SEC v. Clark, C87-711Z.

• Decision Date: 08 September 1988
• Docket Number: No. C87-711Z.,C87-711Z.
• Citation: 699 F. Supp. 839
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. John Naylor CLARK, III, and Russell G. Van Moppes, Defendants.
• Court: U.S. District Court — Western District of Washington

699 F. Supp. 839

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. John Naylor CLARK, III, and Russell G. Van Moppes, Defendants.

No. C87-711Z.

United States District Court, W.D. Washington, Seattle Division.

September 8, 1988.

James A. Kidney, John H. Sturc, Jerry A. Isenberg, Rudolph Gerlich, Jr., Wayne A. Wirtz, S.E.C., Washington, D.C., for plaintiff.

Steven D. Brown, Monroe Stokes Eitelbach & Lawrence, P.S., Seattle, Wash., David J. Hase, Nancy J. Sennett, Foley & Lardner, Milwaukee, Wis., for defendant John Naylor Clark, III.

Thomas A. Sterkin, Martin T. Collier, Betts Patterson & Mines, P.S., Seattle, Wash., W. Michael Drake, Drake & Rogosheske, Minneapolis, Minn., for defendant Russell G. Van Moppes.

ORDER DENYING SUMMARY JUDGMENT

ZILLY, District Judge.

THE COURT has considered the SEC's motion for summary judgment against one of the defendants, Clark, together with the materials submitted by counsel. The motion is denied.¹

I. BACKGROUND

Smith & Nephew Associated Companies plc (SN) is a multi-national corporation, located in the United Kingdom, that manufactures and sells medical, health care, and various other products. In late 1983, Rolyan Manufacturing Company, a manufacturer of health care products located in Wisconsin, was sold to SN and continued to operate as a subsidiary under its new name, Smith & Nephew Rolyan (SNR). At the time of this acquisition, defendant Clark was an officer and shareholder of Rolyan. After the merger, Clark continued as the principal executive of SNR with the title of president.

On January 14, 1985, SN acquired another company associated with the medical industry, Affiliated Hospital Products (AHP). At this time, SN also agreed to make a tender offer of $36 per share, payable in cash, for each AHP share held by the public. Clark remained president of SNR throughout the period in which the AHP acquisition was negotiated and consummated.

Before acquiring AHP, SN made an initial decision to expand its medical products business in the United States through the acquisition of other companies. Thus, SN assembled a team to search for further acquisitions for SN and for its subsidiary, SNR. Clark was part of this team and participated in meetings with various SN employees. At these meetings, the team discussed potential target companies and the needs and interests of SN.

At one meeting in particular, in late 1984, Clark saw a mold used for the manufacture of surgical gloves. Clark announced to those present in the room that SN must be considering the acquisition of a surgical glove company. Someone in the meeting acknowledged that Clark's observation might be accurate.² Additionally, Clark knew that only a few companies in the United States manufactured such gloves. Thus, based on his twenty years of experience in the medical supplies business, his participation on a SN acquisition team, and his knowledge of the surgical glove mold, Clark concluded that only AHP was available for acquisition.

On December 12, 1984, Clark met with a SN employee, Curtis Easter, who had been touring AHP plants in connection with the acquisition. Clark has testified that, at this meeting, he told Easter that he "knew exactly what was going on." Clark Deposition, p. 39. It is unclear how, or whether, Easter responded to this assertion, although Easter has stated that it was his impression that Clark "knew" that SN was planning to acquire AHP. Easter Deposition, p. 23.

One day later, on December 13, 1984, Clark called his broker, codefendant Van Moppes, and ordered 2,000 shares of AHP stock. To disguise the purchase, Clark put the trade in his wife's maiden name and changed the address on her account to the address of her parents. Also on this day, Clark's wife, through her own broker, acquired 100 shares of AHP. Lastly, on December 21, 1984, Clark placed another order with Van Moppes for an additional 1,000 shares of AHP. In sum, Clark purchased a total of 3,000 shares of AHP stock at between 18 1/8 and 19¾. His wife purchased her 100 shares at 17 5/8 .

After the acquisition and the $36 tender offer was announced in January, 1985, Clark and his wife sold their shares and realized profits of at least $49,131.32.

II. DISCUSSION

The securities statute that is relevant to this "insider trading" action is section 10(b), 15 U.S.C. § 78j(b), which makes it unlawful for any person

to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

The corresponding regulation, Rule 10b-5, 17 C.F.R. § 240.10b-5, 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 they were made, 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.

The civil enforcement mechanism for these provisions consists of both express and implied remedies. One express remedy is for a suit by the SEC for injunctive relief. Aaron v. SEC, 446 U.S. 680, 688, 100 S.Ct. 1945, 1951, 64 L.Ed.2d 611 (1980). Alternatively, it is settled that one of the implied remedies allows a court, exercising its equitable powers, to order disgorgement of profits in an SEC enforcement action. See, e.g., SEC v. Commonwealth Chemical Securities, Inc., 574 F.2d 90, 102 (2d Cir.1978); SEC v. Lund, 570 F.Supp. 1397 (C.D.Cal.1983).

The parties agree on the elements that are needed to establish insider trading. First, a breach of a duty to disclose information or abstain from trading must be established. Chiarella v. United States, 445 U.S. 222, 228, 100 S.Ct. 1108, 1114-15, 63 L.Ed.2d 348 (1980). Second, this information must be material and nonpublic. Id. Third, the insider must have acted with scienter. Aaron, 446 U.S. at 691, 100 S.Ct. at 1952-53. However, the parties dispute the applicable law with respect to when the duty to disclose or abstain arises. Similarly, the parties dispute whether issues of material fact exist as to the second and third elements of insider trading, so as to preclude summary judgment.³

A. Duty to Disclose

It is settled that a failure to disclose is actionable under section 10(b) and Rule 10b-5 only when there is a duty to disclose, which is primarily a duty to abstain from trading. However, Clark maintains that this duty arises exclusively when there is a fiduciary relationship between the insider and the investors involved in the securities transaction. Oppositely, the SEC contends that this duty arises when an insider "misappropriates" inside information and uses this information for his own benefit; this is duly named the "misappropriation theory." The Court adopts the misappropriation theory of liability.

The Supreme Court case of Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), provides a discussion of the two legal theories asserted by the parties. Chiarella was employed by a financial printer that handled the announcement of corporate takeover bids. Although the names of companies involved in the takeovers were concealed by blank spaces, Chiarella was able to deduce the names of the target companies from other information contained in the documents. Without disclosing this knowledge, Chiarella purchased stock in the target companies. Chiarella's conviction was reversed by a majority of the Court, which held that a duty to disclose under section 10(b) does not arise from the mere possession of nonpublic market information.⁴Id. at 235, 100 S.Ct. at 1118. Rather, liability was premised upon a duty to disclose arising from a relationship of "trust and confidence" between parties to the securities transaction. Id. at 230, 100 S.Ct. at 1115-16. Thus, absent a fiduciary relationship with the sellers of stock, a purchaser has no duty to disclose material, nonpublic market information.⁵Id. at 229, 100 S.Ct. at 1115.

However, both Justice Stevens' concurrence and Chief Justice Burger's dissent provide the cornerstone for the "misappropriation theory." Stevens argues that when Chiarella purchased securities in the open market

he violated (a) a duty to disclose owed to the sellers from whom he purchased target company stock and (b) a duty of silence owed to the acquiring companies.

Id. at 237, 100 S.Ct. at 1119. From this proposition, Stevens agrees with the majority that no fiduciary duty existed and acknowledges that the Court left open the question of whether the conviction could have been affirmed on grounds of misappropriation since that theory had not been presented to the jury. Id.

Similarly, Burger's dissent postulates a broad theory of insider liability but uses a alternate theory. Specifically, Burger states that an absolute duty to disclose information or refrain from trading arises when a person has "misappropriated" nonpublic information.⁶ Id. at 240, 100 S.Ct. at 1120-21. However, Burger does not put any parameters on this wide-ranging theory.

The Second Circuit has adopted Burger's misappropriation theory in name but the application of the theory has been modified in order to make it more specific and consistent.⁷ In United States v. Newman, 664 F.2d 12, 66 A.L.R.Fed. 833 (2d Cir.1981), cert. denied, 464 U.S. 863, 104 S.Ct. 193, 78 L.Ed.2d 170 (1983), two officers of different investment banking firms passed inside...