Opinion ID: 201377
Heading Depth: 3
Heading Rank: 4

Heading: Instruction on Scienter

Text: 62 Happ also contends that the district court improperly injected a negligence standard into its instruction on the scienter element. The court instructed the jury that an element of the Section 10(b) claim was that the defendant engaged in an act, practice, or course of business that operated, or, by an ordinarily prudent person in his position at the time he acted, would be expected to operate as a fraud or deceit upon some person. This appears to be an attempt to restate one type of act which Rule 10b-5 makes unlawful. See 17 C.F.R. § 240.10b-5 (It shall be unlawful for any person ... (c) [t]o engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.). Although this instruction, standing alone, could be said to inject an incorrect negligence standard, the district court plainly instructed the jury that it must find intentional or knowing conduct in order to find the requisite scienter. The jury's special finding that Happ acted with intent and with knowledge further demonstrates that there was no prejudice. 3. Monetary Awards Against the Defendant A. Disgorgement Amount 63 Happ challenges the district court's so-called disgorgement order. He argues that the sum awarded was inappropriately based on the loss avoided, i.e., the difference between the value of his Galileo stock when sold on June 29, 1998 ($46,758), and the value of the same number of shares on July 24, 1998, the day after Galileo's July 23 press release ($12,000). Happ contends that the most he should be required to disgorge, if anything, is the profit on the sale of his Galileo stock, i.e., the difference between his proceeds on June 29, 1998 and his cost basis for the shares ($14,508.42). 64 The district court's disgorgement order is reviewed for abuse of discretion. SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1475 (2d Cir.1996). In an insider trading case, the proper amount of disgorgement is generally the difference between the value of the shares when the insider sold them while in possession of the material, nonpublic information, and their market value a reasonable time after public dissemination of the inside information. SEC v. MacDonald, 699 F.2d 47, 54-55 (1st Cir.1983); see also SEC v. Patel, 61 F.3d 137, 139 (2d Cir.1995); SEC v. Shapiro, 494 F.2d 1301, 1309 (2d Cir.1974). The amount of disgorgement need only be a reasonable approximation of profits causally connected to the violation. SEC v. First City Fin. Corp., 890 F.2d 1215, 1231 (D.C.Cir.1989). The risk of uncertainty in calculating disgorgement should fall on the wrongdoer whose illegal conduct created that uncertainty. Id. at 1232; Patel, 61 F.3d at 140; see also MacDonald, 699 F.2d at 55 (doubts are to be resolved against the defrauding party). Once the SEC shows that the disgorgement is a reasonable approximation, the burden shifts to the defendant to demonstrate that the amount of disgorgement is not a reasonable approximation. First City Fin., 890 F.2d at 1232. 65 Happ contends that the amount of disgorgement ordered was not causally connected to the violation because he did not know the information contained in the July 23 press release when he sold his stock on June 29. The SEC argues that the fact that Happ did not possess the exact information in the July 23 statement does not detract from the fact that he received information that Galileo was having difficulties in the third quarter. 66 The disgorgement order in the amount of the loss avoided was not an abuse of the district court's discretion. Although the SEC bears the ultimate burden of persuasion that a disgorgement figure is a reasonable approximation of the amount of unjust enrichment, id., the SEC's showing of the stock price drop after Galileo publicly disclosed its third quarter difficulties on July 23 presumptively satisfied that burden. The stock price drop occurred after the release of the July press release, which informed the public both that Galileo had experienced difficulties during the third quarter and indicated the nature of some of those difficulties. Among other things, the press release contained information about the Imagyn receivable, the unsuccessful attempt to negotiate a marketing relationship with Ethicon, decreased orders, continued difficulty in obtaining export licenses due to the jurisdictional dispute, a reorganization and a reduction in force that would lead to substantial fourth quarter charges, and a violation of Galileo's bank loan covenants. The loss in Galileo's profits was causally connected to those difficulties. Although the information Happ had earlier received did not disclose the actual nature of Galileo's difficulties, Happ's impropriety nonetheless consisted of selling his shares upon learning of the as yet unspecified difficulties. It is not unreasonable to hold Happ accountable for the drop in value attributable to those same difficulties when fully revealed. 67 Once the burden shifted to Happ, he failed to show that the amount of loss avoided was not a reasonable approximation. Happ failed to demonstrate, for example, any clear break in or considerable attenuation of the causal connection between the illegality and the ultimate profits. Id. Happ offers an alternative calculation, based on his actual profits, but offers no causal link between his cost basis and the losses he avoided through insider trading. As the wrongdoer, Happ must bear the risk of uncertainty in calculating the amount of disgorgement. See id.; Patel, 61 F.3d at 140. We find no error. B. Additional Civil Penalty 68 The Insider Trading and Securities Fraud Enforcement Act (ITSFEA) authorizes courts to impose a penalty of up to three times the profit gained or loss avoided as a result of the insider trading. 15 U.S.C. § 78u-1(a)(2). ITSFEA civil penalties were enacted to enhance deterrence against insider trading, and where deterrence fails, to augment the current methods of detection and punishment of this behavior. H.R.Rep. No. 100-910, at 7 (1988), reprinted in 1988 U.S.C.C.A.N. 6043, 6044. We review an order imposing a civil penalty for abuse of discretion. SEC v. Sargent, 329 F.3d 34, 38 (1st Cir.2003). A court may consider several factors in evaluating whether or not to assess civil penalties, such as: 69 (1) the egregiousness of the violations; (2) the isolated or repeated nature of the violations; (3) the defendant's financial worth; (4) whether the defendant concealed his trading; (5) what other penalties arise as the result of the defendant's conduct; and (6) whether the defendant is employed in the securities industry. 70 Id. at 42. The district court found that factors 1, 2, 4, and 6 favor Happ while factors 3 and 5 favor the imposition of a civil penalty. Happ, 295 F.Supp.2d at 200. The court found the factors decidedly mixed and exercised its discretion to impose a penalty equal to the loss avoided, or $34,758, in order to effectuate the Congressional intent to punish those who violate securities law. Id. Happ does not appear to challenge the court's findings as he raises no arguments concerning factors 3 and 5. Instead, he simply argues that a penalty was not appropriate here. We are satisfied that the court acted within its discretion to impose a civil penalty on Happ, not only to punish him but to serve as a deterrent on insider trading generally. 4. Sanctions Against the SEC 71 During discovery, Happ served requests for admission, which asked the SEC, inter alia, to admit that Hanley did not make a telephone call from Galileo's offices in Sturbridge, Massachusetts to Happ's residence in Weston, Massachusetts, telephone number 781-899-8081, on June 25, 1998. On November 7, 2002, the SEC denied the request based on Hanley's testimony that he made the call from his office. Happ claimed that Galileo's AT & T billing records, which did not show a call on June 25, 1998 to Happ, established that no call was made from Hanley's office to Happ that day. In order to prove that the call did not take place from Hanley's office, Happ deposed AT & T, deposed Bell Atlantic (Galileo's other telephone service provider during June 1998), deposed Galileo's facilities manager who was responsible for tracking telephone bills, and retained an expert concerning business telephone systems and telephone service provider facilities and records. On September 11, 2003, three weeks before trial, the parties stipulated to the authenticity and accuracy of the phone records, but not to their completeness. It was not until Happ was about to call the first of two witnesses, including one expert witness, to establish that the telephone records were complete, that the SEC agreed to stipulate that the telephone records did not reflect a call from Galileo to Happ on June 25, 1998 and that [t]he call did not take place from Mr. Hanley's office on the 25th of June or on the 22nd, the 23rd, or the 24th. 72 In its judgment, the district court imposed sanctions on the SEC in the amount of $87,036 for its refusal to stipulate until mid-trial that the June 25 call did not take place from Hanley's office to Happ's home. Happ, 295 F.Supp.2d at 192-94. The court specifically rejected the SEC's contentions that, in declining to stipulate earlier, it had both reasonable grounds to believe it might prevail on the matter and that the admission sought by Happ was of no substantial importance. See Fed.R.Civ.P. 37(c)(2)(B) and (C), infra. While the SEC now contends on appeal that the court was wrong on both counts and should have awarded no sanction, the SEC does not now question the actual amount of the sanction, which was based on Happ's attorneys' evidence of additional counsel fees and costs related to preparations to prove that the call in question was not made from Hanley's office. Fed.R.Civ.P. 37(c)(2) provides: 73 If a party fails to admit ... the truth of any matter as requested under Rule 36, and if the party requesting the admissions thereafter proves ... the truth of the matter, the requesting party may apply to the court for an order requiring the other party to pay the reasonable expenses incurred in making that proof, including reasonable attorney's fees. 74 The rule requires an award of expenses unless the court finds that: 75 (A) the request was held objectionable pursuant to Rule 36(a), or (B) the admission sought was of no substantial importance, or (C) the party failing to admit had reasonable ground to believe that the party might prevail on the matter, or (D) there was other good reason for the failure to admit. 76 Fed.R.Civ.P. 37(c)(2). We review for abuse of discretion an award of Rule 37(c) sanctions. Marchand v. Mercy Med. Ctr., 22 F.3d 933, 936 (9th Cir.1994). We will not reverse a Rule 37(c) award of sanctions unless we have a definite and firm conviction that the district court committed a clear error of judgment. Id. In contending that the district court abused its discretion in awarding sanctions, the SEC argues that Hanley's testimony gave it reasonable ground to believe [it] might prevail on the matter. Fed.R.Civ.P. 37(c)(2)(C). [T]he true test under Rule 37(c) is not whether a party prevailed at trial but whether he acted reasonably in believing that he might prevail. Fed.R.Civ.P. 37 Advisory Committee Notes, 1970 Amendment. Here, the SEC eventually stipulated that the call did not take place from Hanley's office on the 25th or on earlier dates but argues that prior to that time it entertained reasonable doubts on the outcome of the issue. 77 Whether the district court's ruling was the right one is perhaps a close question, but we are not called on to engage in de novo review but only to say whether the court abused its discretion. See Marchand, 22 F.3d at 936. Favoring the court's ruling is the fact that Hanley's deposition testimony prior to trial concerning the June 25 voicemail was somewhat equivocal. He testified in his deposition merely that he believe[d] he called Happ from his office on June 25. Later at trial, he testified only that his best memory was that he called Happ from his office on June 25. He said he remembered making the call that day because he met with Reidel that day and because his office desk ledger for that date contains Happ's name and phone number (consistent with his habit of writing down a phone number and then calling the number). The telephone company's records were, however, unequivocal in their failure to show a call from Hanley's office to Happ's phone number on June 25. There was nothing whatever to suggest the telephone records were less than accurate or were incomplete. By mid-trial the government tossed in the sponge. The district court concluded that the government should have seen the handwriting on the wall sooner. The court thought it unreasonable for the SEC to have believed that the jury would credit Hanley's equivocal testimony over the objective telephone records. See Happ, 295 F.Supp.2d at 193. 78 While, as noted, we find the point close, we cannot say the district court abused its discretion in rejecting the SEC's argument that Hanley's testimony provided it with reasonable grounds until well into the trial to believe it might prevail on the matter. The SEC eventually stipulated that the call was not made from Hanley's office. It could have done so at some point earlier, saving time and money for its opponent and enabling both parties to focus on the many real disputes in the case. See Marchand, 22 F.3d at 937 (affirming sanctions where misleading answers to requests for admission significantly affected the cost of [plaintiff's] prosecution and contravened the goal of full discovery). Moreover, the stipulation Happ had requested and that was eventually granted was a narrow one — that a call had not been made to Happ from Hanley's office, not whether Hanley might have called Happ on June 25 or on the earlier dates from somewhere else. 79 The SEC also argues that sanctions were inappropriate because the admission sought was not of substantial importance. An issue is of substantial importance when it is material to the disposition of the case. See, e.g., Wash. State Dep't of Transp. v. Wash. Natural Gas Co., Pacificorp, 59 F.3d 793, 806 (9th Cir.1995) (holding that request that plaintiff admit that pollutants posed an immediate risk was of no substantial importance because plaintiff was not required to make such a showing). We think the district court was entitled to believe that it would be of substantial importance for Happ to be able to show that the call was not made on that date from Galileo's office as Hanley himself testified. Such a showing could cast doubt on whether the call was made at all, and it could possibly have affected the jury's view of the credibility of the SEC's key witness, Hanley. 80 We conclude the district court did not abuse its discretion in ordering the SEC to pay Happ the costs incurred in preparing to prove this fact at trial.