Securities & Exchange Commission v. Sargent , 229 F.3d 68 ( 2000 )

United States Court of Appeals
For the First Circuit
____________________
No. 00-1293
SECURITIES AND EXCHANGE COMMISSION,
Plaintiff, Appellant,
v.
MICHAEL G. SARGENT, DENNIS J. SHEPARD,
ROBERT J. SCHARN, UNITED STATES,
Defendants, Appellees.
____________________
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Joseph L. Tauro, Senior U.S. District Judge]
____________________
Before
Torruella, Chief Judge,
Wallace,* Senior Circuit Judge,
and Lipez, Circuit Judge.
_____________________
Eric Summergrad, Deputy Solicitor, with whom David M. Becker,
General Counsel, Meyer Eisenberg, Deputy General Counsel, and Nathan A.
Forrester, Attorney Fellow, Securities and Exchange Commission, were on
brief, for appellant.
Gary C. Crossen, with whom Jack W. Pirozzolo, Stephen C. Warneck
and Foley, Hoag & Eliot, LLP were on brief, for appellee Michael G.
* Of the Ninth Circuit, sitting by designation.
Sargent.
Matthew C. Donahue, Andrea S. Barisano and Donahue & Donahue on
brief for appellee Dennis J. Shepard.
Gregg S. Haladyna on brief for appellee Robert J. Scharn.
____________________
October 11, 2000
____________________
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WALLACE, Circuit Judge. The Securities and Exchange
Commission (Commission) appeals from a directed verdict entered in
favor of defendants-appellees, Dennis J. Shepard, Michael G. Sargent,
and Robert J. Scharn. The Commission also challenges the district
court's denial of its request for pre-trial discovery and the district
court's decision to exclude the criminal convictions of Sargent and
Scharn for lying to Commission investigators. The district court had
jurisdiction under 15 U.S.C. §§ 78u(d)(1), 78u(d)(3), 78u(e), 78u-1,
and 78aa. We have jurisdiction pursuant to 28 U.S.C. § 1291. We
reverse and remand for new trial.
I
Shepard and J. Anthony Aldrich (against whom the Commission
did not file a complaint) were the sole shareholders of a consulting
firm incorporated in the Commonwealth of Massachusetts. Aldrich was
also a member of the board of directors for Purolator Products Co.
(Purolator), a manufacturer of automotive parts. On July 13, 1994,
Mark IV Industries, Inc. (Mark IV) offered to purchase all of the
outstanding shares of Purolator for $22 a share. Negotiations between
the two companies ensued, and on October 3, 1994, Purolator and Mark IV
publicly announced Purolator's acceptance of Mark IV's tender offer of
$25 a share.
Throughout 1994, Shepard and Aldrich ran their consulting
business from a 20' by 15', one-room office located in Shepard's
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basement. The firm used a telephone, voice mail system, and fax
machine from a single line. Shepard could hear what Aldrich said on
the telephone and would occasionally retrieve voice mail messages and
faxes for Aldrich. Aldrich realized that given the "very close
quarters," it was "inevitable [Shepard] would know something was going
on [with Purolator]. He was going to hear something." At some point
in July 1994, Aldrich took Shepard into his confidence and advised him
that Purolator was being pursued. Aldrich told Shepard that this fact
needed to be kept confidential and Shepard agreed not to disclose the
information.
The Purolator Board met several times between Mark IV's
initial offer of July 13 and October 3, 1994. By mid-August, Purolator
had retained Lehman Brothers, Inc. to advise it in the negotiations.
Purolator initially sought to remain independent, but its focus
gradually changed to getting the best price from the highest bidder.
It initiated discussion with at least two other companies in an effort
to raise the price. On September 8, Purolator entered into a
Standstill Agreement with Mark IV in which it agreed to provide Mark IV
with access to nonpublic information and Mark IV agreed not to effect
a hostile takeover while negotiations were pending. Mark IV made two
additional offers that Purolator rejected before Purolator accepted the
offer of $25 a share on October 3, 1994.
On Saturday, September 10, 1994, Shepard, Sargent, and their
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wives met for dinner. Sargent had been Shepard's dentist since 1983,
and the two were "friendly." Shepard had referred at least 75 of his
relatives, friends, and acquaintances to Sargent for their dental work.
Shepard was actively involved in the local chamber of commerce.
Because Sargent had many community ties, Shepard would "go to [Sargent]
periodically" for "contacts, networking to other individuals," and to
look for funds on behalf of the chamber of commerce.
The Sargents and Shepards met for dinner to smooth out some
problems that had developed between them. Shepard's sister-in-law,
Donna, had been hired to decorate the Sargents' home and had been paid
a $1000 retainer. She never completed the work, and the Sargents were
unable to recover the retainer because she had filed for bankruptcy.
Sargent was hoping that Shepard could work something out. Another of
Shepard's sisters-in-law, Brenda, had skipped several of her dental
appointments with Sargent without giving him notice. Sargent informed
her that the next time she did so, he would charge her for the missed
appointment. Brenda wrote Sargent a "scathing letter" complaining of
this treatment and threatening to use Shepard's influence to draw
customers away from Sargent's practice.
At the dinner, the Sargents and Shepards also talked about
Shepard's consulting business. Shepard asked Mrs. Sargent "whether she
could give [him] leads in connection with [his] consulting business."
He talked about his partner, Aldrich, and mentioned that Aldrich was on
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the Purolator board. After dinner, the couples attended the opening of
a new restaurant. While their wives were in the ladies' room, Sargent
and Shepard continued talking. At some point in that conversation,
Shepard said, "I am aware of a company right now that is probably going
to be bought," but "even if I had the money . . . I can't buy stock in
this company because I am too close to the situation." The Commission
alleges that during this conversation Shepard explicitly identified
Purolator as the company to be bought.
The following Monday, September 12, Sargent contacted Brian
Kelly, his broker at Legg Mason, before the market opened. Sargent
told Kelly, "I heard something over the weekend and it concerns
Purolator Products." He asked Kelly to do some research on Purolator.
Sargent called Kelly back that same morning. When asked by Kelly where
he had heard about Purolator, Sargent was evasive and may have replied
that his friend Scharn had overheard two men at a bar talking about
Purolator. Kelly reported that Purolator had not been doing much, that
it was trading close to its 52-week low, and that it was not the kind
of stock Sargent usually chose to purchase. Kelly went so far as to
call Purolator a "piece of crap," but he told Sargent that if he wanted
to invest in Purolator there was only a $1 to $2 downside risk.
Sargent then purchased 2000 shares of Purolator. The next day, Sargent
bought an additional 2000 shares through his account at Charles Schwab
Corp., a discount brokerage firm.
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Between September 12 and October 3, 1994, Sargent purchased
a total of 20,400 shares of Purolator at an average price of $17.67 per
share. This was the largest investment in a single stock that Sargent
had ever made. To finance his purchases, Sargent borrowed $50,000 from
a bank, bought shares on margin, and replaced stock he held in another
company with risky call options in that same company. Sargent had
never before taken out a loan to buy stock. Within a few days of the
tender offer announcement, Sargent sold all of his Purolator stock at
a profit of $140,000.
Sargent notified his close friend Scharn of his purchases in
Purolator. On September 19, 1994, Scharn purchased 5000 shares of
Purolator, his largest stock purchase of the year. Scharn did not
perform any research at all on Purolator. In order to raise the money
for this purchase, Scharn sold 10,000 shares of Telefonica de Argentina
at a loss of $5000. When his broker asked him where he had heard about
Purolator, Scharn responded that he had overheard two men discussing
Purolator at the bar of the restaurant he owned. Later, when the
tender offer was announced, Scharn remarked to his broker that "he knew
that it was going to happen."
Sargent was first contacted by the Commission on January 4,
1995. Peter Sonnenthal, an attorney with the Commission, conducted the
interview. When questioned about his stock purchases, Sargent told
Sonnenthal that his friend Scharn advised him to buy Purolator after
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Scharn had overheard "two guys" at his bar talking about the company.
After this interview, Sargent contacted Scharn to tell him about the
phone call with Sonnenthal; Sargent also advised Scharn that the
Commission might contact him as well. The Commission conducted two
additional telephone interviews with Sargent in which Sargent did not
change his story and in which he denied talking to Shepard about
Purolator. The Commission contacted Scharn on January 10, 1995.
Scharn repeated the story about overhearing two men discuss Purolator.
He even provided the Commission with phony descriptions of the two men.
The Commission subpoenaed both Sargent and Scharn. During
their depositions, both Sargent and Scharn admitted lying to the
Commission representative about Purolator. Sargent's new explanation
for the purchases was that he had acted on a hunch based on two pieces
of information he had learned at the dinner with Shepard, namely the
statements by Shepard (1) that Aldrich was on the Board of Purolator,
and (2) that he knew of a company that was going to be taken over, but
in which he could not invest because he was too close to the situation.
Sargent asserts that Shepard never told him that Purolator was the
company that was going to be acquired.
On May 7, 1996, a grand jury in the United States District
Court for the District of Massachusetts returned indictments against
Sargent and Scharn for making false statements to government officials
in violation of 18 U.S.C. § 1001. Sargent was also charged with
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insider trading in connection with a tender offer in violation of
Securities Exchange Act § 14(e), 15 U.S.C. § 78n(e) (section 14(e)),
and Rule 14e-3 promulgated thereunder, 17 C.F.R. § 240.14e-3 (Rule 14e-
3). The court granted Sargent's motion for a judgment of acquittal on
the insider trading charges. The jury returned guilty verdicts against
Sargent and Scharn for lying to the Commission. The court sentenced
Sargent and Scharn on December 16, 1998.
This action was filed March 25, 1996. In its complaint, the
Commission alleged that the defendants had tipped or traded in
Purolator on the basis of material, nonpublic information that Shepard
had misappropriated from Aldrich. The Commission asserted that this
activity violated section 10(b) of the Securities Exchange Act, 15
U.S.C. § 78j(b) (section 10(b)), and Rule 10b-5 promulgated thereunder,
17 C.F.R. 240.10b-5 (Rule 10b-5). The complaint also alleged that the
defendants violated section 14(e) and Rule 14e-3. The Commission
sought orders enjoining Shepard, Sargent, and Scharn from future
violations of these provisions and requiring them to disgorge their
profits.
In June 1996, the United States Attorney intervened in this
case and successfully moved to stay discovery. In March 1998, the
district court issued another stay of discovery, pending completion of
the criminal trial of Sargent and Scharn. At the conclusion of the
criminal trial, all of the defendants moved for summary judgment; the
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district court granted another stay of discovery, pending the
disposition of these motions. On July 29, 1999, the court denied the
defendants' motion for summary judgment and scheduled a pretrial
conference for August 4, 1999. At the pretrial conference, the
district court announced that it would not permit further discovery.
As a result of the many discovery stays, the Commission had
conducted virtually no discovery in this case. The Commission was
therefore required to rely on the information gathered in its initial
investigation and from the criminal trial. The witness list submitted
by the defendants contained three persons whose testimony the
Commission had never taken. Prior to trial, the Commission requested
leave of the district court to take the deposition of Gerald Lippes,
general counsel to Mark IV. This request was denied.
At trial, the district court excluded evidence of the
convictions of Sargent and Scharn for violating 18 U.S.C. § 1001 over
the repeated objections of the Commission. At the close of the
Commission's evidence, the district court orally granted the
defendants' motion for a directed verdict, holding that there was
insufficient evidence that Shepard tipped Sargent on the evening of
September 10, 1994.
II
The Commission appeals from the judgment as a matter of law
entered in favor of the defendants at the close of the Commission's
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evidence. We review this issue de novo, Wills v. Brown University, 184
F.3d 20, 29 (1st Cir. 1999), mindful that a motion for judgment as a
matter of law under Federal Rule of Civil Procedure 50(a)(1) should be
granted only where, after examining all the evidence in the light most
favorable to the non-moving party, the court finds that a reasonable
jury could not render a verdict for the non-movant. Irvine v. Murad
Skin Research Labs., Inc., 194 F.3d 313, 316 (1st Cir. 1999).
A.
In granting the defendants' motion for a directed verdict,
the district court only addressed the issue of whether Shepard had
provided Sargent with nonpublic information. The district court
correctly observed, and the Commission conceded, that there could be no
violation of section 10(b), section 14(e), Rule 10b-5, or Rule 14e-3 if
Sargent traded on a mere hunch arrived at by putting together the fact
that Aldrich was on the Purolator Board, which was public information,
with the statement made by Shepard that he knew of a company being
pursued. To prevail on its claims, the Commission must show that
Shepard communicated nonpublic information about Purolator to Sargent.
United States v. O’Hagan, 521 U.S. 642, 652, 669 (1997); United States
v. Libera, 989 F.2d 596, 600 (2d Cir. 1993). To that end, the
Commission alleged that "Shepard formed the necessary words, moved his
lips, and told Sargent that he was aware of a company, Purolator, that
was 'probably going to be bought.' "
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As is often true in securities fraud cases, the Commission
was unable to produce direct testimony establishing that Shepard
communicated nonpublic information to Sargent. The Commission instead
relied on circumstantial evidence to prove its allegation. It pointed
to Sargent's behavior following his dinner with Shepard as evidence
that Sargent must have been proceeding on something more than a hunch.
The district judge rejected this evidence, stating, "you can't build
inference on inference on inference." He commented that the Commission
was not making "reasonable use of circumstantial evidence" and that
their circumstantial evidence could not "be a surrogate for a [direct]
statement of insider information."
Although it is true that mere conjecture or speculation over
the evidence will not rise to a triable issue of fact, Irvine, 194 F.3d
at 317, a plaintiff is not required to produce direct evidence:
"circumstantial evidence, if it meets all the other criteria of
admissibility, is just as appropriate as direct evidence and is
entitled to be given whatever weight the jury deems it should be given
under the circumstances within which it unfolds." United States v.
Gamache, 156 F.3d 1, 8 (1st Cir. 1998).
Here, the Commission presented evidence that the first
business day following his dinner with Shepard, Sargent contacted his
broker before the market opened and stated that he had heard something
over the weekend about Purolator. A few hours later, Sargent bought
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Purolator even after receiving a negative recommendation from his
broker. When asked by his broker how he had heard about Purolator,
Sargent was evasive, and there was some evidence that even at that
early stage, he was telling the "two guys in a bar" lie. Over the next
three weeks, Sargent purchased 20,400 shares, his largest investment
ever in a single stock. He even took out a $50,000 bank loan to
finance the purchase.
After resolving all doubts and credibility issues in favor
of the Commission, we conclude that a jury could reasonably infer from
this evidence that Sargent was operating on more than just a hunch and
that he had received nonpublic information from Shepard about
Purolator.
B.
In their joint motion for a directed verdict, Shepard,
Sargent, and Scharn raised additional grounds that the district court
did not reach in granting their motion. On appeal, they argue that
these alternate grounds independently require us to affirm all or part
of the district court's judgment. We are not restricted to reviewing
only those grounds explicitly addressed by the district court in its
ruling; rather, we may affirm the judgment on any independently
sufficient ground squarely presented to us and to the district court.
Olsen v. Correiro, 189 F.3d 52, 57-58 (1st Cir. 1999).
1.
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In order to prevail on its section 10(b) and Rule 10b-5
claims against the appellees, the Commission must demonstrate that
Shepard, the alleged misappropriator, breached a fiduciary duty owed to
Aldrich, the source of the nonpublic, material information about
Purolator. O’Hagan, 521 U.S. at 652. The appellees contend that the
Commission failed to present sufficient evidence of a fiduciary
relationship between Shepard and Aldrich to survive a motion for
directed verdict as to these claims.
In the context of section 10(b) and Rule 10b-5 liability
premised on the misappropriation theory, the existence of a fiduciary
relationship turns on whether the source of the misappropriated
information granted the misappropriator access to confidential
information in reliance on a promise by the misappropriator that the
information would be safeguarded. O’Hagan, 521 U.S. at 652 ("[T]he
misappropriation theory premises liability on a fiduciary-turned-
trader's deception of those who entrusted him with access to
confidential information."); United States v. Chestman, 947 F.2d 551,
569 (2d Cir. 1991) (en banc) ("In relying on a fiduciary to act for his
benefit, the beneficiary of the relation may entrust the fiduciary with
. . . property . . . . Because the fiduciary obtains access to this
property to serve the ends of the fiduciary relationship, he becomes
duty-bound not to appropriate the property for his own use.").
At trial, the Commission presented evidence that Aldrich
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expressly told Shepard that Purolator was being pursued and that
Shepard promised not to divulge this information. Further, there was
trial testimony from which a jury could reasonably infer that Aldrich
relied on this promise, since throughout the Purolator negotiations
Aldrich continued to share an office with Shepard, an office which he
described as being "very close quarters" and in which it was
"inevitable [that Shepard] would know something was going on."
In addition, the Commission presented evidence of a pre-
existing fiduciary relationship between Shepard and Aldrich arising out
of their status as sole shareholders of their closely-held business
corporation. Under Massachusetts law, stockholders of such a
corporation "owe one another a duty of 'utmost good faith and loyalty.'
" Leader v. Hycor, Inc., 479 N.E.2d 173, 177 (Mass. 1985), quoting
Donahue v. Rodd Electrotype Co., 328 N.E.2d 505, 515 (Mass. 1975).
Thus, the duties between Shepard and Aldrich as shareholders mirror
those owed between partners in a partnership. Donahue, 328 N.E.2d at
512 ("Just as in a partnership, the relationship among stockholders
must be one of trust, confidence and absolute loyalty if the enterprise
is to succeed."). Shareholders "may not act out of avarice, expediency
or self-interest in derogation of their duty of loyalty to the other
stockholders and to the corporation." Id. at 515. This strict duty
applies to "actions relative to the operations of the enterprise and
the effects of that operation on the rights and investments of other
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stockholders." Id. at 515 n.18.
Shepard argues that he could not have breached this duty to
his co-shareholder because any information regarding Purolator did not
relate to the operations of the Aldrich-Shepard consulting firm. The
defendant in SEC v. Peters, 735 F. Supp. 1505 (D. Kan. 1990), made the
same argument in the context of a partnership. In that case, the
defendant had misappropriated from his partner confidential information
regarding a non-partnership, business interest. The defendant argued
that he had breached no fiduciary duty because the information did not
relate to partnership matters. The court disagreed, holding that it
was clear "under the expectations of the [] partners, a partner's
conversion for personal use of confidential information belonging to
another partner would constitute a breach of fiduciary duty. The
partnership expected that all business matters of each partner would be
held in trust and confidence." Id. at 1521.
In the case before us, evidence was presented that both
Shepard and Aldrich considered it improper to open the other's personal
mail delivered to the office, to read the other's personal faxes that
came in on the office's sole fax machine, or to go through the other's
personal files. Even though Aldrich knew Shepard might inadvertently
overhear information about Purolator, Aldrich remained in the small
office with Shepard because he trusted Shepard to keep such information
confidential. Shepard testified that he would not have disclosed
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information regarding Purolator to anyone because he knew "that it was
confidential, [Aldrich] didn't even have to tell me that . . . I
understand, you know, my responsibilities, you know, my
responsibilities to anyone." We conclude, after reviewing the evidence
in the light most favorable to the Commission, that a jury could
reasonably find that Shepard and Aldrich expected that confidential
business matters, even those unrelated to the consulting firm, would be
held in trust and that Shepard thereby owed a fiduciary duty to
safeguard information relating to Purolator.
2.
In addition, the appellees urge that we affirm the district
court's entry of judgment on the section 10(b) and Rule 10b-5 claims on
the basis that the Commission failed to present evidence that Shepard
benefitted from the alleged tip to Sargent. Under the classical theory
of insider trading, an insider who provides a tip but who does not
himself trade will be liable under 10b-5 only if he "will benefit,
directly or indirectly, from his disclosure." Dirks v. SEC, 463 U.S.
646, 662 (1983). In addition, tippees are not liable under Rule 10b-5
unless benefit to the original tipper is proven. SEC v. Warde, 151
F.3d 42, 47 (2d Cir. 1998). The "benefit" to the tipper need not be
"specific or tangible." Id. at 48-49. A gift to a friend or relative
is sufficient. Id.There is some disagreement about whether benefit to a
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misappropriating tipper is a required element of section 10(b) and Rule
10b-5 liability. A few district court opinions, one of which was
vacated on other grounds, hold that there is a benefit requirement in
misappropriation cases. SEC v. Trikilis, 1992 WL 301398, at *3 (C.D.
Cal. July 28, 1992), vacated, 1993 WL 43571 (C.D. Cal. Jan. 22, 1993);
United States v. Santoro, 647 F. Supp. 153, 170 (E.D.N.Y. 1986); SEC v.
Gaspar, 1985 WL 521, at *16-17 (S.D.N.Y. Apr. 16, 1985). However, two
district court opinions have stated outright, albeit in dicta, that
there is no benefit requirement in misappropriation cases. SEC v.
Willis, 777 F. Supp. 1165, 1172 n. 7 (S.D.N.Y. 1991); SEC v. Musella,
748 F. Supp. 1028, 1038 n. 4 (S.D.N.Y. 1989). In addition, the Second
Circuit strongly implied, also in dicta, that there was no need to make
an affirmative showing of benefit in cases of misappropriation. It
wrote:
The tipper's knowledge that he or she was
breaching a duty to the owner of confidential
information suffices to establish the tipper's
expectation that the breach will lead to some
kind of misuse of the information. This is so
because it may be presumed that the tippee's
interest in the information is, in contemporary
jargon, not for nothing.
Libera, 989 F.2d at 600. Further, in the context of tippee liability,
the court stated in the same case that, "the misappropriation theory
requires the establishment of two elements: (i) a breach by the tipper
of a duty owed to the owner of nonpublic information; and (ii) the
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tippee's knowledge that the tipper had breached the duty. We believe
these two elements, without more, are sufficient for tippee liability."
Id. (citations omitted). Thus, it appears from these statements that
the Second Circuit would probably not require a showing of benefit to
the tipper for tipper (or tippee) liability, but would create a
presumption of section 10(b) and Rule 10b-5 liability if there was
misappropriation followed by a tip.
We need not resolve this conflict to reach a decision in this
case because, whether or not a misappropriating tipper must benefit in
order to violate section 10(b) and Rule 10b-5, the Commission presented
sufficient evidence at trial from which a jury could reasonably
conclude that Shepard did benefit from his alleged tip to Sargent. At
trial, Shepard testified that he and Sargent were "friendly." Shepard
had referred over 75 people to Sargent for their dental work. Further,
Shepard stated that he often went to Sargent for help in connection
with Shepard's service to the local chamber of commerce. Shepard's
sister-in-law owed Sargent money and another of Shepard's relatives was
threatening to harm Sargent's business. From this evidence, a jury
could infer that Shepard tipped Sargent about Purolator in an effort to
effect a reconciliation with his friend and to maintain a useful
networking contact.
3.
Scharn asserts separately that we should affirm the judgment
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as to him because there was insufficient evidence for a jury reasonably
to find that Sargent provided him with nonpublic information. Scharn
did not perform any research prior to his purchase of Purolator;
instead, he relied solely on Sargent's recommendation. His investment
in Purolator was his largest investment of that year. When asked by
his broker where he had heard about Purolator, Scharn lied and said he
had overheard two men at his restaurant discussing the company. This
is the same story that both Sargent and Scharn would later tell the
Commission. After the tender offer was publicly announced, Scharn told
his broker that "he knew it was going to happen."
Of course, Scharn sees it differently. He points out that
he claimed to have said the same thing whenever he made a profit on an
investment and that he frequently bought stock based on what Sargent
was doing. He also states that his purchase in Purolator was not
aberrational because he had made investments of similar magnitude
without doing any research.
So there is a conflict as to inferences to be drawn. The
Commission and Scharn have their own argument. In reaching our
decision, however, we must resolve all doubts and questions of
credibility in favor of the Commission's case. Irvine, 194 F.3d at
316-17. We conclude that a jury could reasonably find from the
circumstantial evidence presented by the Commission that Scharn
possessed nonpublic, material information given him by Sargent.
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4.
The appellees also argue that the Commission failed to
produce evidence that they knew Purolator would be purchased by means
of a tender offer, a fact appellees contend must be established as a
prerequisite to Rule 14e-3 liability. Were we to agree with appellees'
interpretation of Rule 14e-3, this argument would have some merit. The
testimony about the conditions in the office shared by Shepard and
Aldrich is the only evidence from which a jury could infer that Shepard
knew the form that the acquisition of Purolator would take. To find
that Sargent and Scharn knew the form the transaction would take, a
jury would have to speculate about the exact content of Shepard's
communication to Sargent and of Sargent's tip to Scharn.
The plain language of Rule 14e-3, however, contradicts the
appellees’ interpretation:
(a) If any person has taken a substantial step
or steps to commence . . . a tender offer . . .
it shall constitute a fraudulent . . . act . . .
within the meaning of section 14(e) of the Act
for any other person who is in possession of
material information relating to such 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 inside source]. . . to
purchase or sell . . . any of such securities .
. . unless within a reasonable time prior to any
purchase or sale such information and its source
are publicly disclosed . . . .
. . . .
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(d)(1) . . . it shall be unlawful for any
person . . . to communicate nonpublic information
relating to a tender offer to any other person
under circumstances in which it is reasonably
foreseeable that such communication is likely to
result in a violation of this section . . . .
17 C.F.R. § 240.14e-3. There is simply no language in the Rule
indicating that a defendant must know that the nonpublic information in
his possession relates to a tender offer.
The Eighth Circuit reached a similar conclusion when faced
with the issue of whether Rule 14e-3 requires that a defendant know
that substantial steps toward a tender offer have been taken. United
States v. O’Hagan, 139 F.3d 641, 650 (8th Cir. 1998), holds:
Rule 14e-3(a) requires that "any person" must
have taken "a substantial step or steps" towards
the tender offer. The rule does not require the
defendant to have knowledge of these acts.
Instead, the defendant need only "know[] or have
reason to know" that the material information is
"nonpublic and has been acquired directly or
indirectly from" the tender offeror in some way."
Id.Further, when the Commission promulgated Rule 14e-3, it
explained in the accompanying release that the Rule did not require the
trader to know that the nonpublic information related to a tender
offer:
As adopted, the information which will trigger
the operation of the Rule (1) must be material,
(2) must relate to a tender offer, (3) must be
nonpublic and (4) must have been acquired
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directly or indirectly from the offering person,
from the issuer or from another specified person.
For the last two requisites, there is a "knows or
has reason to know" standard by the person who
has possession of the information. For the first
two requisites, i.e., materiality and relation to
a tender offer, there is no "knows or has reason
to know" standard.
Tender Offers, Exchange Act Release No. 17120, 1980 WL 20869, at *6
(Sept. 4, 1980). The Supreme Court has observed that "[b]ecause
Congress has authorized the Commission, in § 14(e), to prescribe
legislative rules, we owe the Commission's judgment 'more than mere
deference or weight.' " O’Hagan, 521 U.S. at 673, quoting Batterton v.
Francis, 432 U.S. 416, 424-26 (1977); see also Cohen v. Brown
University, 101 F.3d 155, 173 (1st Cir. 1996) (explaining that it is
"well settled" that if Congress has expressly delegated to an agency
the power to prescribe regulations, the resulting regulations must be
accorded controlling weight if they are not arbitrary or capricious).
We must defer to the Commission's interpretation "unless [it is]
arbitrary, capricious, or manifestly contrary to the statute." Chevron
U.S.A. Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837,
844 (1984); see also Beaver Plant Operations, Inc. v. Herman, 2000 WL
1239950, at *3 (1st Cir. Sept 7, 2000) (stating that an "agency's
interpretation [of its own regulation] should be given full effect if
it is reasonable"). Since the plain language of the rule leads us to
the same interpretation the Commission reached, the Commission's
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approach is manifestly reasonable. We hold that Rule 14e-3 does not
require that a person charged with violating the rule have knowledge
that the nonpublic information in his possession relates to a tender
offer. Therefore, appellees' contention is rejected.
Thus, neither the basis upon which the district court made
its ruling nor the reasons suggested by appellees to save the directed
verdict can be sustained. A new trial is required.
III
In its appeal, the Commission asserts that the district court
incorrectly excluded the convictions of Sargent and Scharn for lying to
the Commission in violation of 18 U.S.C. § 1001. The district court
applied the balancing test of Federal Rule of Evidence 403 (Rule 403)
to exclude these convictions, reasoning that since the defendants had
testified at trial about their lies, the prejudicial impact of
admitting the convictions outweighed the probative value of the
evidence. The district judge remarked to the Commission, "[Y]ou get
all the probative value you need because the witness admitted he lied."
The Commission asserts that the trial court misconstrued 609(a)(2) of
the Federal Rules of Evidence (Rule 609(a)(2)) when it applied Rule 403
to exclude the convictions. We address this issue because it will
undoubtedly arise during a new trial.
The interpretation of the Federal Rules of Evidence is a
question of law which we review de novo. Correiro, 189 F.3d at 58;
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United States v. Sposito, 106 F.3d 1042, 1046 (1st Cir. 1997). Rule
609(a)(2) provides: "(a) . . . For the purpose of attacking the
credibility of a witness, . . . . (2) evidence that any witness has
been convicted of a crime shall be admitted if it involved dishonesty
or false statement, regardless of the punishment." (Emphasis added.)
Without question, a conviction for lying to a government official is a
crime of "dishonesty or false statement," and we have plainly held that
district courts do not have discretion to exclude prior convictions
involving dishonesty or false statements. United States v. Tracy, 36
F.3d 187, 192 (1st Cir. 1994); United States v. Kiendra, 663 F.2d 349,
354 (1st Cir. 1981) ("[W]e are driven by the force of explicit
statutory language and legislative history to hold that evidence
offered under Rule 609(a)(2) is not subject to the general balancing
provision of Rule 403.").
Further, it is of no consequence that Sargent and Scharn
testified about their lies. The Commission was entitled to attack the
defendants' credibility more forcefully by presenting the fact that the
defendants had been convicted of "knowingly and willfully" making a
"materially false, fictitious, or fraudulent statement or
representation" to a government official. 18 U.S.C. § 1001.
Rule 609(a)(2) simply does not allow for any judicial discretion on
this point. The district court committed error in excluding these
convictions.
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IV
The Commission also contends in its appeal that the district
court erred when it denied the Commission's motion for pre-trial
discovery. Trial judges enjoy broad discretion in managing pretrial
discovery. We may intervene "only upon a clear showing of manifest
injustice, that is, where the lower court's discovery order was plainly
wrong and resulted in substantial prejudice to the aggrieved party."
Mack v. Great Atlantic & Pacific Tea Co., 871 F.2d 179, 186 (1st Cir.
1989); see also City of Waltham v. U.S. Postal Service, 11 F.3d 235,
243 (1st Cir. 1993).
The Supreme Court has long recognized that the Federal Rules
of Civil Procedure are to be construed liberally in favor of discovery.
Hickman v. Taylor, 329 U.S. 495, 507 (1947) ("[T]he deposition-
discovery rules are to be accorded a broad and liberal treatment.").
Here, even though the Commission had already conducted a pre-filing
investigation and had access to the evidence from the criminal trial of
Sargent and Scharn, "there is no authority which suggests that it is
appropriate to limit the SEC's right to take discovery based upon the
extent of its previous investigation into the facts underlying its
case." SEC v. Saul, 133 F.R.D. 115, 118 (N.D. Ill. 1990). We need
not, however, decide whether the district court was "plainly wrong" in
limiting discovery since a new trial is required, and the opportunity
of pretrial discovery will be reconsidered. At that time, the district
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court will have the benefit of our view that discovery should not have
been foreclosed to the Commission merely because of its pre-filing
investigation or information secured from the Sargent and Scharn
criminal trials.
REVERSED AND REMANDED FOR A NEW TRIAL.
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