United States v. Whitman

• Court: U.S. District Court — Southern District of New York
• Writing for the Court: JED S. RAKOFF
• Citation: United States v. Whitman, 904 F. Supp. 2d 363 (S.D. N.Y. 2012)
• Decision Date: 19 November 2012
• Docket Number: No. 12 Cr. 125(JSR).,12 Cr. 125(JSR).
• Parties: UNITED STATES of America, v. Doug WHITMAN, Defendant.

904 F.Supp.2d 363

UNITED STATES of America,

v.Doug WHITMAN, Defendant.

No. 12 Cr. 125(JSR).

United States District Court, S.D. New York.

Nov. 14, 2012.

As Corrected Nov. 19, 2012.

Christopher Lloyd Lavigne, David Seymour Leibowitz, Jillian Blythe Berman, United States Attorney Office, New York, NY, for United States of America.

David Matthew Rody, Michael D. Mann, Sidley Austin LLP, New York, NY, David Lloyd Anderson, Patrick Steven Kelly, Sidley Austin LLP, San Francisco, CA, Nicolas W. Thompson, Sidley Austin LLP, Washington, DC, for Defendant.

OPINION

JED S. RAKOFF, District Judge.

On August 21, 2012, following a three-week trial, a jury convicted defendant Doug Whitman of two counts of conspiracy to commit insider trading and two counts of substantive insider trading in violation of the federal securities laws. Specifically, the counts charged that Mr. Whitman traded or agreed to trade on material inside information that he received from tippees who had, in turn, obtained the information from inside employees at Polycom, Inc., Google, Inc., and Marvell Technology, Inc. In connection with instructing the jury as to these charges, the Court confronted three interrelated issues as to which the law was unsettled. Those issues were:

(1) Whether in a criminal prosecution under the federal securities laws, the scope of an employee's duty to keep material non-public information confidential is defined by state or federal law?

(2) Whether a person who receives such information from someone outside the company must, to be criminally liable for trading on such information, know that the information was originally obtained from an insider who not only breached a duty of confidentiality in disclosing such information but also did so in exchange for some personal benefit?

(3) Whether even a secondary tippee like Mr. Whitman must, in order to be criminally liable, have a specific intent to defraud the company from which the information emanates of the confidentiality of that information?

After receiving written submissions and oral arguments culminating in a three-hour charging conference on August 14, 2012, the Court resolved the questions as reflected in Instructions 10 and 11 of the Court's jury charge. See United States v. Whitman, 12 Cr. 125(JSR), D.E. 102 (S.D.N.Y.2012) (Ct. Ex. 1) (Court's instructions of law to the jury). Although the Court stated its reasons for these rulings from the bench, this Opinion will serve to further amplify and elaborate the Court's reasoning.

By way of background, most insider trading prosecutions (outside the context of tender offers) allege willful violations of Rule 10b–5, codified at 17 C.F.R. § 240.10b–5, which was promulgated in 1942 by the Securities and Exchange Commission (“SEC”) pursuant to Section 10(b) of the 1934 Securities Exchange Act, 15 U.S.C. § 78j(b). See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). Rule 10b–5, in turn, was loosely modeled on the federal mail fraud statute, 18 U.S.C. § 1341, enacted in 1872. See Robert A. Prentice, Scheme Liability: Does It Have a Future After Stoneridge?, 2009 Wisc. L. Rev. 351, 361, 365 & nn. 54–56, 77 (Rule 10b–5 was virtually copied from section 17(a) of the Securities Act of 1933, which in turn was modeled, especially in subdivision (a) of the Rule, on the federal mail fraud statute).

Initially, only civil insider trading cases were brought under Rule 10b–5, first as administrative actions, see Cady, Roberts & Co., 40 S.E.C. 907, 1961 WL 59902 (1961), and then as SEC enforcement actions, see S.E.C. v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir.1968) (en banc). Such cases typically involved executives of companies who, upon learning of confidential information about their companies that would cause its stock price to rise, purchased shares from their own shareholders before the information was publicly announced, thereby breaching their fiduciary duty to their own shareholders. For example, in Texas Gulf Sulphur, the defendants, insiders of a mining company, upon learning that the company had just discovered 25 million tons of valuable mineral ore in eastern Canada, purchased stock and call options in the company before the discovery was publically announced, thereby violating Rule 10b–5. Id. at 843–52.

Soon, however, the cases were extended to situations where an insider in possession of material nonpublic information did not himself trade but disclosed the information to an outsider (a “tippee”) who then traded on the basis of the information before it was publicly disclosed. Eventually, the Supreme Court confronted this situation, in Dirks v. S.E.C., 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983), where it held that such a tippee assumes a fiduciary duty to shareholders of a public company not to trade on material nonpublic information if (a) the tipper has breached his fiduciary duty to the company and its shareholders by disclosing such information to the tippee in return for some personal benefit and (b) the tippee knows or should have known of the breach. Id. at 654–55, 103 S.Ct. 3255. Thus, in Dirks, the defendant, Raymond Dirks, an officer of a New York broker-dealer, received information from Ronald Secrist, a “whistleblower” who disclosed inside information about fraud at his former company, Equity Funding of America. Id. at 649, 103 S.Ct. 3255. Dirks did not himself trade on this information, but he repeated the information to clients of his company, who thereupon liquidated their holdings. Id. at 649–50, 103 S.Ct. 3255. The SEC censured Dirks, but the Supreme Court reversed, holding that because Secrist, the tipper, did not disclose the information for his personal benefit, there was no breach of fiduciary duty (in the sense of self-dealing at the shareholders' expense), and thus there was no derivative breach by Dirks, the immediate tippee (let alone by the secondary tippees, the clients). Id. at 662, 103 S.Ct. 3255.

Collectively, the approaches described above are referred to as the “classical” theories of insider trading because they involve breaches, whether direct or derivative, of duties to shareholders of the insider's company. SEC v. Obus, 693 F.3d 276, 284 (2d Cir.2012). However, around the same time that Dirks was proceeding through the courts, the first criminal insider trading cases were being brought, often involving lower-level employees who tipped or traded on the basis of market-sensitive information that they purloined from their employers but that pertained to the stock, not of their employers' companies, but of other companies. See Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980); Carpenter v. United States, 484 U.S. 19, 108 S.Ct. 316, 98 L.Ed.2d 275 (1987); United States v. O'Hagan, 521 U.S. 642, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997). For example, in Chiarella, which preceded Dirks, a low-level employee at a financial printing company misappropriated his company's confidential information concerning upcoming corporate takeovers involving other companies and thus was able to purchase stock in advance of the takeovers, to his profit. Since in these cases the employee was not purchasing securities from shareholders of his employer, it took awhile for a viable legal theory of these prosecutions to emerge—indeed, the conviction in Chiarella was reversed—but eventually the defendants' undisclosed embezzlement or “misappropriation” of market-sensitive confidential information from their employers was held to be a fraud on their employers that violated not only the mail fraud statute, see Carpenter, 484 U.S. at 25–28, 108 S.Ct. 316, but Rule 10b–5 as well, see O'Hagan, 521 U.S. at 665–66, 117 S.Ct. 2199.

As this thumbnail history illustrates, the prohibition of insider trading in the United States has developed in a somewhat ad hoc manner, leaving many unanswered questions.¹ The instant case—which was prosecuted under a modified “ Dirks ” approach ²—illustrates the point. Under this approach, liability exists if the tipper breaches a fiduciary-like duty of trust and confidence owed to his employer and its shareholders to keep confidential the material nonpublic information that the tipper discloses to his tippee in return for a personal benefit, knowing that the tippee may trade on the information. The first question that this poses is, from whence does this duty arise?

This should not be confused with the question of what is material nonpublic information. What is “nonpublic” or “confidential” information is largely a factual issue, turning on such factors as written company policies, employee training, measures the employer has taken to guard the information's secrecy, the extent to which the information is known outside the employer's place of business, and the ways in which other employees may access and use the information. United States v. Mahaffy, 693 F.3d 113, 135 n. 14 (2d Cir.2012); see also U.S. v. Royer, 549 F.3d 886 (2d Cir.2008). What is “material” information, though a mixed question of fact and law, is necessarily defined by federal law, because materiality relates in this context to what is required by federal securities laws to be disclosed and the very purpose of those laws is to set federal standards and requirements of disclosure in securities transactions. Thus, the relevant precedentsdeal with this issue as a matter of federal law and hold that a fact is “material” in this context if there is “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” Basic, Inc. v. Levinson, 485 U.S. 224, 231, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976)). See also United States v. Contorinis, 692 F.3d 136 (2d Cir.2012).

But the previously unanswered question the Court...