No. 96-842

IN THE SUPREME COURT OF THE UNITED STATES
OCTOBER TERM, 1996

UNITED STATES OF AMERICA, PETITIONER
v.
JAMES HERMAN O'HAGAN

ON  WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE EIGHT CIRCUIT

REPLY BRIEF  FOR THE UNITED STATES

WALTER DELLINGER
Acting Solicitor General
Department of Justice
Washington, D.C. 20530-0001

(202) 514-2217

---------------------------------------- Page Break ----------------------------------------

TABLE OF AUTHORITIES

Cases:                   Page

Basic Inc. v. Levinson, 485 U.S. 224 (1988) . . . . 5
Bateman, Eichler, Hill Richards, Inc. v. Berner,
472 U.S. 299 (1985) . . . . 11
Blue Chip Stamps v. Manor Drug Stores, 421 U.S.
723 (1975) . . . . 5
Boyce Motor Lines, Inc. v. United States, 342 U.S.
337 (1952) . . . . 13
Cady, Roberts & Co., In re, 40 S.E.C. 907 (1961 ). . . . 5
Carpenter v. United States, 484 U.S. 19
(1987) . . . . 14, 18
Chevron U.S.A. Inc. v. Natural Resources Defense
Council, Inc., 467 U.S. 837 (1984) . . . . 17
Chiarella v. United States, 445 U. S. 222
(1980) . . . . 10, 11, 13, 14, 18
Dirks v. SEC, 463 U.S. 646 (1983 ) . . . . 11, 14
Dobbert v. Florida, 431 U.S. 282 (1977) . . . . 
Ford v. United States, 273 U. S. 593 (1927) . . . . 19
Green v. Santa Fe Industries, 533 F.2d 1309
(2d Cir. 1976), rev'd, 430 U.S. 462(1977) . . . . 8
Herman &  MacLean v. Huddleston, 459 U.S. 375
(1983) . . . . 5
Lewis v. McGraw, 619 F.2d 192 (2d Cir.), cert.
denied, 449 U. S. 951(1980) . . . . 17
O'Neill v. Maytag, 339 F.2d 764 (2d Cir. 1964) . . . . 8
Santa Fe Industries v. Green, 430 U.S. 462
(1977) . . . . 6
Schreiber v. Burlington Northern, Inc., 472 U.S. 1
(1985). . . . 16
Screws v. United States, 325 U. S. 91(1945) . . . . 13
Superintendent of Insurance v. Bankers Life &
Casualty Co., 404 U.S. 6 (1971 ) . . . . 10
United States v. Charnay, 537 F.2d 341(9th Cir.),
cert. denied, 429 U.S. 1000(1976) . . . . 13

(I)

---------------------------------------- Page Break ----------------------------------------

II

Cases-Continued:

United States v. Chestman, 947 F.2d 551 (2d Cir.
1991), cert. denied, 503 U.S. 1004 (1992) . . . .
United States v. Dixon, 536 F.2d 1388 (2d Cir.
1976) . . . .
United States v. Lang, 766 F. Supp. 389 (D. Md.
1991) . . . .
United States v. Lanier, No. 95-1717 (Mar. 31,
1997) . . . . 
United States v. Miller, 471 U.S. 130 (1985) . . . . 
United States v. Naftalin, 441 U.S. 768 (1979) . . . .
United States v. Newman, 664 F.2d 12 (1981), aff'd
after remand, 722 F.2d 729 (2d Cir.), cert. denied,
464 U.S. 863 (1983) . . . . 
United States v. Pelts, 433 F.2d 48 (2d Cir. 1970),
cert. denied, 401 U.S. 955 (1971) . . . .
United States v. Ragen, 314 U.S. 513 (1942) . . . .
United States v. United States Gypsum Co.,
438 U.S. 442 (1980) . . . .
United States v. Yermian, 468 U.S. 63 (1984) . . . .
Village of Hoffman Estates v. The Flipside, Hoff-
man Estates, Inc, 455 U.S. 489 (1982) . . . .

Statutes and regulations:

Insider Trading and Securities Fraud Enforcement
Act of 1988, Pub. L. No. 100-704, 102 Stat. 4788 . . . .
Securities Act of 1933, 15 U.S.C. 77a et seq.:
17(a)(l), 15 U.S.C. 77q(a)(1) . . . . 
32(a), 15 U.S.C. 78ff(a) . . . .
Securities Exchange Act of 1934, 15 U.S.C. 78a
et seq.:
  10(b), 15 U.S.C. 78j(b) . . . . 4, 5, 9, 10, 11,
  14(e), 15 U.S.C. 78n(e) . . . . 2, 15, 16, 17
  16(b), 15 U.S.C. 78p(b) . . . . 15
Williams Act, Pub. L. No. 90-439, 3, 82 Stat. 457 . . . . 16, 17
17 C.F.R.:
Section 240.10b-5 (Rule 10b-5) . . . . 20
Section 240.14e-3 (Rule 14a-3) . . . . 18

---------------------------------------- Page Break ----------------------------------------

III

Regulation-Continued:            Page

Section 240.14 e-3(a) (Rule 14a-3(a)) . . . . 15, 18
Miscellaneous:
Ann M. Hart, The Model Rules Are Close and the
Restatement Is Closer, 10 Gee. J. Legal Ethics
192 (1996) . . . . 14
H.R. Rep. No. 910, 100th Cong., 2d Sess. (1988) . . . . 12, 15
Adam Ingber, 10b or Not 10b-5?: Are the Current
Efforts to Reform Securities Litigation Misguided?,
61 Fordham L. Rev. S35.1 (1993) . . . . 5
Louis Loss & Joel Seligman, Securities Regulation
(3d ed. 1989) . . . . 5
Restatement (Second) of Agency (1958) . . . .  4, 6
Restatement (Second) of Torts (1959) . . . . 5
Restatement (Second) of Trusts (1977) . . . . 7
Restatement (Third) of the Law Governing Lawyers:
Preliminary Draft No. 2 (1967) . . . . 14
Tentative Draft No. 3 (1990) . . . .  14
Proposed Final Draft No. 1 (1996) . . . . 14

---------------------------------------- Page Break ----------------------------------------

In the Supreme Court of the United States

OCTOBER TERM, 1996

No. 96-842

UNITED STATES OF AMERICA, PETITIONER

v.

JAMES HERMAN O'HAGAN

ON WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE EIGHTH CIRCUIT

REPLY BRIEF FOR THE UNITED STATES

    1. Respondent argues that his trading in securities on
misappropriated confidential information did not violate
the federal securities laws. He begins by attacking the
factual underpinning of the jury's verdict, which found
that he engaged in that form of deception in connection
with his securities trading. The jury correctly resolved
the factual issues against him.
    Respondent first asserts (Br. 3) that, with the exception
of one order for 5,000 shares of Pillsbury stock, all his
orders for Pillsbury securities were placed with his bro-
kers before August 26, 1988-the date on which partners
at Dorsey & Whitney (Dorsey) met to discuss whether to
continue their representation of Grand Metropolitan PLC
(Grand Met) in its attempt to acquire Pillsbury, and the
earliest date, according to respondent (Br. 2), on which he
could have confirmed the nonpublic information that a

(1)

---------------------------------------- Page Break ----------------------------------------

2

takeover of Pillsbury was being planned. The jury cor-
rectly rejected that contention. The jury was instructed,
on the Section 10(b) counts, that "[t]he government must
prove beyond a reasonable doubt that the defendant used
the material, nonpublic information * * * when he
purchased the Pillsbury securities." J.A. 200. It was also
instructed, on the Section 14(e) counts, that illegal insider
trading with respect to tender offers exists only when
"the defendant, knowing that this information came from
the corporation, invests in securities using material non-
public information." J.A. 203. While respondent suggests
that he traded on publicly reported news stories rather
than material, nonpublic information (Br. 4), the jury was
expressly instructed on the difference between public and
nonpublic information, see J.A. 198-199, and it rejected that
contention. The jury found instead that respondent "used"
material, nonpublic information in his trading.  That
finding, which is supported by the record, is inconsistent
with respondent's claim that he placed all of his options
orders before he learned nonpublic information about the
Pillsbury takeover.  1.

___________________(footnotes)

    1.  Respondent begins from the erroneous premise (Br. 3 n.6) that be
could not have had nonpublic information before August 26, 1988, and
argues that trades before that date were therefore lawful.  Thomas
Tinkham testified, however, that respondent spoke to him "a few days
before" August 26, and that respondent knew by then that the firm
"was doing work on a takeover of the Pillsbury company." J.A. 128-
129. Respondent obtained the money for his options purchases by
executing a mortgage on his home on August 24, 1988, he issued a
200,000 check to the brokerage firm of Robinson Humphrey on August
29, by drawing on a line of credit secured by the mortgage. V Tr. 168;
VI Tr. 121-122. That evidence indicates that respondent had nonpublic
information about the Pillsbury takeover by August 24 at the latest.

    As to the timing of his orders, respondent relies largely (Resp. Br. 3
n.6) on his testimony to the SEC during its investigation.  The jury
was entitled to discredit those self-serving claims.  Even that
testimony shows only that respondent told the SEC that he thought he

---------------------------------------- Page Break ----------------------------------------

3

    Respondent maintains (Br. 5) that the evidence showed
only that an undisclosed client had retained Dorsey with
respect to a potential takeover of Pillsbury. Respondent
does not argue, however, that he owed no fiduciary duty to
that client (or to Dorsey) solely because he did not know

___________________(footnotes)

authorized one of his brokers, Steuart Evans, to purchase 500 October
40 options on August 25, but that Evans misunderstood the order to be
for 2,000 October 40 options. Moreover, according to respondent's SEC
testimony, he learned about Evans' " misunderstanding" on September
7 but agreed to continue purchasing the options to fill out the order for
the 2,000 options. J.A. 47-49, 53-54 12/21/88 Tr. 158-164, 168-172, 176-
178, 182-183.  That testimony undermines any suggestion that
respondent did not make investment decisions (and purchases) after
August 26.
    Respondent's argument also does not account for another 400 options
purchased through Evans or for 100 options purchased through Patricia
Kinnahan (his Janney Montgomery Scott broker) that are charged in
the indictment. Respondent testified during the SEC investigation
that he placed an order for 500 November options with Evans on
September 18 (after respondent returned from a honeymoon in Europe).
Pursuant to that order, Evans also purchased 100 October 45 options on
September 20. Respondent told the SEC that he canceled the order on
September 22 after learning the preceding day that Dorsey & Whitney
had been involved in the Pillsbury takeover. 12/21/88 Tr. 186-191, 193-
197, 204-206,212-213,219-224, 255-257. Kinnahan testified at trial that
she purchased 100 options charged in the indictment for respondent
based on an order placed on August 19,1988. VII Tr. 108, 112, 163-164.
Kinnahan purchased 50 November (she said October) 45 options on
August 30, 1888, and 50 November 45 options on September 8, 1988.
VII Tr. 108, 112-118. In her June 15, 1989, affidavit to the SEC,
however, Kinnahan stated that respondent authorized those purchases
when she called him on those two dates. Kinnahan later changed her
mind and said, in a second affidavit dated June 24, 1993 (after the
indictment was returned), that respondent placed the orders on August
19,1988. VII Tr. 139-143, 154-158,163. Given the conflicting affidavits
and other testimony, the jury was entitled to disbelieve respondent's
evidence and conclude that he had placed the orders charged in the
indictment when in possession of nonpublic information confirming
Dorsey's representation of a client in a planned takeover of Pillsbury.

---------------------------------------- Page Break ----------------------------------------

4

the client's name. Respondent knew that Dorsey had been
engaged to represent a company in "a takeover of the
Pillsbury company," J.A. 129, and he traded on the basis
of that confidential information.  It is irrelevant that.
Dorsey's formal client files did not reflect the details of
the firm's representation, so that some Dorsey employees
would have been unaware of the firm's representation of a
client in matters related to a takeover of Pillsbury (see
Resp. Br. 1 n.l; J.A. 122). Respondent was aware of that
representation, and he therefore had a fiduciary obligation
to the firm's client not to convert its information to his
own benefit. He also had a similar obligation to his part-
ners.  See generally Restatement (Second) of Agency
431 (1958).
    2. a. In arguing that his conduct did not constitute a
"deceptive device or contrivance" in violation of Section
10(b), respondent does not dispute that conduct like his has
long been held to be fraudulent. Nor does he dispute that
this Court's decision in Carpenter v. United States, 484
U.S. 19, 27-28 (1987), holds that a fiduciary's misappropria-
tion of his principal's confidential business information is
fraudulent. Instead, respondent argues (Br. 17 & n.19)
that his conduct was not deceptive. There is no basis,
however, for respondent's suggestion that "deception],"
as used in the text of Section 10(b), defines a class of acts
narrower than fraud. To the contrary, a course of conduct
that is fraudulent is also deceptive, for the concept of fraud
inherently includes deception. "Deceive is to cause to
believe the false or to mislead. Defraud is to deprive of
some right, interest or property by deceit." United Slates
v. Yermian, 468 U.S. 63, 73 n.12 (1984) (emphasis added).
    To narrow the reach of the words "deceptive device,"
respondent asserts that Section 10(b)'s proscription of
deception is limited to the common law tort of deceit.
Resp. Br. 15-16. Even if that were true, it would not help
respondent. He suggests that the common law tort of

---------------------------------------- Page Break ----------------------------------------

5

deceit requires an express misrepresentation or
nondisclosure, rather than deceptive conduct, and requires
proof of reliance.  Under the Restatement (Second) of
Torts 525, cmt. b (1977), however, " `[m]isrepresentation'
* * * denote[s] not only words spoken or written but also
any other conduct that amounts to an assertion not in
accordance with the truth." Respondent's conduct misled
Dorsey and Grand Met into believing that he was a loyal
employee, and he failed to make required disclosures to his
principals, to their detriment. See pp. 6-7,9, infra.
    In any event, this Court has made clear that "[a]ctions
under Rule 10b-5 are distinct from common-law deceit and
misrepresentation claims, and are in part designed to add
to the protections provided investors by the common law."
Basic Inc. v. Levinson, 485 U.S. 224, 244 n.22 (1988) (cita-
tion omitted); see also Herman & MacLean v. Huddleston,
459 U.S. 375, 388-389 (1983) ("the antifraud provisions of
the securities laws are not coextensive with common-law
doctrines of fraud"); Blue Chip Stamps v. Manor Drug
Stores, 421 U.S. 723,744-745 (1975) ("the typical fact situa-
tion in which the classic tort of misrepresentation and de
ceit evolved was light years away from the world of com-
mercial transactions to which Rule 10b-5 is applicable''). 2.
    Respondent also argues (Br. 19) that the misappropria-
tion theory of liability under Section 10(b) is inconsistent
with Santa Fe Industries v. Green, 430 U.S. 462 (1977),
which holds that a mere breach of fiduciary duty, without
deception, does not violate Section 10(b). Respondent

___________________(footnotes)

    2  See generally Louis Loss & Joel Seligman, Securities Regulation
3429-3430 (3d ed. 1989) ("courts have repeatedly said that the fraud pro-
visions in the SEC Acts * * * are not limited to circumstances that
would give rice to a common law action for deceit") Adam Ingber, 10b-
5 or Not 10b-5?: Are the Current Efforts to Reform Securities
Litigation Misguided?, 61 Fordham L. Rev. S351, S380 n.147 (1993)
(summarizing differences between common law fraud actions and anti-
fraud provisions of federal securities law).

---------------------------------------- Page Break ----------------------------------------

6

suggests that, under the misappropriation theory, even
the Santa Fe defendants would be found to have engaged in
deception by impliedly misrepresenting that they were
acting honestly and in the best interests of the business,
and yet the Court found in that case that there was no
deception. Respondent argues that the Court in Santa Fe
must have rejected the view that an implied misrepre-
sentation in a breach of fiduciary duty is a deceptive de
vice. Resp. Br. 19. Santa Fe, however, is not inconsistent
with the misappropriation theory.
Contrary to respondent's claim (Br. 19), the misappro-
priation theory does not posit that every breach of a fidu-
ciary duty necessarily entails deception. Rather, liability
under the misappropriation theory is premised on the fact
that the particular breach of duty involved in the con-
version of confidential information that has been entrusted
to one for a limited purpose inherently involves deception.
Thus, under well settled principles, before an agent may
use his principal's confidential business information for
his personal benefit, he must make disclosure to the prin-
cipal and obtain the principal's consent; the breach of that
duty thus inherently involves deceptive nondisclosures

    ___________________(footnotes)

    3 The common law rule requiring an agent to make disclosure to his
principal before trading on information belonging to the principal is
well established:

      395 Using or disclosing confidential information

         Unless otherwise agreed, an agent is subject to a duty to the   
         principal not to use or to communicate information confidentially
         given him by the principal or acquired by him during the coarse of
         or on account of his agency or in violation of his duties as an agent,
         in competition with or to the injury of the principal, on his own ac-
         count or on behalf of another, although such information does not
         relate to the transaction in which he is then employed, unless the
         information is a matter of general knowledge.

Restatement (Second) of Agency 395 (1958) (emphasis added). By
requiring that the principal and agent agree to any use of the

---------------------------------------- Page Break ----------------------------------------

7

Trustees have similar obligations to obtain the consent of,
and furnish information to, their beneficiaries, and a
trustee's breach of those obligations rests on nondis-
closure. 4. In this case, therefore, it is respondent's failure
to disclose his personal trading to Grand Met and Dorsey,
in breach of his duty to do so, that makes his conduct
"deceptive" within the meaning of Section 10(b). 5

___________________(footnotes)

principal's information by the agent, the Restatement makes clear that
disclosure to the principal is required. See id. cmt. c ("In obtaining
consent of the principal to use or disclose confidential information, the
agent is under the duty of disclosure stated in Section 390."). See also
id. 5390 (agent, when acting on his own account in a matter in which
the principal is interested, must "disclose to [the principal] all facts
which the agent knows or should know would reasonably affect the
principal's judgment''), cmt. a (''an agent has a duty, not only to make
no misstatements of fact, but also to disclose to the principal all
relevant facts frilly and completely," including ''the fact that the agent
is acting on his own account''); id. 381, cmt. d ("If the agent  * * * is
competing with the principal and using information acquired during his
agency, he is under a duty to the principal to reveal such facts in
accordance with the rules stated in Sections 389-392.").
    4  See Restatement (Second) of Trusts  170(2) (1959) (trustee deal-
ing with beneficiary on his own account must disclose all material
facts), id. cmt. a (trustee may not profit at the expense of, or compete
with, beneficiary, without consent or authorization under the terms of
the trust), id. 173 cmt. d (trustee must disclose material facts that the
beneficiary does not know but needs to know for his protection in
dealing with a third person with respect to his interest).
    5 It is in that sense that here, as in Carpenter, the agent's posing
as a loyal employee constitutes deception. Respondent's pose also went
beyond silence, in breach of his duty to disclose his personal trading.
Reengaged in deception in his conversation with Thomas Tinkham by
feigning an interest in working on the Pillsbury takeover litigation.
Respondent erroneously states (Br. 20) that the record does not show
such feigning, and that the government has not previously made that
contention.  Tinkham testified that he thought that respondent's
request to work for him was unusual because respondent was senior to
him in the firm's hierarchy, J.A. 131, thus implying that respondent
had an ulterior motive. The government argued to the jury that

---------------------------------------- Page Break ----------------------------------------

8

    The particular nature of the duty breached by respon-
dent distinguishes this case from Santa Fe, where the
complaint alleged "a breach by the majority of its fiduciary
duty to deal fairly with the minority" by undervaluing the
minority's stock in a short-form merger. Green v. Santa
Fe Industries, 533 F.2d 1283,1285 (2d Cir. 1976), rev'd, 430
U.S. 462(1977). Deception was not necessary to breach
the duty of fairness there, and there was no suggestion
that the majority had a fiduciary duty to accuse itself of
financial unfairness after having fully disclosed the terms
of the merger.  As the Second Circuit recognized in
O'Neill v. Maytag, 339 F.2d 764,767 (1964),

        [b]etween principal and agent and among corporate
    officers, directors and shareholders, state law has
    created duties which exist independently of the sale of
    stock. While the essence of these duties in some cir-
    cumstances is honest disclosure, * * * [other cases]
    are typical of situations in which deception may be
    immaterial to a breach of duties imposed under com-
    mon law principles.

Santa Fe involved an alleged breach of duty in which
deception was "immaterial." 553 F.2d at 1285. This case,
in contrast, presents a situation in which the "essence" of
the agent's duty requires "honest disclosure." Ibid.
    The jury in this case was instructed accordingly. The
court charged, without objection, that "[u]nless otherwise
agreed, an `agent has a duty to the principal not to use or to
communicate information confidentially obtained by him

___________________(footnotes)

respondent "confirmed[ed] the information he somehow learned [about the
Pillsbury takeover] by approaching Tom Tinkham in his office and
engaging Tom Tinkham in conversation." XI Tr. 74, The government
also argued to the court of appeals that respondent had "feigned an
interest in working on the case," and had "masqueraded as a loyal,
trustworthy partner for the purpose of drawing information out of
Tinkham." Gov't C.A. Br. 8, 49.

---------------------------------------- Page Break ----------------------------------------

9

from the principal." J.A. 197. Respondent breached that
duty by failing to disclose to Dorsey and Grand Met that
he planned to buy Pillsbury securities on confidential
client information and failing to obtain their agreement to
that plan. His use of the information, resulting from that
breach, constituted deception. And, contrary to respon-
dent's claim (Br. 19), his deception lulled his principals
into inaction that worked to their detriment.  Respon-
dent's pose of loyalty deprived Grand Met and Dorsey of
the opportunity to protect Grand Met's exclusive right to
use its confidential business information, thus jeopardiz-
ing interests of both Grand Met and Dorsey. 6.
There is no merit to respondent's claim (Br. 20-21) that
the Section 10(b) convictions cannot stand because the
indictment did not charge him with deception, and because
the jury was not expressly instructed that it had to find
"deception." In fact, the indictment did charge deception. 7

___________________(footnotes)    

    6  Thomas Tinkham testified that, if respondent had disclosed that
he was trading in Pillsbury securities during September, Tinkham
would have considered it to be "a very significant problem for the firm
and an enormous breach of trust." V Tr. 99 (Resp. Br. in Opp. App.
17a). Tinkham explained: "[A]s lawyers representing a client, we
have an obligation not to use information from that client for our own
benefit." V Tr. 100 (Resp. Br. in Opp. App. 17a-18a). Tinkham testified
that had he known about the trading, "I would have been more than a
little upset." Ibid. See also J.A. 102-103 (testimony of Alan Parker
that Cravath, Swaine & Moore, as Grand Met's lawyers, "had a legal
obligation to insure that the information would not fall into the hands
of people who would appropriate it for improper use," and explaining
that leaks or misuse of takeover plans would harm Grand Met by
driving up price of Pillsbury shares).
    7  The indictment expressly charged that respondent "did use and
employ manipulative and deceptive devices and contrivances in connec-
tion with the purchase and sale of securities" (J.A. 16), and did "engage
in acts, practices and courses of business which would and did operate
as a fraud and deceit upon Grand Met and Dorsey and Whitney" (J.A.
17).

---------------------------------------- Page Break ----------------------------------------

10

And the conduct described in the instructions (J.A. 195-
198) and found by the jury-use of a principal's confidential
information without the principal's agreement-is inher-
ently a form of deception, just as under the classical
theory of insider trading, an insider's trading in his cor-
poration's own securities in breach of a duty to disclose or
abstain is inherently deceptive. Cf. Chiarella v. United
States, 445 U.S. 222, 230 (1980).
    b. In contending that his conduct was not "in connec-
tion with" the purchase or sale of a security within the
meaning of Section 10(b), respondent argues that the stat-
ute prohibits only fraud "between parties to a securities
transaction'' (Br. 23), or fraud "on a participant in a secu-
rities transaction" (Br. 24 n.27 (emphasis omitted)). Those
limitations are not found in the statutory language and
conflict with this Court's cases.
    Respondent's assertion (Br. 28) that Section 10(b)
contains a "textual requirement that deception * * *
occur between parties to a securities transaction" cannot
be reconciled with Superintendent of Insurance v. Bank-
ers Life & Casualty Co., 404 U.S. 6 (1971). There, a
corporation's insiders defrauded the corporation by di-
recting it to sell the corporation's Treasury bonds and
then misappropriating the proceeds of the completed sale.
The Court found that fraud to be "in connection with" the
sale of the bonds, even though there was no fraud between
the parties to the transaction, i.e., the buyer of the bonds
committed no misconduct. Id. at 9-10. Nor is there merit
to respondent's "participant" test (see Resp. Br. 24 n.27).
In United States v. Naftalin, 441 U.S. 768 (1979), the
Court held that Section 17(a)(l) of the Securities Act of
1933, 15 U.S.C. 77q(a)(l), which prohibits fraud "in the
offer or sale of securities, " is not limited to fraud perpe-
trated on participants in a securities transaction. The
Court stressed there that the antifraud provisions of the
securities laws are not limited to the protection of inves-

---------------------------------------- Page Break ----------------------------------------

11

tors, but extend to "frauds perpetrated upon either
business or investors." 441 U.S. at 776 (emphasis added). 8.
Bankers Life and Naftalin demonstrate that Congress
used the phrase "in connection with" in its ordinary
meaning, as "related to" or "involving."  Respondent's
fraud was "in connection with" his purchases of Pillsbury
securities because, as in Bankers Life, his trades were a
necessary element of his fraud. The nonpublic information
about the Pillsbury takeover had no value to respondent
personally except as it might enable him to reap windfall
profits in the securities market (or enable someone else to
reap such profits, through illegal tipping). Thus, contrary
to respondent's assertion (Br. 23), his deceptive fiduciary
breach and his purchase of securities were connected, be-
cause the breach was consummated by his purchase of
securities.
    Respondent suggests (Br. 24) that by prohibiting frauds
on the source of information used for securities trading,

___________________(footnotes)

    8 Respondent relies (Br. 25-26) on passages from this Court's
opinions  in Chiarella  v. United States, 445 U.S. 222, 230 (1980), where
the Court stated that liability under Section 10(b) "is premised on a
duty to disclose arising from a relationship of trust and confidence
between parties to a transaction," and Dirks v. SEC, 463 U.S. 646, 663
n.23 (1983), where the Court noted that Section 10(b) prohibits "inten-
tional or willful conduct designed to deceive or defraud investors."
Those passages, however, merely reflect the nature of the facts and
legal claims made in those cases; they were not intended to resolve the
question of liability under Section 10(b) in cases like this one, where
deception is practiced on the source of the material, nonpublic infor-
mation used in securities trading but not on a party on the other side of
the trade. The Court expressly reserved the validity of the mis-
appropriation theory in both cases. See Dirks, 463 U.S. at 665 ("Nor
did Dirks misappropriate or illegally obtain the information.");
Chiarella, 445 U.S. at 236-237. See also Bateman, Eichler, Hill
Richards, Inc. v. Berner, 472 U.S. 299, 313 n.22 (1985) ("We have also
noted that a tippee may be liable if he otherwise `misappropriate[s] or
illegally obtain[s] the information.'") (citing Dirks, 463 U.S. at 665).

---------------------------------------- Page Break ----------------------------------------

12

the misappropriation theory departs from the concern of
the securities laws to protect investors. That is incor-
rect. No less than classical insider trading, trading on
misappropriated information damages capital markets and
diminishes the public's faith in honest securities markets.
As the House Report noted when the Insider Trading and
Securities Fraud Enforcement Act of 1988 (ITSFEA),
Pub. L. No. 100-704,102 Stat. 4788, was enacted, "the small
investor will be-and has been-reluctant to invest in the
market if he feels it is rigged against him." H.R. Rep. No.
910, 100th Cong., 2d Sess. 8 (1988). If investors believed
that the securities markets were characterized by trading
on misappropriated information, and that they could not
look to the securities laws and the SEC for protection
from such overreaching, the liquidity of those markets and
capital formation would suffer. That result would injure
the public interest that the SEC is charged with protect-
ing under Section 10(b).
    c. Respondent also argues (Br. 30-33) that application
of the misappropriation theory raises serious questions of
due process, because, he maintains, the theory provides in-
sufficient guidance as to the conduct that is criminal.
That argument is without merit.
    First, to establish a criminal violation of Section 10(b),
the government must show that a person violated that pro-
vision "willfully." 15 U.S.C. 78ff(a). 9. To act willfully, the
defendant must realize that he is committing a wrongful

___________________(footnotes)    

    9 15 U.S.C. 78ff(a) states in relevant part: "Any person who will-
fully violates any provision of this chapter * * * or any rule or
regulation thereunder the violation of which is made unlawful or the
observance of which is required under the terms of this chapter * * *
shall upon conviction be fined to not more than 1,000,000, or im-
prisoned not more than 10 years, or both * * * ; but no Person shall
be subject to imprisonment under this section for the violation of any
rule or regulation if he proves that he had no knowledge of such rule or
regulation."

---------------------------------------- Page Break ----------------------------------------

13

act. See United States v. Charnay, 537 F.2d 341, 352 (9th
Cir. 1976); United States v. Dixon, 536 F.2d 1388, 1397 (2d
Cir. 1976); United States v. Peltz, 433 F.2d 48, 54-55 (2d
Cir. 1970), cert. denied, 401 U.S. 955 (1971). Because the
government must prove consciousness of wrongdoing, "the
accused cannot be said to suffer from lack of warning or
knowledge that the act which he does is a violation of the
law." Screws v. United States, 325 U.S. 91, 102 (1945) (plu-
rality opinion). "This requirement of the presence of culp-
able intent as a necessary element of the offense does
much to destroy any force in the argument that applica-
tion of the [Act]" in these circumstances would be unfair.
Boyce Motor Lines, Inc. v. United States, 342 U.S. 337,342
(1952); see also Village of Hoffman Estates v. The
Flipside, Hoffman Estates, Inc., 455 U.S. 489, 499, 502
(1982); United States v. United States Gypsum Co., 438
U.S. 422,445 (1978); United States v. Ragen, 314 U.S. 513,
524 (1942).
    Second, the misappropriation theory is not impermissi-
bly indefinite because it involves proof of a breach of a
fiduciary or similar duty of trust and confidence. The
classical insider trading theory requires courts to con-
sider whether the trader was under a fiduciary or similar
duty creating an obligation to disclose or abstain from
trading, and the types of relationships considered in that
context are often comparable to the relationships at issue
in this case. 10.  The misappropriation theory extends only

___________________(footnotes)

    10 As this Court has made clear, the obligation to disclose Or abstain
from trading on material, nonpublic information rests on a legal duty
of trust and confidence, and the courts must consider in each case
whether the defendant charged with illegal trading had a legal duty
not to take unfair advantage of the material, nonpublic information
that he or she possessed, See Chiarella, 445 U.S. at 229. As this Court
has noted, "temporary insiders" such as attorneys, accountants, under-
writers, and consultants may have such a duty not to trade on non-
public information, Dirks, 463 U.S. at 655 n.14, on the basis of courts'

---------------------------------------- Page Break ----------------------------------------

14

to those who breach a recognized duty, based in a
particular relationship and "in accordance with [a]
common-law rule," Chiarella, 445 U.S. at 227, not to dis-
close, nor to use information for their own benefit, without
obtaining consent. See United States v. Chestman, 947
F.2d 551,567-568 (2d Cir. 1991) (opinion of Meskill, J.), cert.
denied, 503 U.S. 1004 (1992). A person who has such a well
established duty has no claim to surprise when its breach,
by trading on material, nonpublic information belonging to
another, supports liability under the federal securities
laws. 11.
    Third, there can be no contention that respondent
lacked adequate notice of the applicability of the mis-
appropriation theory to his trading. "[T]he touchstone is
whether the statute, either standing alone or as

___________________(footnotes)
    
    consideration of their entry into a "special confidential relationship"
with the business, in which they received information solely for a
corporate purpose. Ibid.

    11 A lawyer in respondent's position is particularly poorly situated
to claim surprise. Amici Professor Painter, et al., suggest (Br. 22)
that respondent's conduct did not unequivocally violate the standards
for lawyers drafted by the American Law Institute (ALI). See Amici
Br. 22 (citing Draft Restatement (Third) of the Law Governing
Lawyers  111(1)). In fact, the ALI's draft Restatement in August
1987 made clear that lawyers may not "use or reveal confidential client
information . . . even if arguably incurring no risk to the interests of
the client, if doing so is solely for the lawyer's own enrichment." Re-
statement  112 (Preliminary Draft No. 2 (1987)) (quoted in Ann M.
Hart, The Model Rules Are Close and the Restatement Is Closer,
10 Gee. J. Legal Ethics 192, 196 n.92 (1996)). And in a later draft, the
ALI eliminated the loophole noted by Professor Painter, by stating
that a lawyer is prohibited "from using or disclosing confidential client
information for the lawyer's personal enrichment, regardless of lack of
prejudice to the affected client." Restatement (Third) of the Law
Governing Laywers  112(2), cmt, j (Proposed Final Draft No. 1, Mar.
29, 1996). The confidentiality policy of the Dorsey firm, applicable to
respondent, is to the same-effect. See J.A. 26-31. Cf. Carpenter, 484
U.S. at 322.

---------------------------------------- Page Break ----------------------------------------

15

construed, made it reasonably clear at the relevant time
that the defendant's conduct was criminal." United States
v. Lanier, No. 95-1717 (Mar. 31, 1997), slip op. 7. The mis-
appropriation theory was firmly established at the time of
respondent's trades. See United States v. Newman, 664
F.2d 12 (1981) (upholding misappropriation theory), aff'd
after remand, 722 F.2d 729 (2d Cir.), cert. denied, 464 U.S.
863(1983); H.R. Rep. No. 910, supra, at 11 (noting, during
passage of ITSFEA, that misappropriation doctrine was
already ''well established and widely known").
     d. Finally, there is no merit to the argument of amicus
NACDL (Br. 10-14) that the invalidity of the misappropria-
tion theory is demonstrated either by section 16(b) of the
Securities Exchange Act of 1934, 15 U.S.C. 78p(b), creat-
ing strict liability for short-swing profits by corporate
insiders, or the fact that the SEC did not rely on the mis-
appropriation theory when it barred insider trading in In
re Cady, Roberts & Co., 40 S.E.C. 907 (1961). Section 16(b)
creates liability for nonfraudulent as well as fraudulent
trading, and covers only short-swing trading (purchase
and sale within a six-month period). "Congress' failure to
impose criminal sanctions for nonfraudulent conduct un-
der Section 16(b) does not mean that it intended to immu-
nize insider trading that is fraudulent under Section 10(b)
and Rule 10b-5." United States v. Lang, 766 F. Supp. 389,
402 (D. Md. 1991). And the Commission's articulation of
the "classical theory" rather than the misappropriation
theory in Cady, Roberts reflects the fact that the in-
formation in that case was not converted from its right-
ful owner. See 40 S.E.C. at 917 (noting that corporate in-
sider who gave information to broker "probably assumed,
without thinking about it, that the dividend action was
already a matter of public information").
    3. a. Respondent argues (Br. 33-44) that Rule 14e-3(a)
exceeds the SEC's authority under Section 14(e) because
the Rule does not require that the trading on nonpublic

---------------------------------------- Page Break ----------------------------------------

16

information breach a fiduciary duty. In so arguing, how-
ever, he makes no effort to respond to our point that the
second sentence of Section 14(e) authorizes the SEC to
"prescribe means reasonably designed to prevent fraud,"
which authority "necessarily encompasses the power to
proscribe conduct outside the purview of fraud, be it com-
mon law or SEC-defined fraud."  U.S. Br. 40 (quoting
Chestman, 947 F.2d at 558 (opinion of Meskill, J.)).
    Respondent does suggest (Br. 36) that the Court held in
Schreiber v. Burlington Northern, Inc., 472 U.S. 1 (1985),
that the 1970 Amendments to the Williams Act, which
added the second sentence of Section 14(e), did not expand
the scope of the "fraudulent, deceptive, or manipulative
acts" that are prohibited by Section 14(e). The Court in
Schreiber noted, however, that even though the term
"manipulative" in the first sentence of Section 14(e) in-
cludes only deceptive acts, the second sentence "gives the
[SEC] latitude to regulate nondeceptive activities as a
`reasonably designed' means of preventing manipulative
acts." 472 U.S. 11 at n.11 (emphasis added). Schreiber
therefore recognized that, under the second sentence of
Section 14(e), the SEC has authority to prohibit activity
that would not constitute manipulation or fraud at common
law, and would not be prohibited under the self-operative
proscriptions of the first sentence of Section 14(e). Re-
spondent does not answer our showing that prohibiting a
class of trading in which a breach of duty is likely but
difficult to prove is a "means reasonably designed" to pre-
vent the fraudulent use of confidential information in the
tender offer setting. U.S. Br. 43-44.
    b. Respondent also contends that there was no "'tender
offer" within the meaning of Section 14(e) until Grand Met
formally authorized and announced its bid, and therefore
his trades, which took place before the announcement, did
not violate Section 14(e) because they were not "in
connection with a tender offer" within the meaning of that

---------------------------------------- Page Break ----------------------------------------

17

Section. That argument (which was not addressed by the
court of appeals) cannot be  squared with the purpose of the
Williams Act. Under respondent's construction of Section
14(e), bidders and others could engage in fraudulent and
manipulative practices without liability under the statute
until they announced their offer. If Section 14(e) did not
govern at least some events before the formal tender offer,
"either party would be free to disseminate misinformation
up to the effective date of the tender offer, thus defeating
in substantial part the very purpose of the [Williams] Act
-informed decisionmaking by shareholders." Lewis V.
McGraw, 619 F.2d 192, 195 (2d Cir.), cert. denied, 449 U.S.
951 (1980). The SEC, recognizing that at least some
events before a formal tender offer must be covered to
make Section 14(e) effective, has construed the "in con-
nection with" language to encompass situations where a
bidder has taken "a substantial step or steps to commence
*** a tender offer."  That reading is a reasonable
construction of the statute that is entitled to deference.
Chevron U.S.A. Inc. v. Natural Resources Defense
Council, Inc., 467 U.S. 837 (1984).
    c. Under either of respondent's proffered construc-
tions of Section 14(e)-limiting its reach to breaches of
fiduciary duty, or limiting its temporal scope to actions
taken after the formal commencement of a tender offer-
the SEC would have no authority to prohibit "ware-
housing," the practice by which bidders leak advance
information of a tender offer to allies and encourage them
to purchase the target company's stock before the bid is
announced. Yet the Court noted in Chiarella that at that
time the SEC had proposed Rule 14e-3 to prohibit ware-
housing. The Court recognized that warehousing could be
deleterious to the interest of shareholders in a company
for which a tender offer has been planned but not an-
nounced, since in those situations, "the seller's behavior

---------------------------------------- Page Break ----------------------------------------

18

presumably would be altered if he had the nonpublic infor-
mation." Chiarella, 445 U.S. at 234.
    d. Respondent also argues (Br. 41-44) that Rule 14e-
3(a) is invalid because it criminalizes trading before a
tender offer occurs without providing notice of when a
violation occurs and without requiring scienter. Respon-
dent did not present those arguments to the court of
appeals; nor did he object to the district court's instruc-
tion to the jury that it was not required to find that
respondent knew that the substantial steps had been
taken. In any event, the contention is without merit. A
violation of Rule 14e-3(a) requires proof that the bidder
had taken ''substantial steps'' towards a tender offer. That
standard is no more indefinite than is, for example, the
Rule's other requirement that nonpublic information be
"material," or the Sherman Act's predication of liability
on violations of the "rule of reason." See United States
Gypsum, 438 U.S. at 445. Even such "general statements
of the law are not inherently incapable of giving fair and
clear warning." Lanier, slip op. 12. And since a criminal
violation of Rule 14e-3(a) requires proof of willfulness, i.e.,
conscious wrongdoing (see pp. 12-13, supra), it is unlikely
that the Rule will ever be a "`trap for the unwary,' im-
posing criminal sanctions on `wholly innocent conduct.'"
Yermian, 468 U.S. at 74. Moreover, the jury in this case
found that respondent knew that the information on which
he traded was nonpublic, material, and obtained directly or
indirectly from the tender offeror, and that he acted with
intent to defraud. See J.A. 204 (jury instructions on Rule
14e-3(a)). Under those circumstances, respondent cannot
claim that he was punished for violating the Rule without
scienter.
    4. Finally, respondent argues (Br. 49) the mail fraud
indictment in this case differs from the indictment in
Carpenter v. United States, 484 U.S. 19 (1987), in that the
indictment here describes the overall "scheme to defraud"

---------------------------------------- Page Break ----------------------------------------

19

by alleging fraud "in connection with the purchase and
sale of securities." J.A. 8. Respondent claims that if his
fraud is not "in connection with" his securities trades
within the meaning of Section 10(b), then there can be no
fraud "in connection with" his securities trades for pur-
poses of the mail fraud counts. That claim fails because
the offense of mail fraud does not contain an "in connection
with" element, the jury was not charged that it had to find
that respondent's fraud was "in connection with" his pur-
chase of Pillsbury securities on the mail fraud counts, and
"[a] part of the indictment unnecessary to and independent
of the allegations of the offense proved may normally be
treated as `a useless averment' that `may be ignored.'"
United States v. Miller, 471 U.S. 130, 136 (1985) (quoting
Ford v. United States, 273 U.S. 593,602 (1927)). 12.
    In any event, respondent's argument does not distin-
guish the indictment in Carpenter. The Carpenter indict-
ment first charged that the conspiracy involved "fraud in
the purchase and sale of securities," as well as acts "in
connection with the purchase and sale of securities" that
operated as a fraud (using the language of Rule 10b-5).
Resp. Br. App. 3a,  7-8. It then incorporated those con-
spiracy allegations into the substantive wire fraud counts.
Id. at 15a,  40. There is, therefore, no material difference

___________________(footnotes)

    12 In Miller, the Court, upheld the permissibility of striking super-
fluous allegations from a mail fraud charge. Consistent with that doc-
trine, the trial court here did not charge the jury that it was required
to find, as an element of the mail fraud counts, that the scheme to
defraud was "in connection with" the purchase or sale of securities (or
that respondent violated Section 10(b)). Rather, the court charged that
the jury had to find that respondent had devised a scheme to defraud
Grand Met or Dorsey "out of money, property, or property rights by
purchasing Pillsbury securities while in possession of material
nonpublic information" (J.A. 192). That is a conventional application of
the law of mail fraud under Carpenter, and a reasonable construction of
the indictment.

---------------------------------------- Page Break ----------------------------------------

20

between the indictment in this ease and that in Carpenter,
and the court of appeals' departure from Carpenter cannot
be sustained.    *****

    For the forgoing reasons, and also for the reasons set
forth in our opening brief, the judgment of the court of
appeals should be reversed.

Respectfully submitted.

WALTER DELLINGER
Acting Solicitor General

APRIL 1997