evidence. Id. at 388 and 391.

Neither predicate event has occurred in the instant

case as the civil proceedings have been stayed.

Defendant’s argument that the extent of discovery

should cause jeopardy to attach is rejected.

| While Defendant was also prosecu in state court the

separate sovereigns doctrine defeats any claim of double jeop-

ardy in regard to the state prosecution vis-a-vis the federal

prosecutions. See Abbate v. United States, 359 U.S. 187 (1959);

Rinaldi v. United States, 434 U.S. 22, 28 (1977). While Defen-

dant raises the possibility that the separate sovereigns doctrine

is no longer valid after Grady v. Corbin, 110 S.Ct. 2084 (1990),

Grady has recently been overruled by the United States Su-

preme Court. United States v. Dixon, 1993 WL 224417 (June

28, 1993).

45a

FEDERALISM AND PETITE v. UNITED STATES, 361

U.S. 529 (1960)

Defendant contends that all Counts, 1-57, of the

indictment must be dismissed because this prosecu-

tion violates the principles of federalism and the

Petite policy of the Justice Department as set forth in

Petite v. United States, 361 U.S. 529, 530-31 (1960).

The Petite policy is a general internal guideline of

the Department of Justice that counsels against

bringing a federal prosecution following a state prose-

cution based on substantially the same act or acts

unless there is a compelling federal interest. As this

“policy” is an internal procedural guideline, it cannot

be enforced against the government. United States v.

Woodward, 927 F.2d 433, 435 (8th Cir.), cert. denied,

112 S. Ct. 246 (1991); United States v. Robinson, 774

F. 2d 261, 275 (8th Cir. 1985).

Defendant’s federalism argument is equally flawed.

Violation of federal laws and statutes is distinct from

violation of state laws. See United States v. Jacobs,

No. 92-3696 (8th Cir. September 1, 1993) (per curiam)

(“The fact that the federal government prosecutes a

federal crime in federal court that could have or has

been prosecuted as a state crime in a state court does

not itself violate due process.”). Finally, this Court

has found that this indictment does not raise double

jeopardy concerns.

PROSECUTORIAL VINDICTIVENESS

Defendant contends that all Counts, 1-57, should be

dismissed for prosecutorial vindictiveness. Defen-

dant is grasping at straws.

Negotiations were conducted between Defendant’s

attorney and the prosecuting attorney in an attempt

to resolve all of the charges facing Defendant. These

46a

global settlement negotiations were unsuccessful.

Subsequently, Defendant changed attorneys and

these attorneys met with the prosecuting attorney in

an attempt to have the government abandon its

prosecution of Defendant, in part because they felt

Defendant had been punished enough. The govern-

ment refused and in response to the attorneys’

queries noted that Defendant had been an attorney,

had enjoyed societly's] benefits and that his crimes

were many and involved millions of dollars. The

prosecuting attorney went on to note that compared

to less privileged members of society, who might rob a

bank, gain only $500.00 and yet be sentenced to 15 to

20 years in prison, Defendant had little to complain

about. On this thin reed, Defendant bases his argu-

ment of vindictive prosecution.

A defendant may demonstrate vindictive prosecu-

tion by either: (1) proving through objective evidence

that the prosecutor’s decision was intended to punish

him for the exercise of a legal right; or (2) by relying

on a presumption of vindictiveness. See United

States v. Beede, 974 F.2d 948, 951 (8th Cir. 1992), cert.

denied, U.S. __, 113 S. Ct. 1016 (1993). A rebut-

table presumption of vindictiveness may arise when a

prosecutor increases the number or severity of

charges. See United States v. Punelli, 892 F.2d 1364,

1371 (8th Cir. 1990). Absent such a presumption, De-

fendant has the burden of proving vindictiveness. Id.

at 1372.

As the Beede court recognized, prosecutorial vin-

dictiveness is not shown where plea negotiations fail

and the prosecutor goes ahead with the prosecution.

See United States v. Beede, 974 F.2d at 951 (citing

Bordenkircher v. Hayes, 434 U.S. 357 (1978) and

United States v. Goodwin, 457 U.S. 368, 382-83

47a

(1982)). Moreover, “‘A prosecutor should remain free

before trial to exercise the broad discretion entrusted

to him to determine the extent of the societal interest

in prosecution.’” Id. at 952 (citing United States v.

Goodwin, 457 U.S. 368, 382 (1982)). These principles

govern this case.

Defendant attempted to negotiate a global settle-

ment and attempted to persuade the prosecuting

DELAY

Defendant contends that all Counts, 1-57, should be

dismissed for preindictment delay. Defendant is in

error. The only evidence in support of Defendant’s

argument is the testimony of Defendant’s former at-

torneys in the SEC civil proceeding. These attorneys

formulated a belief that Defendant would be indicted

in the near future. The government made no repre-

sentations in this regard.

In United States v. Purham, 725 F.2d 450, 453 (8th

Cir. 1984) the Eighth Circuit stated that:

Plreindietment delay may violate the due process

clause. Vnited States v. Lovasco, 431 U.S. 783,

789-90 (1977); United States v. Marion, 404 U.S.

307, 324 (1971). ‘A defendant is entitled to

dismissal of an indictment where he [or she] shows

actual prejudice from an unreasonable delay on

the part of the government. Where actual

prejudice is established, the reasons for the delay

are balanced against the prejudice shown by the

accused.’ United States v. Taylor, 603 F.2d 732, 735

(8th Cir.) (citations omitted; emphasis in the

original), cert. denied, 444 U.S. 982 (1979).

Assuming for the purposes of argument that the

delay of more than a year between the date of the

crime and the filling of the federal indictment was

unreasonable, a careful review of the record con-

vinces us that the district court correctly found

that appellant did not demonstrate actual prej-

udice. Appellant has relied solely on the admit-

tedly ‘real possibility of prejudice inherent in any

extended delay: that memories will dim, witnesses

become inaccessible, and evidence be lost

49a

[These possibilities are not in themselves enough

to demonstrate that [appellant] cannot receive a

fair trial and to therefore justify the dismissal of

the indictment.’ United States v. Marion, 404

U.S. at 326; see United States v. Hendricks, 661

F.2d 38, 40 (5th Cir. 1981); United States v.

Taylor, 603 F. 2d at 735. (Footnote omitted).

Dismissal may also be appropriate if a defendant can

show that the delay was an intentional device used by

the government to gain tactical advantage over the

accused and caused substantial prejudice to his right

to fair trial. United States v. Jackson, 714 F.2d 809,

811 (8th Cir. 1983). “The ultimate question in deter-

mining whether a deliberate or reckless delay is

‘tactical’ is whether it is engineered to impair the

defendant's ability to mount an effective defense by

causing him to lose evidence.” United States v.

Dennis, 625 F. 2d 782, 794 (8th Cir. 1980).

Defendant has failed to demonstrate any actual

prejudice from the delay in bringing the indictment

against him. Similarly, Defendant has failed to show

that any delay was tactical. In the absence of actual

prejudice, Defendant’s motion must fail.

FAILURE TO STATE AN OFFENSE—CHARACTER

OF INFORMATION

Defendant contends that all Counts, 1-57, must be

dismissed for failure to state an offense because the

information obtained by Defendant, concerning Grand

Met’s tender offer, was public and immaterial as a

matter of law. Whether information is material is a

question of fact to be decided by the trier of fact. See

TSC Indus. v. Northway, 426 U.S. 438, 450 (1976);

Berg v. First American Bankshares, Inc., 796 F.2d

489, 494-95 (D.C. Cir. 1986); SEC v. Singer, 786 F.

— a a a

50a

Supp. 1158, 1172 (S.D.N.Y. 1992). The materiality and

nonpublic nature of the information Defendant ob-

tained are elements of the government’s case-in-chief

which must be proven at trial. On this record, this

Court finds that ultimate resolution of these issues

must be left to the trier of fact.’

FAILURE TO STATE AN OFFENSE—MAIL FRAUD

Defendant contends that the mail fraud counts, 1

through 20, must be dismissed because they fail to

allege that he obtained money or property from Grand

Met or Dorsey & Whitney, an essential element of the

crime. Defendant's motion appears to raise two

issues: first, whether the counts allege that De-

fendant obtained property from Grand Met and

Dorsey & Whitney, and second, whether the property

allegedly obtained is property as that term is used in

18 U.S.C. § 1341.

We turn to the allegations of the indictment. Count

1 sets forth the scheme. Paragraph 2 alleged Defen-

dant engaged in a scheme to defraud Grand Met and

Dorsey & Whitney by trading in Pillsbury, Inc. com-

mon stock, while in possession of material nonpublic

information about Grand Met’s future tender offer for

Pillsbury common stock. In paragraph 14, it is al-

leged that Defendant, a partner in the firm of Dorsey

2 Defendant in his supplemental motion to dismiss revisits

these issues arguing that Counts 21-54 of the Indictment must

be dismissed “based upon the failure to charge an offense

because the defendant did not possess any material non-public

information at the time he placed the orders for the purchase

of Pillsbury common stock and options identified in the

indictment.” See Defendant’s Supplemental motion to Dismiss.

Again these issues must be left to the trier of fact. This Court

will not presage their decision.

5la

& Whitney, learned his firm was retained b

Met to represent them in connection with, —

offers and then purchased Pillsbury stock and call

options, which he later sold at a profit after the tender

offer became public information.

The allegations, read together and given a common

sense interpretation, allege that Defendant defrauded

Grand Met and Dorsey & Whitney by using, without

permission, their confidential business information

before it became public, to trade in Pillsbury stock.

1 — — * that the indietment fails to

essential elem

. ent of the offense must be

In resolving the second issue, it must be deter-

mined whether the tender offer information was

property within the meaning of the mail fraud statute.

Defendant relies on McNally v. United States, 483

U.S. 350 (1987). In McNally, the Supreme Court held

that the public’s interest in honest and impartial

government is not property within the meaning of the

mail fraud statute. Defendant’s apparent contention

is that confidential information is not property sub-

ject to the mail fraud statute under McNally.

Defendant’s premise was rejected in Carpenter v.

United States, 484 U.S. 19 (1987). In Carpenter, the

er Court 1 — 1 confidential business infor-

on is property within the scope of the mai

statute. Id. at 28. In Carpenter, "the mie tad

used information on the publication date and contents

of a Wall Street Journal article to trade in the mar-

ket, based on the probable impact on the market when

the article was published. The distinction between

McNally and Carpenter is not between tangible and

intangible property, but between those interests

which do not constitute property and those interests -

52a

that are either tangible or intangible property.

United States v. Grandberry, 908 F.2d 278, 280 (8th

Cir. 1990).

Under Carpenter Grand Met’s confidential busi-

ness information is property protected by the mail

fraud statute. Law firms have a property interest in

keeping information confidential to retain and gain

clients. United States v. Grossman, 843 F.2d 78, 86

(2d Cir. 1988). Dorsey & Whitney also has a property

interest protectable under the mail fraud statute.

Defendant’s motion must be denied at this time. The

issue of whether the business information was

confidential and misappropriated must await proof at

trial.

FAILURE TO STATE AN OFFENSE—NOT IN

FURTHERANCE

Defendant next moves to dismiss all of the mail

fraud counts, 1 through 20, on the ground that the

mailings alleged in each count were not ‘n further-

ance of the scheme to defraud as required by the mail

fraud statute, 18 U.S.C. § 1341. Each count alleges

the mailing to Defendant from his broker of a con-

firmation of Pillsbury stock or call option purchases.

Defendant argues that the stock purchases were on

record with his brokers and the confirmation slips

were not required to prove ownership, nor were they

ever used by him for any purpose, and thus did not

further the scheme.

Defendant relies on Kann v. United States, 323

U.S. 88 (1944); Parr v. United States, 363 U.S. 370

(1960); Maze v. United States, 414 U.S. 395 (1974); and

United States v. Taylor, 789 F.2d 618 (8th Cir. 1986).

In Kann, the court held that mailing a check from the

bank that cashed it to the drawee bank was not in

W

53a

furtherance of a scheme to defraud because defen-

dants had the money and it was immaterial to them

whether the bank, which paid the check, could collect

from the drawee bank. See also United States v.

Taylor, supra. In Parr and Maze, the Supreme

Court held that credit card invoices, mailed after the

goods and services had been obtained, were not in

furtherance of the scheme to defraud. In both cases,

it was immaterial to the defendant whether the

Invoices were mailed, since he had completed his

scheme.

; The above cases are distinguishable from the

instant case. The scheme here alleges that the De-

fendant bought Pillsbury stock based on confidential

information and sold it later, when the information

became public and drove up the price of the stock. The

scheme alleged was therefore only half complete when

the stocks were purchased. Businesses, including

stock brokers, make errors when executing and

recording transactions. The slips confirming the

purchases would be important to settle disputes over

the fact of or the amount of stock purchased. The

slips would also be important in determining which

blocks of stock or call options to sell in order to

maximize profits when the price began to rise.

The Second Circuit in United States v. Grossman,

843 F. 2d 78, 89 (2d Cir. 1988) held that confirmation

slips were sent in furtherance of a scheme to defraud

because:

1)They provided notification that the purchase

was complete; 2) provided a tally of purchase, and

3) provided proof of ownership.

Defendant attempts to distinguish Grossman because

the slips in that case were sent to defendant's rela-

—— ee a ee |

54a

tives to conceal ownership. The principles of Gross-

man are applicable, however, because of the factors

listed above. Defendant’s motion to dismiss because

the confirmation slips were not in furtherance of the

conspiracy must be denied.

FAILURE TO STATE AN OFFENSE—CRIMINALITY

Defendant contends that Counts 21-37 must be dis-

missed for failure to state an offense because Section

10(b) of the Securities Exchange Act of 1934 does not

criminalize insider trading. This Court rejects De-

fendant’s argument. Two cases are illustrative of

this point.

In United States v. Lang, 766 F. Supp. 389, 399 (D.

Md. 1991), the District Court found that insider

trading was criminalized under Rule 10b-5, rejecting

the type of argument that Defendant advances. More

critically, in SEC v. O’Hagan, 793 F. Supp. 218, 221

(D. Minn. 1992), the District Court found that Rule

10b-5 prohibits insider trading, where the defendant

argued that the SEC’s claims were implied under

Lampf, because Rule 10b-5 did not specifically pro-

hibit insider trading. Given the confluence of Lang

and O’Hagan, this Court must reject Defendant’s

argument. While Defendant criticizes the decision in

Lang, in light of O’Hagan, it appears that the rule in

this district is that Section 10(b), through the applica-

tion of Rule 10b-5, .riminalizes insider trading.

FAILURE TO STATE AN OFFENSE—FIDUCIARY

DUTY

Defendant moves to dismiss Counts 21 through 37,

which allege insider trading, because the counts fail

to charge that he breached a fiduciary duty or other

relationship of trust and confidence to Pillsbury

stockholders, the target of Grand Met’s takeover

55a

offer. Defendant was neither an officer or director,

nor did his law firm represent Pillsbury. Absent such

a relationship, he argues he was free to trade in

Pillsbury stock without disclosure of allegedly confi-

dential information. The government counters De-

fendant violated Rule 10(b)-5, when he breached a duty

to Grand Met and Dorsey & Whitney, its law firm, by

misappropriating their confidential business informa-

tion and using it to trade in the market.

The Securities and Exchange Commission (SEC) in

In the matter of Cady, Roberts & Co., 40 S.E.C. 907

(1961) ruled that a corporate insider, who has material

nonpublic information, must under Rule 10(b)-5 ab-

stain from trading in his corporate stock unless he

discloses the information known to him. The Su-

preme Court accepted and applied the principles of

Cady, Roberts in United States v. Chiarella, 445 U.S.

222 (1980). In Chiarella, documents relating to a

takeover bid had been sent to a company for printing.

One of the printing company’s employees deciphered

the identity of the target company and profited from

Rule 10(b)-5, codified at 17 C.F.R. § 240-10b-5 (Employ-

ment of manipulative and deceptive devices), states:

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, (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 there were made, not mis-

leading, or (c) To engage in any act, practice, or course of

business which operates or would operate as a fraud of

deceit upon any person, in connection with the purchase or

sale of any security.

56a

trading in its stock, without disclosing the informa-

tion he had learned. The court held there was no gen-

eral requirement to disclose inside information, when

trading in the market. United States v. Chiarella,

445 U.S. 222, 229 (1980). The Supreme Court reversed

the criminal conviction for violating Rule 10(b)-5 be-

cause the printer, absent a fiduciary duty or a

relationship of trust and confidence to the sharehold-

ers of the target company, owed no duty to disclose

his information. The majority in Chiarella rejected

the government’s invitation to affirm the convictions

because the printer had breached his duty to the ten-

der offeror by misappropriating the information. In

their view, the theory was not presented to the jury.

The SEC contended in Dirks v. SEC, 463 U.S. 464

(1983) that a broker, who received material nonpublic

information from corporate officers and employees,

which he gave to some of his customers, who traded in

the stock, was in violation of Rule 10(b)-5. The SEC

censured Dirks for the violation. The Supreme Court

said at page 665:

It is undisputed that Dirks himself was a stranger

to Equity Funding with no preexisting fiduciary

duty to its shareholders. He took no action, di-

rectly or indirectly, that enticed the shareholders

or officers of Equity Funding to repose trust or

confidence in him. There was no expectation by

Dirks’ sources that he would keep their informa-

tion in confidence nor did Dirks misappropriate or

illegally obtain the information about Equity

Funding. Unless the insiders breached their

Cady, Roberts duty to shareholders in disclosing

the nonpublic information to Dirks, he breached no

duty, when he passed it on to investors

57a

The court went on to hold that the tippers in Dirks

did not breach any duty to Equity Funding share-

holders and concluded, therefore, that Dirks, the

tippee, was not in violation of Rule 10(b)-5.

Under the principles of Chiarella and Dirks, the

government concedes Defendant cannot, as he con-

tends, be prosecuted under Rule 10(b)-5 for failure to

disclose inside information to Pillsbury stockholders.

Defendant had no preexisting fiduciary to them, and

he did nothing to induce the officers and directors of

Pillsbury to place their trust and confidence in him.

As far as Pillsbury stockholders were concerned,

Defendant was free under Chiarella and Dirks to use

the alleged inside information as he saw fit.

We turn to the question of whether Defendant vio-

lated Rule 10(b)-5 if, as charged, he breached a duty by

misappropriating Grand Met’s and Dorsey & Whit-

ney’s confidential business information, and without

disclosure, used it to trade in Pillsbury stock. Stated

another way, the question is whether Defendant can

be convicted if neither the seller nor the buyer of

securities was defrauded.

The Supreme Court has not addressed this ques-

tion. As set forth above, the question was not an-

swered in Chiarella or Dirks. In the former, because

the issue was not presented to the jury. In the later,

because there was no claim of misappropriation of

information. In Carpenter v. United States, 484 U.S.

19 (1987), an equally divided court affirmed without

opinion a Rule 10(b)-5 criminal conviction for the mis-

appropriation of confidential business information of

the Wall Street Journal, and its use to trade in the

market based upon the impact on the market when the

information became public. The misappropriation

theory of insider trading posits that Rule 10b-5

58a

prohibits the purchase or sale of securities while in

possession of material, nonpublic information if it is a

breach of a fiduciary duty owed to the source of the

information, whether or not that source was involved

in the security transaction and whether or not there

was a breach of duty to any purchaser or seller. It is

under this broader theory of insider trading that the

government charges Defendant. While the Eighth

Circuit has not specifically adopted the misappropria-

tion theory, other circuits have.

In United States v. Newman, 664 F.2d 12 (2d Cir.

1981), cert. denied, 464 U.S. 863 (1983), two employees

at the Kuhn Loeb investment banking firm:

Misappropriated confidential information concern-

ing proposed mergers and acquisitions that was

entrusted to their employers by corporate clients.

This information was conveyed to Newman, a

securities trader and manager of the over-the-

counter trading department of a New York broker-

age firm. Newman passed along the information to

two confederates . . . [TJhe three conspirators

purchased stock in companies that were takeover

targets . They then reaped substantial gains

when the mergers or takeovers were announced

and the market price of the stock rose.

United States v. Newman, 664 F.2d 12, 15 (2d Cir.

1981). The district court dismissed the securities

fraud charges because it concluded the federal securi-

ties laws did not proscribe the defendants’ conduct. In

reversing the district court, the Second Circuit

reasoned, first, that § 10(b) was written as both a

regulatory and criminal piece of legislation, going on

to note that, “The courts, not the Congress, have

limited Rule 10(b)-5 suits for damages to the purchas-

59a

ers and — of securities. The district court’s

statement fraud perpetrated purchasers or

— 2 dlement ender the

securities laws’ is, therefore, an overbroad and

incorrect summary of the law.” Id. at 17. The court

than noted that a plaintiff, “need not be a defrauded

purchaser or seller in order to sue for injunctive

relief under Rule 10(b)-5.” Id. Finding that the defen-

dants had wronged both the investment firm and their

clients by misappropriating the confidential informa-

tion, the court concluded:

In other areas of law, deceitful misappropriation of

confidential information by a fiduciary, whether

described as theft, conversion, or breach of trust,

has consistently been held to be unlawful. (cita-

tions omitted). Appellee would have had to be most

ingenuous to believe that Congress intended to

establish a less rigorous code of conduct under the

Securities Acts. (citations omitted).

Id. at 18.

In Rothberg v. Rosenbloom, 771 F.2d 818 (ard Cir.

1985), cert. denied, 481 U.S. 1017 (1987), officer and

director, David Rosenbloom obtained information that

his company, Nytronics, intended to merge with Gul-

ton Industries. Rosenbloom conveyed this informa-

tion to Rothberg, who invested on the basis of this

information. The trial court held that Rosenbloom

breached a duty to his own company, whether or not

be breached a duty to Gulton shareholders.

On appeal, it was contended that, “with respect to

the Gulton transaction, he was an outsider and could

not have violated § 10(b), relying on Chiarella.” Id. at

822. The Third Circuit found Chiarella inapposite,

holding that Rosenbloom owed a fiduciary duty to his

60a

own company, Nytronics, “not to disclose secret

information which would cause others to buy Gulton

stock, thereby making it more difficult for Nytronics

to consummate a merger on favorable terms.” Id.

Citing Newman, the court upheld the trial court,

holding that: “An insider on either side of a proposed

transaction violates the insider trading rule when he

uses insider information in violation of the fiduciary

duty owed to the corporation to which he owes a duty

of confidentiality.” Id.

In SEC v. Clark, 915 F.2d 439 (9th Cir. 1990), Clark

was president of Rolyan Manufacturing. Rolyan was

acquired by Smith & Nephew, ple, (S&N), a British

concern. S&N employed Clark as part of an acquisi-

tions team to find new companies for S&N to acquire.

Through his employment with SEN, Clark discovered

that S&N intended to acquire Affiliated Heath

Products (AHP). Acting on the basis of this informa-

tion, Clark arranged to purchase AHP stock in

anticipation of the takeover. In the trial court, Clark

was found in violation Rule 10(b)-5 under a misap-

propriation theory. On appeal, the Third Circuit

stated that, “Our task is to determine whether Con-

gress, in enacting § 10(b), empowered the SEC to

promulgate rules which would encompass the misap-

propriation theory. In addition, we must determine

whether Rule 10b-5 was drafted such that the theory

may legitimately be implied.” SEC v. Clark, 915 F.2d

439, 443 (9th Cir. 1990).

Discussing Newman, Rothberg and a number of

other cases upholding the misappropriations theory,

the Court upheld the application of the misappropria-

tion theory reasoning:

1. Rule 10(b)-5 is a “catchall” antifraud provision,

id. at 448;

6la

2. The misappropriation theory fits “comfortably”

within the concept of fraud in § 10(b) and Rule 10(b)-5,

id. at 449;

3. Clark’s actions were in connection with the

we pe es or — any pov ond because, “Clark’s

purpose in obtaining non-public information

about SN’s plans to acquire AHP iio to make a fast

buck by trading in securities,” id.;

4. “(Tyhe scant legislative history on § 10(b) con-

tains no indication that the misappropriation theory

is out of step with congressional intent.” Jd. at 450.

— court found the same to be true for Rule 10(b)-5;

5. Looking to the passage of the Insider Tradin

and Securities Fraud Enforcement Act of 1988 —

court found that Congress had manifested a belief

that the misappropriation theory was consistent with

§ 10(b) and Rule 10(b)-5, noting the House Report

this legislation. Id. at 452. e

The Ninth Circuit concluded that:

The “peculiar blend of legislative, administrative,

and judicial history” surrounding § 10(b) and Rule

10(b)-5, (citation omitted), provides strong evi-

dence that the misappropriation theory is com-

patible with the broad language of those provi-

sions. Although the Supreme Court has yet to

recognize the theory, (footnote omitted) we none-

theless adopt it as it was prosecuted in this case.

Specifically, we hold that an employee’s knowing

misappropriation and use of his employer’s mate-

rial nonpublic information regarding its intention

to acquire another firm constitutes a violation of

§ 10(b) and Rule 10(b)-5.

62a

* * *

[While] Clark . . . claims that adopting the

theory in this case would introduce a “parity-of-

information” rule which has been previously re-

jected by the Supreme Court as inconsistent with

§ 10(b) and Rule 10(b)-5, see Dirks, 463 U.S. at 654,

103 S.Ct. at 3261; Chiarella, 445 U.S. at 233, 100

S.Ct. at 1117. (footnote omitted). We disagree.

The misappropriation theory, as we have adopted it

today, applies only where the misappropriation

occurs by means of a violation of fiduciary or

similar duty. (footnote omitted). Thus it does not

run afoul of Supreme Court precedent.

Id. at 453.

In SEC v. Cherif, 933 F.2d 403 (7th Cir. 1991), cert.

denied, ~ U.S. __, 112 S.Ct. 966 (1992), Cherif was

employed by First National Bank of Chicago. After

being terminated from his employment, Cherif re-

tained his magnetic identification card, which he used

to enter the building. Using this card, Cherif gained

unauthorized access to the building after his termina-

tion and obtained confidential information from the

Specialized Finance Department. Cherif then traded

on this information.

In upholding the application of the misappropriation

theory to Cherif, the Seventh Circuit stated:

The misappropriation theory has won adherents

in numerous circuit and district courts despite the

lack of explicit approval from the Supreme Court.

The bulk of the cases have arisen in the Second

Circuit, (citations, to include Newman, omitted),

but the theory has now been adopted by the Third

and Ninth Circuits. (citations to Clark and

63a

Rothberg omitted). District courts in other cir-

cuits have welcomed the theory, too. SEC v.

Peters, 735 F. Supp. 1505 (D. Kan. 1990); United

States v. Elliott, 711 F. Supp. 425 (N. D. Ill. 1989).

We join these courts in holding that a person

violates Rule 10b-5 and Section 10(b) of the

Securities Exchange Act of 1934 by misappropri-

ating and trading upon material information

entrusted to him by virtue of a fiduciary relation-

ship such as employment. There is a common

sense notion of fraud behind the misappropriation

theory. As the Clark court put it:

[By] becoming part of a fiduciary or similar

relationship, an individual is implicitly stating

that she will not divulge or use to her own

advantage information entrusted to her in the

utmost confidence. She deceives the other

party by playing the role of the trustworthy

employee or agent; she defrauds it by actually

using the stolen information to its detriment.

Clark, 915 F. 2d at 448. We agree that buying or

selling securities “in connection with” fraud per-

petrated on an employer to obtain material non-

public information constitutes a violation of Rule

10b-5. (footnote omitted).

SEC v. Cherif, 983 F.2d 408, 410 (7th Cir. 1991). The

court applied the theory, even though Cherif was not

employed by First National at the time he misappro-

priated the confidential information.‘

The Court noted:

Cherif was bound by a broader common law duty. This

common law duty obligates an employee to protect any

64a

Most recently, the Second Circuit has reaffirmed

Newman, upholding convictions where:

Appellant’s convictions are based on the so-called

misappropriation theory arising out of Section

10(b) of the Securities Exchange Act of 1934, 15

U.S.C. § 78j(b). (footnote omitted). Sitting in

banc, we recently restated that theory[:] “[OJne

who misappropriated nonpublic information in

breach of a fiduciary duty and trades on that

information to his own advantage violates Section

10(b) and Rule 10b-5.” United States v. Chestman,

947 F.2d 551, 564 (2d Cir. 1991) (in banc) (citation

omitted), cert. denied. U.S. 112 S.Ct. 1759,

confidential information entrusted to him by his employer

during his employment. In addition, an employee is obli-

gated to continue to protect such information after his

termination.

* * *

Cherif breached a continuing duty to his former employer

when he used the key card and specific, confidential knowl-

edge he had learned about First Chicago as an employee to

break into the bank immediately after termination and steal

inside information about upcoming transactions. It makes

no difference that Cherif carried out the thefts formally

after his employment ended. The confidential property

and information he came to possess during his tenure at the

bank provided the foundation for the success of the subse-

quent break-ins. Cherif attained his objective of obtaining

deal-specific information by wrongfully converting other

confidential information entrusted to him by First Chicago.

His trades were “in connection with” a fraudulent scheme

to gain access to material, non-public information possessed

by first Chicago. This is all the nexus that Rule 10b-5 re-

quires.

Id. at 411.

65a

118 L. Ed. 2d 422 (1992); see also id. at 576

(“[L]ower courts have added to the Dirks Iv. SEC,

463 U.S. 646, 103 S.Ct. 3255, 77 L. Ed. 2d 911 (1983),

breach of duty doctrine a misappropriation of

information doctrine, which prohibits trading in

securities based on material, nonpublic

information acquired in violation of a duty to any

owner of such information, whether or not the

owner is the corporation whose shares are

traded.”) (Winter J., concurring and dissenting

opinion). We have found the requisite fiduciary

duty in the employer/employee context. (citation

omitted). We have also noted that “the

misappropriation theory does not require that the

buyer or seller of securities be defrauded.”

Chestman, 947 F.2d at 566. Rather, “the predicate

act of fraud may be perpetrated on the source of

the nonpublic information, even though the source

may be unaffiliated with the buyer or seller of

securities.” Jd. This fraud has been analogized to

embezzlement, see Carpenter, 791 F.2d at 1033 n.

11, and may simply be thought of as the misuse, by

trading, of stolen information. See Chestman, 947

F. 2d at 578 (Winter, J., concurring and dissenting

opinion).

United States v. Libera, 989 F.2d 599-600 (2d Cir.

1993). This Court is persuaded by the reasoning of

the cases from the Second, Third, Seventh and Ninth

Circuits adopting the misappropriation theory. This

Court finds that Defendant can be convicted of having

violated Rule 10(b)-5 if, as charged, he breached a duty

by misappropriating Grand Met’s and Dorsey & Whit-

ney’s confidential business information, and without

disclosure, used it to trade in Pillsbury stock, even

66a

though neither the seller nor the buyer of securities

was defrauded.

STATUTE OF LIMITATIONS

Defendant argues that the securities fraud Counts,

21-54, must be dismissed because they are barred by

the statute of limitations. The conduct at issue in

these Counts took place in August and September of

1988. The pending indictment was handed down on

December 17, 1992. Defendant argues that the appli-

cable statute of limitations is that announced in

Lampf, Pleva, Lipkind, Prupis & Petigrow v.

Gilbertson, 111 S. Ct 2773, 2782 (1991); one year after

5 Defendant’s subsidiary argument that the misappropria-

tion theory invades the exclusive province of state law is

without foundation. While state law may well regulate Defen-

dant’s acquisition of the confidential information at issue, and

the ethical propriety of such actions, federal law addresses the

use of that information. Defendant cites no Minnesota statu-

tory scheme that will be disrupted by the application of Rule

10(b)-5 to Defendant’s use of the confidential information. The

fraud encompassed by Section 10(b) and Rule 10b-5 extends to

conduct which touches the purchase or sale of securities. See

Superintendent of Ins. v. Bankers Life & Cas., 404 U.S. 6, 12-13

(1971); see also United States v. Gruenberg, 898 F.2d 971 (8th

Cir. 1993). This touching requirement has been interpreted

broadly and reaches Defendant’s conduct. See SEC v. Cherif,

933 F.2d at 411; SEC v. Clark, 915 F.2d at 449; United States v.

Newman, 664 F.2d at 18.

Similarly, Defendant’s argument that Section 10(b) and Rule

10b-5 are void for vagueness with respect to the misappropria-

tion theory because they do not provide fair notice of prosecu-

tion and violate due process has been rejected. See United

States v. Newman, 664 F.2d at 19; United States v. Lang, 766

F. Supp. at 402. In light of the cases discussed, surra, this

Court must agree.

67a

discovery and within three years after the violation.

The government argues that the applicable statute of

limitations is five years, as set out in 18 U.S.C.

§ 3282. This Court finds that Lampf is inapplicable to

this case and the appropriate statute of limitations is

that set out at 18 U.S.C. § 3282.

The Supreme Court’s decision in Lampf only ap-

plies to private actions based on Section 10(b) of the

Securities Exchange Act of 1934. This is the context

in which Lampf arose and the Court noted that “in

this litigation we must determine which statute of

limitations is applicable to a private suit brought

pursuant to § 10(b) of the Securities Exchange Act of

1934, 48 Stat. 891, 15 U.S.C. § 78j(b), and to Securities

and Exchange Commission Rule 10b-5, 17 C. F. R.

§ 240.10-b-5 (1990), promulgated thereunder.” Lampf,

Pleva, Lipkind, Prupis & Petigrow v. Gilbertson,

111 S. Ct. 2773, 2776 (1991) (emphasis added). As the

instant suit is brought by the government, Lampf is

inapplicable.

Moreover, Lampf applies only to implied, not

express, causes of action. Jd. at 2779-80. This Court

has found that “[AJn SEC enforcement action is

express, not implied, regardless of whether judicial

interpretation has broadened the rule which the SEC

seeks to enforce.” SEC v. O’Hagan, 793 F. Supp. 218,

221 (D. Minn. 1991). As this action is an SEC enforce-

ment action it is express and Lampf has no applica-

tion.

As the 1934 Act does not provide for a specific

statute of limitations the catch-all five year statute of

limitations for offenses not capital, 18 U.S.C. § 3282,

applies. See e.g., United States v. Vogt, 910 F.2d 1184,

1195 (4th Cir. 1990) (RICO); United States v. Thomas,

887 F. 2d 1341, 1349 (9th Cir. 1989) (Lacey Act); United

68a

States v. Pepe, 747 F.2d 632, 663 (11th Cir. 1984)

(RICO); United States v. Sloan, 389 F. Supp. 526, 528

(S.D.N.Y. 1975) (Exchange Act); United States v.

Bloom, 78 F.R.D. 591, 598 (E.D. Pa. 1977) (same).

MULTIPLICITY OF COUNTS

Defendant contends that Counts 21-54 are multi-

plicitous and should be consolidated into two or three

counts. Defendant is in error. Multiplicitous counts

charge a single offense in several counts. See United

States v. George, 986 F.2d 1176, 1179 (8th Cir. 1993).

Defendant argues that he only made three stock

orders and only once formulated the intent to commit

fraud. Therefore, he reasons, the counts reflecting

the purchases, as carried out by his brokers, are

multiplicitous. Defendant’s allegations are unproven

assertions of fact that will ultimately be determined

at trial.

Assuming, arguendo, that Defendant’s charac-

terization of his behavior is true, the Counts are not

multiplicitous. In Blue Chip Stamps v. Manor Drug

Stores, 421 U.S. 723, 730-31 (1975), the Supreme Court

identified the actual purchase or sale of a security as

the operative event for purposes of Section 10(b)

liability. Thus, the intent to commit fraud and the

placement of the orders by themselves are irrelevant

as orders do not violate Section 10(b) without a pur-

chase or sale taking place. The general principle of

charging a defendant with each sale of a security as a

separate offense has been upheld by the Eighth Cir-

cuit. See United States v. Naftalin, 606 F.2d 809, 810

(8th Circuit 1979) (prosecution under Section 17(a) of

the Securities Act of 1933); see also United States v.

Willis, 737 F. Supp. 269 (S.D.N.Y. 1990).

69a

SEC’S AUTHORITY TO PROMULGATE RULE 14e-3

Defendant contends that Counts 38-54 of the indict-

ment, charging Defendant with violating Section 14e

and Rule 14e-3 of the 1934 Act, must be dismissed

because the SEC exceeded its rulemaking authority

in promulgating Rule 14e-3. Section 14e provides in

pertinent part:

(e) It shall be unlawful for any person to . en-

gage in any fraudulent, deceptive, or manipulative

acts or practices, in connection with any tender

offer. . The Commission shall, for purposes of

this subsection, by rules and regulations define,

and prescribe means reasonably designed to pre-

vent, such acts and practices as are fraudulent,

deceptive or manipulative.

15 U.S.C. § 78n(e).

Rule 14e-3 reads in pertinent part:

(a) If any person has taken a substantial step or

steps to commence, or has commenced a tender

offer (the “offering person”), it shall constitute a

fraudulent, deceptive or manipulative act or prac-

tice within the meaning of Section 14(e) of the Act

for any other person who is in possession of

material information relating to such tender offer

which information he knows or has reason to know

is nonpublic and which he knows or has reason to

know has been acquired directly or indirectly

OME...

70a

(3) Any officer, director, partner or employee or

any other person acting on behalf of the offering

person or such issuer, to purchase or sell or cause

to be purchased or sold any of such securities or

any securities convertible into or exchangeable

for such securities or any option or right to obtain

or to dispose of any of the foregoing securities,

unless within a reasonable time prior to any

purchase or sale such information and its source

are publicly disclosed by press release or other-

wise.

17 C.F.R. § 240.14e-3(a). Defendant’s argument has

been considered and rejected. See United States v.

Chestman, 947 F.2d 551 (2d Cir. 1991); United States

v. Marcus Schloss & Co., Inc., 710 F. Supp. 944

(S.D.N.Y. 1989). This Court finds these cases persua-

sive and declines Defendant’s invitation to find that

these cases were wrongly decided.

FAILURE TO STATE AN OFFENSE—SUBSTANTIAL

STEPS

Defendant contends that Counts 38-54 of the indict-

ment must be dismissed for failure to state an offense

because the indictment fails to allege that Grand Met

took substantial steps toward the takeover of Pills-

bury, as required by Rule 14e-3. See supra. De-

fendant is in error. The indictment alleges that

Grand Met formulated an intent to takeover Pillsbury

and then set about taking steps to implement that

plan to include soliciting advice and arranging for

financing. See Indictment, Docket No. „ pp. 14-15.

71a

While Defendant argues that, since no specific

price is referenced, no substantial steps can be found

to have been taken, this argument is unsupported by

case law and defies common sense. Similarly, Defen-

dant’s argument that, due to evidence relating to

Grand Met’s financing of the takeover, the steps un-

dertaken by Grand Met cannot be considered substan-

tial, is premature, being clearly an issue for trial.

FAILURE TO STATE AN OFFENSE—UNLAWFUL

ACTIVITY

Defendant contends that Counts 55-56 must be

dismissed for failure to state an offense because

neither mail fraud nor securities fraud were defined

as “specified unlawful activity” in 1988, pursuant to

the money laundering statutes under which De-

fendant is charged, 18 U.S.C. § 1957 (Count 55) and 18

U.S.C. § 1956(a)(1)(B)(i) (Counts 56 and 57). Defendant

is in error.

Defendant committed his alleged illegal acts in

August and September of 1988. As of that time 18

U.S.C. § 1956(c)(7)(A) defined the necessary predicate

acts for liability under the statute to include any act

listed in 18 U.S.C. § 1961(1). Similarly, as of that time

18 U.S.C. § 1957(f) (3) defined the necessary predicate

acts for liability under the statute as the same as

those in § 1956, thus including any act listed in 18

U.S.C. § 1961(1).

As of the date of Defendant’s alleged illegal activ-

ity, § 1961(1) included the mail fraud statute, § 1341,

and any o*fense involving “fraud in the sale of securi-

ties.” “Fraud in the sale of securities” includes con-

duct proscribed by Section 10 and Rule 10b-5. See e.g.,

James v. Meinke, 778 F.2d 200, 204-05 (5th Cir. 1985);

72a

Ohman v. Kahn, 685 F. Supp. 1302, 1309-10 (S. D. N. V.

1988) (RICO). Thus, Defendant's argument does not

hold water as both mail fraud and fraud in the sale of

securities were defined as “specified unlawful activ-

ity” in 1988, pursuant to the money laundering stat-

utes under which Defendant is charged, 18 U.S.C. §

1957 (Count 55) and 18 U.S.C. § 1956(a)(1)(B)(i)

(Counts 56 and 57).

RECOMMENDATION

Accordingly, TT IS HEREBY RECOMMENDED that

Defendant’s motion to dismiss the indictment and his

supplemental motion to dismiss be DENIED.

is/ J. EARL CUDD _

Hon. J. EARL CUDD

UNITED STATES MAGISTRATE JUDGE

Dated: Sept. 10, 1993

Pursuant to Local Rule 72.1(c) any party may object

to this Report and Recommendation by filing with the

Clerk of the Court, and serving all parties within ten

(10) days, a writing which specifically identifies those

portions of this Report to which objections are made

and the basis of those objections. Failure to comply

with this procedure shall operate as a forfeiture of the

objecting party’s right to seek review in the Court of

Appeals.

Unless the parties are prepared to stipulate that the

District Court is not required by 28 U.S.C. § 636 to

review a transcript of the hearing in order to resolve

all objections made to this Report and Recom-

mendation, the party making the objections shall

timely order and cause to be filed a complete tran-

script of the hearings.

73a

APPENDIX C

UNITED STATES DISTRICT COURT

DISTRICT OF MINNESOTA

FOURTH DIVISION

No. 4-92-CR-219

UNITED STATES OF AMERICA

.

JAMES HERMAN O’HAGAN

[FILED: Dec. 30, 1993]

ORDER

This matter is before the Court on appeal from

Reports and Recommendations issued by the Honor-

able J. Earl Cudd, United States Magistrate Judge, on

September 1, 1993, and September 10, 1993. In the

September 1, 1993, report, the magistrate recom-

mended that defendant’s motion to dismiss Counts 21

through 54 of the indictment for improper venue be

denied. The September 10, 1993, report recommended

that defendant’s motion to dismiss the indictment be

denied. As part of this report and recommendation,

the magistrate ruled, inter alia, that the Double

Jeopardy Clause of the Fifth Amendment did not bar

this prosecution. The defendant filed objections to

the report and recommendations, pursuant to Local

Rule 72.1(c).

74a

Based upon a de novo review of the record herein,

the Court adopts the magistrate’s reports and recom-

mendations.

Conclusion

For the reasons set forth above, and based on all

files, records, and proceedings, IT IS ORDERED

that:

1. Defendant’s motion to dismiss Counts 21

through 54 of the indictment for improper venue is

denied.

2. Defendant’s motion to dismiss the indictment,

and his supplemental motion to dismiss, is denied.

3. Jury selection in this matter will commence, as

previously determined, on January 3, 1994, and trial

will commence January 11, 1994.

Dated: December 30th, 1993

/s/ JAMES M. ROSENBAUM

JAMES M. ROSENBAUM

United States District Judge

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UNITED STATES COURT OF APPEALS

EIGHTH CIRCUIT

Nos. 94-8714, 94-8856MNMI

UNITED STATES OF AMERICA,

PLAINTIFF -APPELLEE/CROSS-APPELLANT

v.

JAMES HERMAN O’HAGAN,

DEFENDANT-APPELLANT/CROSS-APPELLEE

[Filed: Nov. 13, 1996]

ORDER DENYING PETITION FOR

REHEARING AND SUGGESTION

FOR REHEARING EN BANC

The suggestion for rehearing en banc is denied.

Judge MeMillian would grant the suggestion.

The petition for rehearing by the panel is also

denied.

Chief Judge Richard S. Arnold, Judge Magill, Judge

Loken, and Judge Murphy took no part in the con-

sideration or decision of these cases.

Order Entered at the Direction of the Court:

/s/ MICHAEL E. GANS

MICHAEL E. GANS

Clerk, U.S. Court of

Appeals, Eighth Circuit

76a

APPENDIX E

STATUTES AND REGULATIONS

1. Section 1341 of Title 18, United States Code,

states follows:

§ 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 pretenses,

representations, or promises, or to sell, dispose 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 intimated or held out to

be such counterfeit or spurious article, for the pur-

pose of executing such scheme or artifice or attempt-

ing so to do, places in any post office or authorized

depository for mail matter, any matter or thing what-

ever to be sent or delivered by the Postal Service, or

deposits or causes to be deposited any matter or thing

whatever to be sent or delivered by any private or

commercial interstate carrier, or takes or receives

therefrom, any such matter or thing, or knowingly

causes to be delivered by mail or such carrier accord-

ing 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

under this title or imprisoned not more than five

years, or both. If the violation affects a financial

institution, such person shall be fined not more than

$1,000,000 or imprisoned not more than 30 years, or

both.

77a

2. Section 10 of the Securities Exchange Act of

1934, 15 U.S.C. 78, states, in pertinent part:

It shall be unlawful for any person, directly or

indirectly, by the use of any means or instrumental-

ity of interstate commerceor of the mails, or of any

facility 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 regis-

tered, any manipulative or deceptive device or contri-

vance in contravention of such rules and regulations

as the (Securities and Exchange] Commission may

prescribe as necessary or appropriate in the public

interest or for the protection of investors.

8. Section 14(e) of the Securities Exchange Act of

1934, 15 U.S.C. 78n(e), states:

It shall be unlawful for any person to make any

untrue statement of a material fact or omit to state

any material fact necessary in order to make the

statements made, in the light of the circumstances

under which they are made, not misleading, or to

engage in any fraudulent, deceptive, or manipulative

acts or practices, in connection with any tender offer

or request or invitation for tenders, or any solicita-

tion of security holders in opposition to or in favor of

any such offer, request, or invitation. The [Securi-

ties and Exchange] Commission shall, for the pur-

poses of this subsection, by rules and regulations

define, and prescribe means reasonably designed to

prevent, such acts and practices as are fraudulent,

deceptive, or manipulative.

78a

4. Rule 10b-5 of the Securities and Exchange

ssion, 17 C.F.R. 240.10b-5 (1983), provides:

A

indirectly, by the use of any means or instrumental

ity of interstate commerce, or of the mails or of any

facility 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

not misleading, or

(c) 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.

5. Rule 14e-3(a) of the Securities and Exchange

Commission, 17 C. F. R. 240.14e-3, provides:

Rule 14e-3(a) provides:

(a) If any person has taken a substantial step or

steps to commence, or has commenced, a tender offer

(the “offering person”), it shall constitute a fraudu-

lent, deceptive, or manipulative act or practice within

the meaning of section 14(e) of the [Securities Ex-

change] Act for any other person who is in possession

of material information relating to such tender offer

nonpublic and which he knows or has reason to know

has been acquired directly or indirectly from:

(1) The

(2) The issuer of the securities sought or to be

sought by such tender offer, or

(3) Any officer, director, partner, or employee or

any other person actir on behalf of the offering per-

son or such issuer,

to purchase or sell or cause to be purchased or sold

any of such securities 7 ay ace convertible

— puschane or cale — and ite

source are publicly disclosed by press release or

otherwise.