S.E.C. v. Peters
| Decision Date | 26 October 1992 |
| Docket Number | No. 90-3346,90-3346 |
| Citation | 978 F.2d 1162 |
| Parties | , Fed. Sec. L. Rep. P 97,045, 36 Fed. R. Evid. Serv. 1036 SECURITIES and EXCHANGE COMMISSION, Plaintiff-Appellant, v. Don S. PETERS, Defendant-Appellee. |
| Court | U.S. Court of Appeals — Tenth Circuit |
Jacob H. Stillman, Associate Gen. Counsel (James R. Doty, Gen. Counsel, Katharine Gresham, Asst. Gen. Counsel, Mark Pennington, Atty., and Paul Gonson, Sol., of counsel, with him, on the brief), S.E.C., Washington, D.C., for plaintiff-appellant.
Stephen M. Joseph (Charles E. Millsap, with him, on the brief), Joseph, Robison & Anderson, Wichita, Kan., for defendant-appellee.
Before MOORE and EBEL, Circuit Judges, and ALLEY, District Judge. *
This is an appeal from a jury verdict for the defendant in a civil suit for insider trading in violation of Section 10(b) of the Securities and Exchange Act of 1934 ("the Act"), 15 U.S.C. § 78j(b), and Securities and Exchange Commission Rules 10b-5 and 14e-3, 17 C.F.R. §§ 240.10b-5 and 240.14e-3. First, we hold that the SEC has authority under Section 14(e) of the Act, 15 U.S.C. § 78n(e), to promulgate Rule 14e-3, which provides for insider trading liability against a defendant for trading securities, or causing securities to be traded, upon material, nonpublic information relating to a tender offer so long as the defendant knew or had reason to know that the information came from an insider. Thus, we hold that the district court erred in instructing the jury that a defendant must also breach a fiduciary duty before Rule 14e-3 is violated. Second, we hold that the district court erred by refusing to permit cross-examination of the defendant and his opinion character witnesses regarding prior fraud suits against the defendant that settled without findings or admissions. Because we conclude that these errors were prejudicial, we reverse and remand for a new trial.
In 1983, the defendant-appellee, Don S. Peters, entered into a partnership called Investment Management Group ("IMG"). One of the IMG partners, Ivan West, individually did consulting work for Energy Resources Group, Inc. ("ERG"). This work included assisting ERG in finding an investor to make a friendly tender offer for ERG's stock. West's consulting work for ERG was excluded from the IMG partnership because that work was underway at the time that the IMG partnership was formed.
With West's help, ERG reached an agreement with Broken Hill Proprietary Company ("Broken Hill"), pursuant to which Broken Hill made a tender offer for ERG's stock. Shortly before the announcement of the tender offer, several private investors bought substantial quantities of ERG stock, which they sold at a significant profit soon after the announcement was made. The SEC alleged that these investors traded upon inside information and that Peters was the source of this information.
The SEC brought a civil suit against Peters for insider trading under Section 10(b) and SEC Rules 10b-5 and 14e-3. The SEC's theory was that Peters secretly viewed documents regarding the Broken Hill tender offer that West kept at the IMG offices. According to the SEC, Peters gave information from these documents regarding the timing of the imminent tender offer to two parties. First, the SEC alleged, Peters gave the information to a broker named Ken Mick, who passed it on to several of his clients, who in turn used the information to profit by trading ERG stock. After receiving a share of the profits from these clients, Mick repaid a $43,000 debt to Peters. Second, the SEC alleged that Peters gave the information to a former client, Bernard Lounsbury, who used the information to profit by trading ERG stock. Lounsbury used a portion of his profits to repay a $7,500 debt to Peters.
The jury returned a verdict for Peters on all of the allegations. The SEC appeals that verdict and the district court's denial of its motion for a new trial. The SEC asserts two grounds of error on appeal. First, the SEC argues that the district court erred by instructing the jury that liability under Rule 14e-3 requires a breach of fiduciary duty. Second, the SEC argues that the district court erred by restricting its ability to cross-examine Peters and several of his character witnesses regarding prior fraud suits against Peters. We address each of these arguments in turn.
The district court instructed the jury that to find a violation of Rule 14e-3 it must find "that the defendant's action ... constituted a violation of the relationship of trust and confidence he held with West." Jury Instruction 17, in SEC App. at 144. The SEC objected to this element of the Rule 14e-3 instruction and now appeals its inclusion. We review this legal question de novo. Northern Natural Gas Co. v. Grounds, 931 F.2d 678, 681 (10th Cir.1991).
On its face, Rule 14e-3 requires no breach of a fiduciary duty. The Rule provides, in relevant part, that
it shall constitute a fraudulent, deceptive or manipulative act or practice within the meaning of section 14(e) of the Act for any ... person who is in possession of material information relating to [a] 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 [an insider] to purchase or sell or cause to be purchased or sold any of [the securities sought by the tender offer] ... unless within a reasonable time prior to any purchase or sale such information and its source are publicly disclosed by press release or otherwise.
As explained by the Second Circuit:
One violates Rule 14e-3 if 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. Rule 14e-3 is a disclosure provision. It creates a duty in those traders who fall within its ambit to abstain or disclose, without regard to whether the trader owes a pre-existing fiduciary duty to respect the confidentiality of the information.
United States v. Chestman, 947 F.2d 551, 557 (2d Cir.1991) (en banc) (emphasis added), cert. denied, --- U.S. ----, 112 S.Ct. 1759, 118 L.Ed.2d 422 (1992).
Peters does not dispute that Rule 14e-3, on its face, contains no fiduciary duty requirement. Rather, he argues that a fiduciary duty requirement must be read into Rule 14e-3 to prevent the rule from exceeding the SEC's rulemaking authority under Section 14(e). The district court apparently agreed. We disagree, and hold that Rule 14e-3, as written--i.e., with no fiduciary duty requirement--is within the SEC's statutory rulemaking authority.
A rule exceeds its statutory authority if it is " 'inconsistent with the statutory mandate or ... frustrate[s] the policy that Congress sought to implement.' " Securities Indus. Ass'n v. Board of Governors ("SIA "), 468 U.S. 137, 143, 104 S.Ct. 2979, 2992, 82 L.Ed.2d 107 (1984) (citation omitted). We hold that Rule 14e-3 is consistent with its statutory mandate and with the policy that Congress sought to implement.
The statutory mandate for Rule 14e-3 is broad--indeed, much broader than the statutory mandate for Rule 10b-5. Section 14(e) specifically authorizes the SEC to "define, and prescribe means reasonably designed to prevent, such acts and practices as are fraudulent, deceptive, or manipulative." 15 U.S.C. § 78n(e). 1 This mandate Peters argues that the phrase "fraudulent, deceptive, or manipulative" in Section 14(e) refers only to fraudulent nondisclosure as defined by the caselaw under Section 10(b) and Rule 10b-5. See Schreiber v. Burlington Northern, Inc., 472 U.S. 1, 10-11, 105 S.Ct. 2458, 2464, 86 L.Ed.2d 1 (1985) ( ) (citations and footnote omitted). 2 Liability for fraudulent nondisclosure under Section 10(b) and Rule 10b-5 requires breach of a duty to disclose before trading premised upon a fiduciary duty "of trust and confidence between parties to the transaction." See Chiarella v. United States, 445 U.S. 222, 230, 100 S.Ct. 1108, 1115, 63 L.Ed.2d 348 (1980). Thus, Peters argues, liability for fraudulent nondisclosure under Section 14(e)--i.e., for "fraudulent, deceptive, or manipulative acts or practices"--also requires breach of a fiduciary a duty of trust and confidence. 3
raises two questions: First, what did Congress mean by "fraudulent, deceptive, or manipulative" in Section 14(e)? Second, to what extent does this definition constrain the SEC's rulemaking authority
Even if we were to accept Peters' argument that Section 14(e) is concerned only with preventing fraudulent nondisclosure as defined under Section 10(b), 4 we conclude that Rule 14e-3 is "reasonably designed" to achieve this goal in the tender offer context. Chestman, 947 F.2d at 558. Rule 14e-3 helps to prevent such fraudulent nondisclosure by easing an evidentiary burden that might often prevent liability from attaching to such conduct in a tender offer setting.
Proving under Section 10(b) that a trader has breached a fiduciary duty in trading on undisclosed insider information may be extremely difficult. For example, under Rule 10b-5, a tippee assumes a duty to disclose "only when [an] insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should have known Particularly in the context of a tender offer, there is a fairly wide circle of people with confidential information who may lack a long-term loyalty to the issuer and...
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