U.S. v. O'Hagan

• Decision Date: 13 November 1996
• Docket Number: 94-3856,Nos. 94-3714,s. 94-3714
• Parties: , Fed. Sec. L. Rep. P 99,284 UNITED STATES of America, Plaintiff-Appellee/Cross-Appellant, v. James Herman O'HAGAN, Defendant-Appellant/Cross-Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 612

92 F.3d 612

65 USLW 2119, Fed. Sec. L. Rep. P 99,284

UNITED STATES of America, Plaintiff-Appellee/Cross-Appellant, v. James Herman O'HAGAN, Defendant-Appellant/Cross-Appellee.

Nos. 94-3714, 94-3856.

United States Court of Appeals,

Eighth Circuit.

Submitted Oct. 17, 1995.

Decided Aug. 2, 1996.

Rehearing and Suggestion for Rehearing En Banc Denied Nov.

13, 1996. ^*

John Dwyer French, Minneapolis, MN, argued (Charles Lee Hawkins and Elizabeth L. Taylor, on the brief), for appellant.

Christopher J. Bebel, Asst. U.S. Atty., argued, Minneapolis, MN, for appellee.

Before FAGG, 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 government cross-appeals, contending that the district court erroneously calculated O'Hagan's sentence. Although 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 Exchange Commission (SEC) exceeded its rulemaking authority under section 14(e) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(e), when it promulgated 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 dismissed as moot.

I.

James Herman O'Hagan was a partner in the Dorsey & Whitney law firm in Minneapolis, Minnesota. 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 acquiring the Pillsbury Company (Pillsbury), a Minneapolis, Minnesota, company. Throughout the remainder of the summer and into the fall of 1988, Grand Met maintained a continued interest in acquiring Pillsbury, 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. ¹ He subsequently purchased 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 option contracts. ² 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. ³ 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 securities shortly before its takeover by Grand Met. This investigation, which was later joined by other federal law enforcement authorities, culminated with O'Hagan being charged in the instant 57-count indictment. 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 thereunder. 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 laundering 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 sentenced 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 convictions, 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 theory, 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:

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--

. . . . .

(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 prescribe 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 connection with the purchase or sale of any security." Id. Our focus in this case is on the deception element of § 10(b). ⁴

Acting pursuant to the authority granted to it under § 10(b), the SEC promulgated Rule 10b-5, which provides in relevant part:

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) [t]o employ any device, scheme, or artifice to defraud, [or]

. . . . .

(c) [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, 511 U.S. 164, ----, 114 S.Ct. 1439, 1446, 128 L.Ed.2d 119 (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, 97 S.Ct. 1292, 1300, 51 L.Ed.2d 480 (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, 96 S.Ct. 1375, 1383, 47 L.Ed.2d 668 (1976)). Thus, although § 10(b) has been described as a broad catchall provision, the fraud that must be caught must also constitute deception within the meaning of the statute. Chiarella v. United States, 445 U.S. 222, 234-35, 100 S.Ct. 1108, 1117-18, 63 L.Ed.2d 348 (1980) ("Section 10(b) is aptly described as a catchall provision, but what it catches must be fraud.").

In construing the scope of conduct that may be regulated under § 10(b), the Supreme Court has definitively ruled that the text of the statute is dispositive. See Central Bank, 511 U.S. at ----, 114 S.Ct. at 1446 ("With respect ... 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, 100 S.Ct. at 1118 ("As we have emphasized 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, accepted 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 prohibited by § 10(b), the statute itself resolves the case....

Central Bank, 511 U.S. at ----, 114 S.Ct. at 1448. This is because "[t]he 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, 97 S.Ct. at 1301. 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 securities 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...