Sec. & Exchange Comm'n v. Sargent

Citation229 F.3d 68
Decision Date04 August 2000
Docket NumberNo. 00-1293,00-1293
Parties(1st Cir. 2000) SECURITIES AND EXCHANGE COMMISSION, PLAINTIFF, APPELLANT, V. MICHAEL G. SARGENT, DENNIS J. SHEPARD, ROBERT J. SCHARN, UNITED STATES, DEFENDANTS, APPELLEES. . Heard
CourtUnited States Courts of Appeals. United States Court of Appeals (1st Circuit)

APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF MASSACHUSETTS.

Hon. Joseph L. Tauro, U.S. District Judge.

[Copyrighted Material Omitted]

[Copyrighted Material Omitted] Eric Summergrad, Deputy Solicitor, with whom David M. Becker, General Counsel, Meyer Eisenberg, Deputy General Counsel, and Nathan A. Forrester, Attorney Fellow, Securities and Exchange Commission, were on brief, for appellant.

Gary C. Crossen, with whom Jack W. Pirozzolo, Stephen C. Warneck and Foley, Hoag & Eliot, Llp were on brief, for appellee Michael G. Sargent.

Matthew C. Donahue, Andrea S. Barisano and Donahue & Donahue on brief for appellee Dennis J. Shepard.

Gregg S. Haladyna on brief for appellee Robert J. Scharn.

Before Torruella, Chief Judge, Wallace,* Senior Circuit Judge, and Lipez, Circuit Judge.

Wallace, Circuit Judge.

The Securities and Exchange Commission (Commission) appeals from a directed verdict entered in favor of defendants-appellees, Dennis J. Shepard, Michael G. Sargent, and Robert J. Scharn. The Commission also challenges the district court's denial of its request for pre-trial discovery and the district court's decision to exclude the criminal convictions of Sargent and Scharn for lying to Commission investigators. The district court had jurisdiction under 15 U.S.C. §§ 78u(d)(1), 78u(d)(3), 78u(e), 78u-1, and 78aa. We have jurisdiction pursuant to 28 U.S.C. § 1291. We reverse and remand for new trial.

I.

Shepard and J. Anthony Aldrich (against whom the Commission did not file a complaint) were the sole shareholders of a consulting firm incorporated in the Commonwealth of Massachusetts. Aldrich was also a member of the board of directors for Purolator Products Co. (Purolator), a manufacturer of automotive parts. On July 13, 1994, Mark IV Industries, Inc. (Mark IV) offered to purchase all of the outstanding shares of Purolator for $22 a share. Negotiations between the two companies ensued, and on October 3, 1994, Purolator and Mark IV publicly announced Purolator's acceptance of Mark IV's tender offer of $25 a share.

Throughout 1994, Shepard and Aldrich ran their consulting business from a 20' by 15', one-room office located in Shepard's basement. The firm used a telephone, voice mail system, and fax machine from a single line. Shepard could hear what Aldrich said on the telephone and would occasionally retrieve voice mail messages and faxes for Aldrich. Aldrich realized that given the "very close quarters," it was "inevitable [Shepard] would know something was going on [with Purolator]. He was going to hear something." At some point in July 1994, Aldrich took Shepard into his confidence and advised him that Purolator was being pursued. Aldrich told Shepard that this fact needed to be kept confidential and Shepard agreed not to disclose the information.

The Purolator Board met several times between Mark IV's initial offer of July 13 and October 3, 1994. By mid-August, Purolator had retained Lehman Brothers, Inc. to advise it in the negotiations. Purolator initially sought to remain independent, but its focus gradually changed to getting the best price from the highest bidder. It initiated discussion with at least two other companies in an effort to raise the price. On September 8, Purolator entered into a Standstill Agreement with Mark IV in which it agreed to provide Mark IV with access to nonpublic information and Mark IV agreed not to effect a hostile takeover while negotiations were pending. Mark IV made two additional offers that Purolator rejected before Purolator accepted the offer of $25 a share on October 3, 1994.

On Saturday, September 10, 1994, Shepard, Sargent, and their wives met for dinner. Sargent had been Shepard's dentist since 1983, and the two were "friendly." Shepard had referred at least 75 of his relatives, friends, and acquaintances to Sargent for their dental work. Shepard was actively involved in the local chamber of commerce. Because Sargent had many community ties, Shepard would "go to [Sargent] periodically" for "contacts, networking to other individuals," and to look for funds on behalf of the chamber of commerce.

The Sargents and Shepards met for dinner to smooth out some problems that had developed between them. Shepard's sister-in-law, Donna, had been hired to decorate the Sargents' home and had been paid a $1000 retainer. She never completed the work, and the Sargents were unable to recover the retainer because she had filed for bankruptcy. Sargent was hoping that Shepard could work something out. Another of Shepard's sisters-in-law, Brenda, had skipped several of her dental appointments with Sargent without giving him notice. Sargent informed her that the next time she did so, he would charge her for the missed appointment. Brenda wrote Sargent a "scathing letter" complaining of this treatment and threatening to use Shepard's influence to draw customers away from Sargent's practice.

At the dinner, the Sargents and Shepards also talked about Shepard's consulting business. Shepard asked Mrs. Sargent "whether she could give [him] leads in connection with [his] consulting business." He talked about his partner, Aldrich, and mentioned that Aldrich was on the Purolator board. After dinner, the couples attended the opening of a new restaurant. While their wives were in the ladies' room, Sargent and Shepard continued talking. At some point in that conversation, Shepard said, "I am aware of a company right now that is probably going to be bought," but "even if I had the money... I can't buy stock in this company because I am too close to the situation." The Commission alleges that during this conversation Shepard explicitly identified Purolator as the company to be bought.

The following Monday, September 12, Sargent contacted Brian Kelly, his broker at Legg Mason, before the market opened. Sargent told Kelly, "I heard something over the weekend and it concerns Purolator Products." He asked Kelly to do some research on Purolator. Sargent called Kelly back that same morning. When asked by Kelly where he had heard about Purolator, Sargent was evasive and may have replied that his friend Scharn had overheard two men at a bar talking about Purolator. Kelly reported that Purolator had not been doing much, that it was trading close to its 52-week low, and that it was not the kind of stock Sargent usually chose to purchase. Kelly went so far as to call Purolator a "piece of crap," but he told Sargent that if he wanted to invest in Purolator there was only a $1 to $2 downside risk. Sargent then purchased 2000 shares of Purolator. The next day, Sargent bought an additional 2000 shares through his account at Charles Schwab Corp., a discount brokerage firm.

Between September 12 and October 3, 1994, Sargent purchased a total of 20,400 shares of Purolator at an average price of $17.67 per share. This was the largest investment in a single stock that Sargent had ever made. To finance his purchases, Sargent borrowed $50,000 from a bank, bought shares on margin, and replaced stock he held in another company with risky call options in that same company. Sargent had never before taken out a loan to buy stock. Within a few days of the tender offer announcement, Sargent sold all of his Purolator stock at a profit of $140,000.

Sargent notified his close friend Scharn of his purchases in Purolator. On September 19, 1994, Scharn purchased 5000 shares of Purolator, his largest stock purchase of the year. Scharn did not perform any research at all on Purolator. In order to raise the money for this purchase, Scharn sold 10,000 shares of Telefonica de Argentina at a loss of $5000. When his broker asked him where he had heard about Purolator, Scharn responded that he had overheard two men discussing Purolator at the bar of the restaurant he owned. Later, when the tender offer was announced, Scharn remarked to his broker that "he knew that it was going to happen."

Sargent was first contacted by the Commission on January 4, 1995. Peter Sonnenthal, an attorney with the Commission, conducted the interview. When questioned about his stock purchases, Sargent told Sonnenthal that his friend Scharn advised him to buy Purolator after Scharn had overheard "two guys" at his bar talking about the company. After this interview, Sargent contacted Scharn to tell him about the phone call with Sonnenthal; Sargent also advised Scharn that the Commission might contact him as well. The Commission conducted two additional telephone interviews with Sargent in which Sargent did not change his story and in which he denied talking to Shepard about Purolator. The Commission contacted Scharn on January 10, 1995. Scharn repeated the story about overhearing two men discuss Purolator. He even provided the Commission with phony descriptions of the two men.

The Commission subpoenaed both Sargent and Scharn. During their depositions, both Sargent and Scharn admitted lying to the Commission representative about Purolator. Sargent's new explanation for the purchases was that he had acted on a hunch based on two pieces of information he had learned at the dinner with Shepard, namely the statements by Shepard (1) that Aldrich was on the Board of Purolator, and (2) that he knew of a company that was going to be taken over, but in which he could not invest because he was too close to the situation. Sargent asserts that Shepard never told him that Purolator was the company that was going to be acquired.

On May 7, 1996, a grand jury in the United States District Court for the District of Massachusetts returned indictments against Sargent and Scharn for making false statements to...

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