Opinion ID: 202498
Heading Depth: 3
Heading Rank: 1

Heading: The Deceptive Devices

Text: 30 The SEC contends that Mrs. Rocklage engaged in deceptive devices, in connection with a securities transaction, when she tricked her husband into revealing confidential information to her so that she could, and did, assist her brother with the sale of his Cubist stock. We agree and think it helpful to view the devices in terms of deceptive acquisition of information and then deceptive tipping of her brother, both of which were steps in a broader scheme to enable her brother to trade in Cubist securities. The question of whether Mrs. Rocklage's disclosure makes these acts nondeceptive is a different question, which we address later. 31 We start with the second of these actions. Had Mrs. Rocklage never made any disclosure of her intent to tip her brother, there would have been deception in connection with a securities transaction when she did tip her brother, without her husband's consent, to enable her brother to trade in securities. Under O'Hagan, this would have been the case irrespective of the means by which Mrs. Rocklage acquired the information. 6 32 Still putting aside for the moment any consideration of the effects of disclosure, we turn to the other alleged deceptive action—Mrs. Rocklage's acquisition of information. Here more analysis is required. We agree that this acquisition of information was deceptive. The complaint alleges, and we must take as true, that before her husband's initial disclosure about the clinical trial, Mrs. Rocklage did absolutely nothing to correct his mistaken understanding that she would keep the trial results confidential. This was so even though Mrs. Rocklage knew that her husband had this (mis)understanding, and even though she had a preexisting arrangement to disclose certain confidential information to her brother. 33 The defendants argue that this acquisition of information, even if deceptive, was not in connection with a securities transaction. They point to language from O'Hagan discussing the in connection with requirement and explaining that the fiduciary's fraud is consummated, not when the fiduciary gains the confidential information, but when ... he uses the information to purchase or sell securities. O'Hagan, 521 U.S. at 656, 117 S.Ct. 2199. In defendants' view, Mrs. Rocklage's deceptive acquisition of information was simply too far removed from her brother's sale of securities to satisfy § 10(b)'s in connection with requirement. 34 We disagree with defendants' reading of O'Hagan and of the in connection with requirement. We read the quoted sentence in O'Hagan as explaining when a misappropriator's deceptive scheme ends, and not as indicating when it begins. See Webster's 3d New International Dictionary of the English Language Unabridged 490 (Philip Babcock Gove ed., 1993) (defining the verb to consummate as meaning to bring to completion). Next, O'Hagan had no occasion to interpret the in connection with requirement in a case alleging deceptive acquisition of information intended to be used in a securities transaction. The opinion does not discuss whether O'Hagan tricked or deceived his law firm into telling him about the tender offer, and whether while doing so he knew he would use the information for trading. The government's brief to the Supreme Court stated that [t]he record does not indicate how [O'Hagan] first learned about the potential tender offer. See Brief for the United States at 4 n. 1, O'Hagan, 521 U.S. 642, 117 S.Ct. 2199, 138 L.Ed.2d 724 (No. 96-842). There was no claim that O'Hagan had used deception to obtain the information. On those facts, it is no surprise that the Supreme Court based liability only on O'Hagan's act of undisclosed trading itself. See United States v. Falcone, 257 F.3d 226, 233 (2d Cir.2001) (noting that the defendant in O'Hagan legitimately possessed the information and that any misappropriation only occurred when he used that information to trade securities). 35 Since the act of trading was itself deceptive in O'Hagan, the securities transaction and the breach of duty thus coincide[d]. O'Hagan, 521 U.S. at 656, 117 S.Ct. 2199. In this case it is true there was no such exact coincidence. But that disjunction does not mean the deception in obtaining the information was not in connection with the sale of securities. 36 This case differs from O'Hagan in that the SEC squarely alleges that Mrs. Rocklage deceptively obtained information, and that she did so as part of a preexisting scheme to assist her brother in the sale of securities. The question is how that difference is relevant to the in connection with requirement. Indeed, in a case raising somewhat similar concerns the Second Circuit recognized that the Supreme Court in O'Hagan did not purport to set forth the sole combination of factors necessary to establish the requisite connection in all contexts. Falcone, 257 F.3d at 233. 37 The Second Circuit's opinion in Falcone held that O'Hagan did not alter that circuit's long standing rule, stated in United States v. Carpenter, 791 F.2d 1024, 1027 (2d Cir.1986), aff'd by an equally divided court and aff'd by the full court on other grounds, 484 U.S. 19, 108 S.Ct. 316, 98 L.Ed.2d 275 (1987), that the government can satisfy the in connection with requirement when a tipper misappropriates information that his tippees later trade on. The court reasoned that 38 the [defendants'] use of the misappropriated information for the[ir] financial benefit ... and to the financial detriment of those investors with whom [the defendants] traded supports the conclusion that [the defendants'] fraud was in connection with the purchase or sale of securities under section 10(b) and Rule 10b-5. We can deduce reasonably that those who purchased or sold securities without the misappropriated information would not have purchased or sold, at least at the transaction prices [they obtained], had they had the benefit of that information. Certainly the protection of investors is the major purpose of section 10(b) and Rule 10b[-]5. 39 Falcone, 257 F.3d at 230 (quoting Carpenter, 791 F.2d at 1032 (internal citations omitted)) (internal quotation marks omitted). Although neither Carpenter nor Falcone was a case in which the court relied on the tipper specifically engaging in deception in order to acquire information, both stand for the proposition that the in connection with requirement may be satisfied even when the act of misappropriation in breach of a duty (in those cases, tipping), and the act of trading, do not coincide. In our view O'Hagan not only left this untouched, see id. at 233-34, but reinforced it. 40 Indeed, O'Hagan's discussion of the in connection with requirement actually bolsters the SEC's position in this case. O'Hagan discussed a hypothetical in which a person defrauds a bank into giving him a loan and then uses the proceeds to purchase securities. See 521 U.S. at 656-57, 117 S.Ct. 2199. That hypothetical thus dealt with a case of deceptive acquisition, albeit the deceptive acquisition of money. Importantly, the Supreme Court indicated that such deception was not in connection with a securities transaction because the acquired item was money and not information. See id. The wide variety of uses for money made this deceptive acquisition sufficiently detached from a subsequent securities transaction. Id. at 657, 117 S.Ct. 2199. But the information Mrs. Rocklage deceptively obtained and gave her brother did not have that same variety of uses; it was instead the sort of information that misappropriators ordinarily capitalize upon to gain no-risk profits through the purchase or sale of securities. Id. at 656, 117 S.Ct. 2199. Thus her deceptive acquisition of the information is fairly regarded as an act that was part of a broader scheme of deception in connection with the sale of securities. 41 Moreover, we think that Mrs. Rocklage's actions fit within a natural reading of the in connection with requirement. Mrs. Rocklage's preexisting arrangement with her brother can easily be understood as a scheme or practice or course of business, 17 C.F.R. § 240.10b-5(a),(c), whose goal was to enable her brother to trade in Cubist securities at a substantially reduced level of risk. Her deception of her husband was a natural and integral part of this scheme; she induced her husband to reveal material negative information to her about Cubist, knowing full well that in obtaining that information she would enable her brother to execute a securities transaction. She then actively facilitated a securities transaction by tipping her brother, and securities were in fact sold based on her information. These events show that her deceptive acquisition of material inside information was in connection with a securities transaction. 42 Finally, our interpretation finds further support in the investor protection purposes of § 10(b). See SEC v. Zandford, 535 U.S. 813, 819-20, 122 S.Ct. 1899, 153 L.Ed.2d 1 (2002) (interpreting § 10(b)'s in connection with requirement flexibly so as to further the statute's broad investor protection purposes); O'Hagan, 521 U.S. at 658-59, 117 S.Ct. 2199 (same). One of the animating purposes of the statute was to insure honest securities markets and thereby promote investor confidence. O'Hagan, 521 U.S. at 658, 117 S.Ct. 2199. It furthers that purpose if the in connection with requirement reaches schemes in which one party deceptively and intentionally obtains material nonpublic information to enable another to trade with an unfair informational advantage. See id. at 658-59, 117 S.Ct. 2199 (discussing how informational disparities can negatively impact securities markets). 43 2. The Effect of Mrs. Rocklage's Pre-Tip Disclosure of her Intent to Tip her Brother 44 We have determined that the complaint alleges that Mrs. Rocklage engaged in a scheme involving devices that would have been deceptive in the absence of disclosure, and we have concluded that these devices were employed in connection with a securities transaction. We now turn to the heart of defendants' argument: whether Mrs. Rocklage's pre-tip disclosure to her husband, indicating her intent to pass the information to her brother, nonetheless means no claim of deception is stated by virtue of O'Hagan's language about disclosure. 45 The defendants' view is that a pre-tip disclosure to the source of an intention to trade or tip completely eliminates any deception involved in the transaction. They rely on O'Hagan's language that if the fiduciary discloses to the source that he plans to trade on the nonpublic information, there is no `deceptive device' and thus no § 10(b) violation. Id. at 655, 117 S.Ct. 2199. The defendants argue that O'Hagan put no qualifiers on what is meant by disclos[ure] to the source of a plan to trade on nonpublic information, and so the SEC is not free to qualify the concept. 46 The SEC disagrees, arguing that the disclosure referenced in O'Hagan must mean disclosure that is useful to the fiduciary's principal. The SEC draws support from a footnote in O'Hagan which may be read as implying that disclosure enables a source to take remedial action. See id. at 659, 117 S.Ct. 2199 n. 9 (explaining that once a disloyal agent discloses his imminent breach of duty, his principal may seek appropriate equitable relief under state law). As the SEC sees it, disclosure to the source serves a useful purpose when the source of material non-public information reasonably could be expected to, and reasonably could, prevent the unauthorized use of the information for securities trading. 47 Under that standard, the SEC argues, Mrs. Rocklage's disclosure was not a useful one for her source—and in this regard was unlike O'Hagan's hypothetical disclosure. The SEC argues this is so due to both the timing of the events and the marital relationship of the people involved. The timing of Mrs. Rocklage's disclosure that she intended to tip her brother— coming during or right before the New Year's holiday—meant that Mr. Rocklage would have had a great deal of difficulty pursuing remedial action to stop the sale of the securities. In fact, the sale was effectuated immediately at the next opening of the market. Also, the SEC argues it would be unreasonable to expect Mr. Rocklage to have risked marital discord by taking action against his wife; once she made clear she would tell her brother despite her husband's wishes, his interest may have shifted to protecting her against liability. The SEC makes the point that under Massachusetts law Mr. Rocklage was probably unable to pursue legal action against his wife in reaction to her disclosed intention to tip (such as by seeking to enjoin her from tipping). See Mass. Gen. L. ch. 233 § 20 (preventing husbands and wives from testifying about their private conversations). 7 48 In our view this case presents a narrower question. We start by asking about the nature of the various acts in the deceptive scheme before considering the role of and the nature of the disclosure. Unlike this case, O'Hagan was not a case which involved the deceptive acquisition of information. Arguably, the language in O'Hagan can be read to create a safe harbor if there is disclosure to the fiduciary principal of an intention to trade on or tip legitimately acquired information. This is because under O'Hagan's logic such a safe harbor applies, if at all, when the alleged deception is in the undisclosed trading or tipping of information. In those cases, disclosure of the intent to trade arguably will eliminate the sole source of deception. But a case of deceptive acquisition of information followed by deceptive tipping and trading is different. It makes little sense to assume that disclosure of an intention to tip using deceptively acquired information would necessarily negate the original deception. 49 Indeed, by framing the issues this way, we see a second important distinction between O'Hagan and the case at bar. O'Hagan was a case in which only one deceptive device was alleged: undisclosed trading on confidential information. In this case the SEC's complaint is fairly read as alleging sequential acts that could each constitute deceptive devices: (1) the acquisition of material non-public information through the deception of Mrs. Rocklage's husband, and (2) Mrs. Rocklage's use of this information to tip off her brother without her husband's consent, followed by the tippees' use of the information to trade. Perhaps, under O'Hagan, Mrs. Rocklage's disclosure made the second of these devices non-deceptive. But then the proper question becomes whether disclosure that negates deception as to one set of actions in a scheme necessarily renders all prior deceptive acts non-deceptive. 50 While that question was not directly addressed in O'Hagan, the opinion does offer helpful clues. In a passage that leads to a third distinction between O'Hagan and the fact pattern here, the Court in O'Hagan seemed to contemplate that any liability-avoiding disclosure would come before the defendant engaged in the deceptive activity. See O'Hagan, 521 U.S. at 655, 117 S.Ct. 2199 (explaining that there would be no liability if the fiduciary discloses to the source that he plans to trade on the nonpublic information) (emphasis added). There is no indication that O'Hagan meant to change the earlier understood view of § 10(b), albeit one articulated outside the insider trading context, that a disclosure is not effective if it comes after the positions of the parties have changed in reliance on an earlier deceptive statement. 5C Jacobs, Disclosure and Remedies Under the Securities Laws, § 12:110, at 12-502.7 (2006) (citing In re Commonwealth Oil/Tesoro Petroleum Corp. Sec. Litig., 467 F.Supp. 227, 246-47 (W.D.Tex.1979)). Indeed, in a non-insider trading § 10(b) case, this court has sustained liability in the face of post-transaction disclosures; the after-the-fact disclosures did not cure the fact that the key information was originally withheld. See Holmes v. Bateson, 583 F.2d 542, 559 (1st Cir.1978). On the facts of this case, we are unwilling to say that O'Hagan requires us to conclude that Mrs. Rocklage's post-acquisition disclosure of her intention to tip somehow rendered her acquisition of information non-deceptive. 51 Our analysis is bolstered by the Supreme Court's explanation that the misappropriator defrauds the principal of the exclusive use of [his] information. O'Hagan, 521 U.S. at 652, 117 S.Ct. 2199 (emphasis added). Mr. Rocklage was deprived of the exclusive use of the information, before his wife stated her intention to tip, through Mrs. Rocklage's deceptive acquisition. Her later disclosure did nothing to change this. 52 Once the various distinctions between this case and O'Hagan are understood, defendants' position is really that because some of Mrs. Rocklage's actions may have been non-deceptive, her scheme as a whole had no deceptive elements. We do not believe that O'Hagan requires such an understanding of § 10(b), and we in fact conclude that O'Hagan rejects such an understanding. 53 In related areas of the law, it is well accepted that a scheme can be deceptive or fraudulent even if not all parts of the scheme are deceptive or fraudulent. The Supreme Court's decision in Carpenter, discussing the mail and wire fraud statutes, is especially instructive. O'Hagan cited with apparent approval the government's argument that Carpenter's discussion of fraud was a particularly apt source of guidance . . . because [the mail fraud statute] (like section 10(b)) has long been held to require deception. 521 U.S. at 654, 117 S.Ct. 2199 (alteration in original) (quoting Brief for the United States, supra, at 18 n. 9) (internal quotation marks omitted); see also id. (describing Carpenter as addressing a fraud of the same species as the fraud that the misappropriation theory targets); 2 Welling et al., Federal Criminal Law and Related Actions § 17.5, at 8 (1998) (recognizing the central role of deception in the mail and wire fraud statutes at issue in Carpenter ). 54 The scheme in Carpenter was fraudulent insofar as the defendants were misappropriating articles from the Wall Street Journal in advance of publication. See 484 U.S. at 25-28, 108 S.Ct. 316. They did so in order to trade in stocks the articles covered, with the understanding that the Journal's future coverage would affect stock prices. In sustaining the defendants' convictions for mail and wire fraud, the unanimous Court noted that it was sufficient that the Journal itself, in its final published form, was ultimately distributed to customers via the wires and the mail. Id. at 28, 108 S.Ct. 316. Importantly, the Court deemed distribution of the articles to Journal customers to be an essential part of the scheme. Id. There was no suggestion in that case, nor could there be, that the distribution of the Journal to its regular customers was somehow fraudulent. Yet the defendants' actions as a whole still comprised a scheme or artifice to defraud, see 18 U.S.C. §§ 1341, 1343, and so the Court sustained their convictions under the mail and wire fraud statutes. See id. at 25, 108 S.Ct. 316; see also Schmuck v. United States, 489 U.S. 705, 714-15, 109 S.Ct. 1443, 103 L.Ed.2d 734 (1989) (holding that innocent and nonfraudulent mailings can support a conviction under the mail fraud statute if they are part of a scheme that has a fraudulent element); cf. Carpenter, 791 F.2d at 1027-34 (finding, under a misappropriation theory, that the Carpenter events constituted a deceptive scheme for § 10(b) purposes), aff'd by an equally divided court, 484 U.S. at 24, 108 S.Ct. 316. 55 In light of her disclosure to her husband, Mrs. Rocklage's mechanism for distributing the information to her brother may or may not have been rendered non-deceptive by her stated intention to tip. But because of the way in which Mrs. Rocklage first acquired this information, her overall scheme was still deceptive: it had as part of it at least one deceptive device. Thus as a matter of the facts alleged in the complaint, and taking all facts and inferences in favor of the plaintiff, a § 10(b) claim is stated. 56 Contrary to the parties' arguments, we decline to articulate a broad, generalized test for exactly when disclosure will negate deception under a § 10(b) misappropriation theory. That is deliberate. The import and reach of the Supreme Court's language in O'Hagan about disclosure as a cure for deception has created uncertainty in the courts and has provoked a great deal of academic commentary. 8 Until the Supreme Court has clarified its language about disclosure, this uncertainty is an important factor in why we are unwilling to state generalized rules. Our task is to decide cases on an individual basis, and it suffices for us to say that on the facts asserted in the complaint, the SEC has stated a claim. Given the variety of types of deception and types of disclosure, caution is warranted until the complexity and variety of problems are understood. Furthermore, the SEC may wish to address this issue through the regulatory process. 57 We acknowledge that defendants' argument is both strong and very well presented. In the end, only the Supreme Court, Congress, or the SEC can bring the needed clarity to these questions.