Opinion ID: 1352520
Heading Depth: 1
Heading Rank: 2

Heading: Securities Fraud and Wire Fraud

Text: The defendants challenge their securities fraud and wire fraud convictions on numerous grounds, the most colorable of which are here addressed. The securities fraud counts went to the jury on two alternative theories: first, that the defendants unlawfully traded in various securities on the basis of material confidential information that Royer had misappropriated and then shared with Elgindy for the purpose of securities trading, see United States v. O'Hagan, 521 U.S. 642, 651-52, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997), and, second, a market manipulation theory involving the defendants' orchestration of trading by themselves and the AP site members in order to artificially affect the market prices of various thinly traded securities, see Gurary v. Winehouse, 190 F.3d 37, 44-46 (2d Cir.1999). With regard to the first theory, the defendants argue that even if Royer improperly obtained the law enforcement information here at issue from confidential law enforcement reports, much of the information reflected in those reports was also publicly available and therefore any related trading was not trading on nonpublic confidential information. See SEC v. Mayhew, 121 F.3d 44, 50 (2d Cir.1997). The Government does not dispute that someone who knew where to look could have lawfully discovered some of the information that Royer obtained improperly from nonpublic law enforcement reports, but it argues that, as the district court instructed the jury, the fact that information may be found publicly if one knows where to look does not make the information public for securities trading purposes unless it is readily available, broadly disseminated, or the like. In so concluding, the district court relied on the Supreme Court's decision in United States Department of Justice v. Reporters Committee for Freedom of the Press, 489 U.S. 749, 751, 109 S.Ct. 1468, 103 L.Ed.2d 774 (1989), in which the Court considered whether the disclosure of criminal histories compiled by the FBI could reasonably be expected to constitute an unwarranted invasion of personal privacy within the meaning of the privacy exemption from disclosure under the Freedom of Information Act. In upholding the application of that exemption, the Court distinguished criminal history information that a member of the public could obtain only with difficulty from information that was freely available. The very fact that federal funds have been spent to prepare, index, and maintain these criminal-history files demonstrates that the individual items of information in the summaries would not otherwise be freely available either to the officials who have access to the underlying files or to the general public. Indeed, if the summaries were freely available, there would be no reason to invoke the FOIA to obtain access to the information they contain. Id. at 764, 109 S.Ct. 1468. Although the Supreme Court's interpretation of FOIA is not directly applicable to the issue presented in the instant case, its logic is highly instructive. The law enforcement reports that Royer misappropriated were not themselves public in any practical sense, even if some of the sources from which they were compiled could be accessed by the public. Moreover, the manner in which law enforcement information was combined in the reports was itself nonpublic and helped inform its relevance for trading purposes. See United States v. Winans, 612 F.Supp. 827, 832 (S.D.N.Y. 1985) (although all the information in reporter's published columns was public, the timing, subject and tenor of the misappropriated columns was not public prior to publication), aff'd in relevant part sub nom. United States v. Carpenter, 791 F.2d 1024, 1031-32 (2d Cir.1986), aff'd, 484 U.S. 19, 108 S.Ct. 316, 98 L.Ed.2d 275 (1987). While the trial court's instruction here given might not be universally appropriate, in the factual context of this case it correctly stated the relevant principles the jury needed to apply. [11] Alternatively, defendants argue that their actions cannot be the basis of a securities fraud conviction because they disclosed both the information and its source to the AP site subscribers. However, as the district court correctly instructed the jury, when someone misappropriates material nonpublic information, he is obligated, under the law, either to disclose the information to make it public, or to abstain from trading. When an investor with such information chooses to disclose it, the non-public information remains non-public for purposes of the insider trading laws until it has been disseminated in a manner sufficient to insure its availability to the investing public or to insure that the market has had an opportunity to absorb the disclosed information such that the company's stock price has already adjusted to reflect that information. Tr. at 8839. See Mayhew, 121 F.3d at 50. Elgindy's disclosure of the confidential law enforcement information he obtained from Royer to the AP site subscribers did not accomplish the necessary public dissemination. Finally, defendants also argue that it was error to instruct the jury that it could convict the defendants if the defendants traded while in knowing possession of nonpublic information material to those trades, as opposed to requiring proof that the defendants used such information in making the trades. But we previously resolved this issue in favor of the knowing possession standard in United States v. Teicher, 987 F.2d 112, 119-21 (2d Cir.1993) and while this resolution was arguably dictum, it was the product of sustained and detailed consideration as set forth in the opinion. Nothing that has developed since persuades us of any different resolution. On the contrary, the SEC subsequently enacted Rule 10b5-1, adopting a knowing possession standard, and that determination is itself entitled to deference. See Chevron U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 843-44, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984); Roth ex rel. Beacon Power Corp. v. Perseus L.L.C., 522 F.3d 242, 249 (2d Cir. 2008) (holding that SEC rules are entitled to Chevron deference). We consequently adhere to the knowing possession standard articulated in Teicher. [12] With respect to the Government's alternative theory of liabilitymarket manipulationthe district court instructed the jury as follows: The essential element of manipulation is the deception of investors into believing that prices at which they purchase and sell securities are determined by the natural interplay of supply and demand. [13] Consequently, any conduct that is designed to deceive or defraud investors by controlling or artificially affecting the price of securities is prohibited. Congress intended that Section 10(b) prevent fraud, whether it is a garden variety fraud, or a unique, novel or atypical form of deception. Market manipulation may be accomplished through a variety of means or ways undertaken either alone or in combination. The government alleges that the defendants engaged in a variety of conduct designed to impact artificially the price of stocks, including by making materially false and misleading public statements on the InsideTruth.com website and on the Internet and by coordinating their trading of the stocks of certain companies for the purpose of impacting the price of the stock. I instruct you, however, that group trading by itself without the intent to deceive and defraud is not market manipulation. Similarly, the dissemination of truthful information, negative or not, into the marketplace by itself is not market manipulation. Tr. at 8844-45 (emphases supplied). Defendants argue that this instruction was erroneous because it arguably allowed for conviction without a finding that the defendants disseminated false information to the marketplace. However, the statute here in issue, § 10(b) of the Securities Exchange Act of 1934, simply prohibits the use of any manipulative or deceptive device or contrivance in contravention of SEC rule. 15 U.S.C. § 78j(b). This broad language, on its face, extends to manipulation of all kinds, whether by making false statements or otherwise. Rule 10b-5, in turn, prohibits not only conventional frauds brought about by making materially false or misleading statements, see Chiarella v. United States, 445 U.S. 222, 227-28, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), but also so-called constructive frauds, i.e., other forms of misconduct that have the same practical effect as a conventional fraud. Specifically, the third alternative prong of Rule 10b-5 prohibits any person from engag[ing] in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person. 17 CFR § 240.10b-5(c). As the Supreme Court recently confirmed, [c]onduct itself can be deceptive, and so liability under § 10(b) and Rule 10b-5 does not require a specific oral or written statement. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. ___, 128 S.Ct. 761, 769, 169 L.Ed.2d 627 (2008); see United States v. Finnerty, 533 F.3d 143, 148 (2d Cir.2008). Accordingly, in United States v. Regan, 937 F.2d 823, 829 (2d Cir.1991), we sustained a conviction under Rule 10b-5 of the underwriter of a convertible bond offering who attempted to depress the stock price of the issuer by arranging for artificial short sales to a broker-dealer. Similarly, in Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 792-98 (2d Cir. 1969), we held that Rule 10b-5 was violated when the defendant sought to thwart a tender offer by purchasing the target company's stock on the open market at increasingly higher prices while simultaneously secretly selling the stock in off-market sales. In the present case, the defendants sought to artificially affect the prices of various securities by directing the AP site subscribers to trade and to disclose the negative information at times and in manners orchestrated by the defendants that were dictated not by market forces, but by defendants' desire to manipulate the market for their own benefit. It would be hard to imagine conduct that more squarely meets the ordinary meaning of manipulation. Defendant Elgindy also challenges the legal basis of the two wire fraud counts of which he was convicted. These counts concern Elgindy's practices of trading against his advice to his AP site subscribers and his related practice of front running, i.e., making his own trades before advising the site subscribers to trade in a security and thus guaranteeing himself increased profits. Both of these alleged practices were presented to the jury as violations of the prong of the wire fraud statute that prohibits use of interstate or international wire communications in execution of a scheme to deprive another of the intangible right of honest services. 18 U.S.C. §§ 1343, 1346. Specifically, the Government alleged that Elgindy, by trading against his advice to the AP site subscribers and trading in advance of the trades he directed them to make, cheated his AP site subscribers of the honest services he owed them. Elgindy, however, contends that no such duty was owed. We have explained that the term scheme or artifice to deprive another of the intangible right to honest services in section 1346, when applied to private actors, means a scheme or artifice to use the mails or wires to enable an officer or employee of a private entity (or a person in a relationship that gives rise to a duty of loyalty comparable to that owed by employees to employers) purporting to act for and in the interests of his or her employer (or of the other person to whom the duty of loyalty is owed) secretly to act in his or her or the defendant's own interests instead, accompanied by a material misrepresentation made or omission of information disclosed to the employer or other person. United States v. Rybicki, 354 F.3d 124, 141-42 (2d Cir.2003) (en banc) (footnote omitted). Applying this standard to the facts of this case, we find that Elgindy owed the requisite duty of honest services to the AP site subscribers. Elgindy charged his subscribers fees of $200 to $600 per month; he specifically warranted on his website that he would not front run or trade against advice; and he not only offered investment advice to his subscribers, he specifically directed their trading activities and threatened to remove them from the site if they did not follow his instructions. While an investment advisor does not automatically owe a duty of honest services to those who rely on her advice, in this case Elgindy took numerous affirmative steps to create a relationship in which, for a price, his subscribers agreed to let him, in effect, dictate their trades, secure in his promise that he would not undercut their trades for his own benefit. This was more than enough to create a duty of honest services, which Elgindy then blatantly breached. [14]