U.S. v. Falcone

• Decision Date: 01 August 2000
• Docket Number: No. 00-1768,00-1768
• Parties: (2nd Cir. 2001) UNITED STATES OF AMERICA, Appellee, v. JOSEPH FALCONE, Defendant-Appellant
• Court: U.S. Court of Appeals — Second Circuit

Page 226

257 F.3d 226 (2nd Cir. 2001)

UNITED STATES OF AMERICA, Appellee, v. JOSEPH FALCONE, Defendant-Appellant.

No. 00-1768.

August Term, 2000.

UNITED STATES COURT OF APPEALS,

SECOND CIRCUIT.

Argued: May 16, 2001.

Decided: July 20, 2001.

Appeal from a judgment of the United States District Court for the Eastern District of New York (Platt, J.) convicting defendant after a jury trial of one count of conspiracy to commit securities fraud and thirteen counts of securities fraud, based on the misappropriation of pre-release confidential information in a column in Business Week magazine discussing companies and their stocks. Affirmed.

JOHN LAURENCE KASE (Paula Schwartz Frome, on the brief), Kase & Druker, Garden City, NY, for defendant-appellant.

MICHAEL CORNACCHIA, Assistant United States Attorney for the Eastern District of New York (Loretta E. Lynch, United States Attorney, Peter Norling, Demetri M. Jones, Assistant United States Attorneys, Eastern District of New York, on the brief), Brooklyn, NY, for appellee.

Before: FEINBERG, VAN GRAAFEILAND, and SOTOMAYOR, Circuit Judges.

SOTOMAYOR, Circuit Judge:

Defendant Joseph Falcone appeals from a judgment of the United States District Court for the Eastern District of New York (Platt, J.) convicting him after a jury trial of thirteen counts of securities fraud, in violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. §78j(b) ("section 10(b)"), and one count of conspiracy to commit securities fraud, in violation of 18 U.S.C. § 371, based on the "misappropriation theory" of insider trading. The charges arose from a scheme involving the misappropriation of pre-release confidential copies of a magazine column that discussed securities for the purpose of trading in the securities of the featured companies. In challenging the district court's finding that this case is governed by this Court's decision in United States v. Libera, 989 F.2d 596 (2d Cir. 1993), which upheld a conviction based on a similar scheme, defendant argues on appeal that Libera should not govern the result in this case because: 1) under the Supreme Court's more recent decision in United States v. O'Hagan, 521 U.S. 642 (1997), the misappropriations at issue in both Libera and the instant case would not satisfy section 10(b)'s requirement that the misappropriation be "in connection with" the purchase or sale of a security; and 2) this case is materially distinguishable from Libera.¹ We disagree and affirm the judgment of conviction.

BACKGROUND

Defendant's conviction arose from his participation in a scheme in which an employee of Hudson News, a magazine wholesaler, faxed a stockbroker acquaintance of defendant's, Larry Smath, pre-release confidential copies of a column in Business Week magazine - "Inside Wall Street" - that discussed companies and their stocks. Business Week is a weekly financial publication owned by McGraw-Hill, Inc. Smath himself used the information to trade securities and also passed the information along to defendant, who likewise traded in the securities discussed in the column.

Evidence was introduced at trial indicating that the value of stocks discussed favorably in the column tended to increase after the magazine was released to the public and that, because of this impact, Business Week imposed a strict confidentiality policy prior to that release on all those involved in the magazine's production and distribution. This policy applied to Hudson News and was implemented through a broader company policy, applicable to all the magazines Hudson News distributed, prohibiting employees from taking copies of the magazines or portions thereof out of the company's delivery department.

After the jury returned a guilty verdict, the district court denied defendant's motion to set the verdict aside. Although expressing concern about the "boundless expansion of the misappropriation theory," the district court reluctantly declared that it was bound by this court's imposition of liability on virtually identical facts in United States v. Libera, 989 F.2d 596 (2d Cir. 1993). Libera dealt with the criminal liability of individuals who, like defendant here, received pre-release copies of the same "Inside Wall Street" column in Business Week magazine in violation of Business Week's confidentiality policy and traded on the information. See id. at 598-99. In Libera, the information was passed to the defendants after it had been misappropriated by an employee of Business Week's printer. Id.

Here, employees of entities further down the chain of distribution were the misappropriators. According to the evidence at trial, after being printed, Business Week magazine is sent to a national distributor of magazines, Curtis Circulation Company ("Curtis"). See United States v. Falcone, 97 F. Supp. 2d 297, 299 (E.D.N.Y. 2000). Curtis sells the magazine to various wholesalers, including Hudson News. Gregory Salvage, a 22-year employee of Hudson News, arranged for a subordinate to fax copies of the "Inside Wall Street" column - prior to the close of the stock market on Thursdays and prior to the public release of the magazine later that evening - to Smath, a stockbroker at Renaissance Securities and Salvage's neighbor. Smath himself traded based on this information and also passed it on to defendant, who likewise traded in reliance thereon.

On appeal, defendant argues that under the misappropriation theory as defined in O'Hagan, it is not sufficient for the purposes of section 10(b) liability that a misappropriation ultimately results in securities trading. Instead, he argues, the misappropriation in breach of a duty must itself have a certain nexus with securities trading that is lacking in the scenario at issue in Libera and the instant case. Defendant further argues that even assuming Libera applies here, there was insufficient evidence to convict him of securities fraud or conspiracy to commit securities fraud. Although the first contention merits some discussion, we ultimately reject both arguments.

DISCUSSION

I. The Law of Insider Trading

A. Relevant Statutory Authority

Section 10(b) of the Securities Exchange Act of 1934 is violated when: (1) "any manipulative or deceptive device" is used, (2) "in connection with the purchase or sale of any security." 15 U.S.C. § 78j(b). Pursuant to this section, the Securities and Exchange Commission has adopted Rule 10b-5, which provides in relevant part that:

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,

I. To employ any device, scheme, or artifice to defraud, [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.

17 C.F.R. § 240.10b-5.

B. The Traditional Theory

Under traditional insider trading theory, section 10(b) is violated when a corporate insider, such as an officer of the corporation, "trades in the securities of his corporation on the basis of material, non-public information." O'Hagan, 521 U.S. at 651-52. Such trading constitutes deception under section 10(b) because "a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation," and this relationship gives rise to "a duty to disclose [or to abstain from trading] because of the necessity of preventing a corporate insider from... tak[ing] unfair advantage of... uninformed... stockholders." Id. at 652 (internal quotation marks omitted; alterations in original). Although the requirement that the deception be "in connection with" the purchase or sale of a security is not often discussed in traditional insider trading case law, the connection is almost self-evident: the duty of disclosure being breached is to persons with whom the insider is engaging in securities transactions, and the insider breaches that duty when he or she engages in the securities transaction without disclosure.

In Dirks v. SEC, 463 U.S. 646 (1983), the Supreme Court held that under the traditional theory, it is equally a section 10(b) violation if, under certain circumstances, the corporate officer does not actually trade but instead "tips" a corporate outsider (e.g., a friend or a family member) with the information for the purpose of having the outsider trade. See id. at 660. In deciding Dirks, the first issue for the Supreme Court was what duty of disclosure, if any, a corporate outsider was subject to, such that his or her trading in violation of that duty would constitute deception under section 10(b). The Court emphasized that there was no general duty of disclosure between all those who invest in the stock market, id. at 657-58, and that, unlike corporate officers, corporate outsiders have no relationship with the corporation's shareholders from which any duty to disclose could arise, id. at 654-55. While the Court ultimately determined that tippees could nevertheless still be in violation of section 10(b), it held that the circumstances under which that could occur were limited:

[A] tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.

Id. at 660.

The second issue for the Court in Dirks was to determine when an insider's duty was breached where the insider had not himself or herself traded based on material non-public information but had simply given outsiders such information. In Dirks, the corporate insider had given the defendant, an officer of a securities broker-dealer, information that a massive fraud was...