S.E.C. v. Rocklage

• Decision Date: 14 November 2006
• Docket Number: No. 06-1571.,06-1571.
• Citation: 470 F.3d 1
• Parties: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, Appellee, v. Patricia B. ROCKLAGE; William M. Beaver; David G. Jones, Defendants, Appellants.
• Court: U.S. Court of Appeals — First Circuit

Page 1

470 F.3d 1

SECURITIES AND EXCHANGE COMMISSION, Plaintiff, Appellee, v. Patricia B. ROCKLAGE; William M. Beaver; David G. Jones, Defendants, Appellants.

No. 06-1571.

United States Court of Appeals, First Circuit.

Heard September 11, 2006.^*

Decided November 14, 2006.

David H. Erichsen, with whom Peter Spaeth, Pratik A. Shah, and Wilmer Cutler Pickering Hale and Dorr LLP were on brief, for appellant Patricia B. Rocklage.

David E. Marder, with whom Benjamin D. Stevenson and Robins, Kaplan, Miller & Ciresi LLP were on brief, for appellant William M. Beaver.

Brian E. Whiteley and Scibelli, Whiteley and Stanganelli, LLP on brief for appellant David G. Jones.

Randall W. Quinn, Assistant General Counsel, with whom Brian G. Cartwright, General Counsel, Jacob H. Stillman, Solicitor, and Jeffrey Tao, Senior Counsel, were on brief, for appellee.

Before TORRUELLA, LYNCH, and LIPEZ, Circuit Judges.

LYNCH, Circuit Judge.

This is an interlocutory appeal from the denial of defendants' motion to dismiss a civil complaint based on an issue of law.

The complaint was brought by the SEC on a misappropriation theory of insider trading. It alleged that defendant Patricia B. Rocklage intentionally used deceptive means to obtain from her husband highly negative and non-public information about his publicly-traded company, in order to tip her brother who owned company stock, which then led to trading of the stock by her brother and another. Specifically, Mrs. Rocklage initially concealed from her husband her prior agreement with her brother to tip him if she learned significant negative information about the company. She also concealed that she did not intend to maintain the confidentiality that her husband had reasonably understood to bind her. After Mrs. Rocklage acquired the information on the basis of this deception, and shortly before she actually tipped her brother, however, she told her husband that she was going to give her brother the information. Her husband asked her not to do so, but she did so anyway, pursuant to the agreement. Under the circumstances and timing of the events, there was little her husband could do to prevent her from tipping her brother or to prevent her brother from trading on the information. Her brother sold his stock in the company on the next day the market opened and he passed the information on to a friend who did the same. The brother, William M. Beaver, and friend, David G. Jones, are also defendants.

The three defendants moved under Federal Rule of Civil Procedure 12(b)(6) to dismiss the SEC's complaint for failure to state a claim; they argued that under language in United States v. O'Hagan, 521 U.S. 642, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997), Mrs. Rocklage's pre-tip disclosure to her husband, telling him that she intended to tip-off her brother, completely negated any liability under the misappropriation theory. We conclude that O'Hagan does not require dismissal of this suit for failure to state a claim.

I.

On January 12, 2005, the SEC filed a civil complaint against the defendants. The complaint alleged the following key facts, which we must take as true under Rule 12(b)(6). See Conley v. Gibson, 355 U.S. 41, 45-46, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957). We draw all reasonable inferences in the SEC's favor. See Ramirez v. Arlequin, 447 F.3d 19, 20 (1st Cir.2006).

Mrs. Rocklage was the wife of Scott M. Rocklage. Mr. Rocklage was the Chairman and CEO of Cubist Pharmaceuticals, Inc., a publicly-traded biotechnology company. Mrs. Rocklage was not an employee of Cubist.

On December 31, 2001, Mr. Rocklage learned that one of the company's key drugs had failed its clinical trial. That afternoon, he phoned Mrs. Rocklage to discuss the trial results and he reached her while she was in a limousine. Before discussing the results with her, Mr. Rocklage made clear his intention that the results be kept confidential. He told her that she was not to react to what he was about to say, and he instructed her not to discuss the results in front of the limousine driver. She agreed. From the time that Mr. Rocklage joined Cubist in 1994, he had routinely communicated material, nonpublic information to his wife, and she had always kept the information confidential. Based on Mrs. Rocklage's agreement, and based on their prior history of sharing nonpublic information about the company and her keeping that information confidential, Mr. Rocklage had a reasonable expectation that she would not disclose the trial results to anyone. Based on his understanding that she would keep the information confidential, Mr. Rocklage informed his wife that the clinical trial had failed. Before the results were disclosed to her, Mrs. Rocklage understood her husband's expectation of confidentiality.

Unbeknownst to her husband, Mrs. Rocklage had a preexisting understanding with her brother, defendant Beaver, that she would inform him with "a wink and a nod" if she learned significant negative news about Cubist. At the time that Mrs. Rocklage learned the negative trial results, she knew or had reason to believe that Beaver owned Cubist stock. She also knew or had reason to know her brother would trade in Cubist securities if she disclosed the nonpublic information to him.

On the evening of December 31, 2001, Mr. Rocklage discussed the failure of the drug trial in more depth with Mrs. Rocklage. He informed her that Cubist would be making a public announcement about the results, and that until that happened the results were nonpublic. Mrs. Rocklage asked how the news would affect Cubist's stock, and Mr. Rocklage informed her that the stock price would drop significantly. As before, at the time that Mr. Rocklage originally conveyed this information to Mrs. Rocklage, he had a reasonable expectation that she would keep it confidential and would not otherwise have disclosed the information. In effect, by her deception Mrs. Rocklage induced her husband to disclose material non-public information he would not otherwise have disclosed, and she did so with the intention of sharing this information with her brother to allow him to trade securities.

After that conversation, and on or about the evening of December 31, 2001, Mrs. Rocklage informed her husband that she planned to signal her brother to sell his stock. Mr. Rocklage urged her not to do so, and he expressed his displeasure at the idea. Nevertheless, sometime before the morning of January 2, 2002, Mrs. Rocklage called Beaver and gave him "a wink and a nod" regarding Cubist. Beaver interpreted this to mean that he should sell his Cubist stock, and so on the morning of January 2, 2002—the first possible trading day after he was tipped off—Beaver sold all of his 5,583 shares of Cubist stock. By tipping her brother, Mrs. Rocklage was providing a gift of confidential information to a relative, and so she personally benefitted.

Beaver also tipped off his close friend and neighbor, defendant Jones. Jones knew that Beaver's brother-in-law, Mr. Rocklage, was Chairman and CEO of Cubist. Jones sold all of his 7,500 shares of Cubist stock on the morning of January 3, 2002.

Cubist publicly announced the negative drug trial results on January 16, 2002, after the market had closed for the day. By selling when they did, Beaver and Jones avoided losses of $99,527 and $133,222, respectively.

The SEC alleged that on the basis of these facts all three defendants were guilty of insider trading under § 10(b) of the Securities Exchange Act of 1934, see 15 U.S.C. § 78j(b), and Rule 10b-5 thereunder, see 17 C.F.R. § 240.10b-5.¹ It sought both injunctive relief and monetary penalties from the defendants.

All three defendants filed a Rule 12(b)(6) motion to dismiss for failure to state a claim. On August 23, 2005, the district court issued an opinion denying their motion. In its opinion, the court explained that the Supreme Court has recognized two theories of insider trading liability: the "classical theory" and the "misappropriation theory." The classical theory generally only imposes liability when a trader or tipper is an insider of the traded-in corporation. The classical insider-trader thus breaches a fiduciary duty owed to the corporation's shareholders. The misappropriation theory, however, creates liability when a tipper or trader misappropriates confidential information from his source of the information. The misappropriator thus breaches a fiduciary duty owed to the source.

The district court agreed with defendants that Mrs. Rocklage could not be held liable under the classical theory. She was not a traditional insider at Cubist. And the court determined that the relationship between Mrs. Rocklage and Cubist's shareholders was not of the kind that could lead to "temporary insider" status: no alleged facts demonstrated that Mr. Rocklage's disclosure to her was "solely for corporate purposes." See Dirks v. SEC, 463 U.S. 646, 655 n. 14, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983).

The district court disagreed, however, with the defendants' argument that there was no liability under the misappropriation theory. Although O'Hagan had said that disclosure to the source would negate liability under the misappropriation theory, the district court found O'Hagan distinguishable. However, the court's grounds for distinguishing O'Hagan were based on a misreading of O'Hagan's facts. The court reasoned that because O'Hagan's law firm had obligations to the traded-in company (as the district court read the case), any hypothetical disclosure by O'Hagan would have quickly made its way to the shareholders. In Mrs. Rocklage's case, by contrast, the special nature of the marital relationship meant that her disclosure would never make its way to the shareholders; Mr. Rocklage's loyalties lay first and foremost with his wife. Thus the district court found that the complaint stated facts sufficient to support a misappropriation theory of liability.

The district court also refused to dismiss the case...