Court Opinion

ID: 9480323
Source: CourtListenerOpinion
Date Created: 2023-08-05 07:44:45.157683+00
Date Added: 2024-06-11T17:47:36.853236
License: Public Domain

CARMAN, Judge,
concurring in part and dissenting in part:
I concur with Judge Mahoney as to Parts I, II and III of Judge Miner’s opinion for the court, reversing Chestman’s securities fraud, mail fraud and perjury convictions. As to Part IV, I concur with the result of Judge Mahoney’s opinion reversing Chest-man’s conviction for violations of rule 14e-3.
An examination of rule 14e-3 and 15 U.S.C. § 78n(e) (1988) (“section 14(e)”) leads to the conclusion that there should be no conviction of a crime under rule 14e-3 unless there has been separate substantive proof of fraudulent, deceptive, or manipulative acts. Since the trial court declined to instruct the jury as to the elements of fraud, Chestman’s convictions for violation of rule 14e-3 should be reversed.
The scope of the rule should not be permitted to exceed the powers granted to the SEC by the statute. Cf. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 214, 96 S.Ct. 1375, 1391, 47 L.Ed.2d 668 (1976). It would seem we should first examine the statute, 15 U.S.C. § 78n(e) and then the rule, 17 C.F.R. § 240.14e-3 (1988). Cf. Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 472-73, *8797 S.Ct. 1292, 1300-01, 51 L.Ed.2d 480 (1977).
Section 14(e) by its own terms makes it “unlawful for any person ... to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer_” 15 U.S.C. § 78n(e). Congress delegated authority to the SEC in section 14(e) to promulgate regulations to “define ... such acts and practices as are fraudulent, deceptive, or manipulative” in the context of tender offers. Id. The Supreme Court stated in Schreiber v. Burlington Northern, Inc., that in enacting section 14(e) Congress was concerned with “requiring disclosure more explicitly addressed to the tender offer context than that required by § 10(b) [of the Securities Exchange Act of 1934].” 472 U.S. 1, 11, 105 S.Ct. 2458, 2464, 86 L.Ed.2d 1 (1985).
Rule 14e-3, although it does not use the term, effectively gives insider status to any person, except the tender offeror, exclusively and based upon his possession of nonpublic information which he knows or has reason to know has been acquired directly or indirectly from: (1) the offering person, (2) the issuer of the securities sought or to be sought by such tender offeror, or (3) any officer, director, partner, or employee or any other person acting on behalf of the offering person or such issuer. The rule declares “it shall constitute a fraudulent, deceptive or manipulative act or practice within the meaning of section 14(e) of the Act ” for the insider to trade in such securities unless within a reasonable time prior to any purchase or sale, such information and its source are publicly disclosed by press release or otherwise. 17 C.F.R. § 240.14e-3(a) (emphasis added). This type of provision has been characterized as a “disclose or abstain” rule. Cf. Chiarella v. United States, 445 U.S. 222, 227, 100 S.Ct. 1108, 1114, 63 L.Ed.2d 348 (1980) (construing rule 10b-5, 17 C.F.R. 240.10b-5).
A plain reading of rule 14e-3 could lead to the conclusion that if a defendant were to violate all of the interdictions outlined in rule 14e-3 the defendant could be guilty of a crime even if no fraud, deception or manipulation were separately and substantively proven. Mere possession of the material nonpublic information under the circumstances outlined in rule 14e-3 without proving the elements of fraud would seem to be sufficient to convict.
If that interpretation were to be adopted, I would be obliged to agree with Judge Mahoney that the rule should be held invalid as exceeding the authorization granted to the SEC by Congress. See Note, Rule 14.eS: Invalid in the Criminal Context, 16 Am.J.Crim.L. 367 (1979). At no place is it shown that Congress delegated to the SEC the power to redefine fraud. Congress directed only that the SEC prescribed means reasonably designed to prevent fraudulent, deceptive or manipulative acts and practices by rules and regulations. See 15 U.S.C. § 78n(e).
It appears to me that as an administrative agency, the SEC is entitled to a presumption of regularity in the conduct of its affairs and that it will act properly and according to law in carrying out its statutory mandate. See FCC v. Schreiber, 381 U.S. 279, 296, 85 S.Ct., 1459, 1470, 14 L.Ed.2d 383 (1965). In promulgating rule 14e-3 shortly after the Chiarella decision, the SEC seeking to implement the will of Congress as expressed in section 14(e) can be presumed to have contemplated that the rule would be read to include commonly accepted principles and elements associated with fraud. It is for this reason that I agree with the trial court and Judge Miner that the promulgation of rule 14e-3 was not an invalid exercise of the SEC’s rule-making authority pursuant to section 14(e).
In recognition that rule 10b-5 was the model for rule 14e-3, see Schreiber v. Burlington Northern, Inc., 472 U.S. at 10, 105 S.Ct. at 2463, courts have generally applied the principles developed in the context of rule 10b-5 to violations of rule 14e-3. See, e.g., Connecticut Nat’l Bank v. Fluor Corp., 808 F.2d 957, 961 (2d Cir.1987). I see no reason why this case should be an exception.
As a general matter, fraud requires proof of the elements of scienter, see Dirks v. SEC, 463 U.S. 646, 663 n. 23, 103 S.Ct. *883255, 3261 n. 23, 77 L.Ed.2d 911 (1983) (“Scienter — ‘a mental state embracing intent to deceive, manipulate, or defraud,’ Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193-194, n. 12 [96 S.Ct. 1375, 1381, n. 12, 47 L.Ed.2d 668] (1976) — is an independent element of a Rule 10b-5 violation.”), and breach of a duty. Chiarella, 445 U.S. at 228, 100 S.Ct. at 1114. Fraud in the context of a failure to disclose under the securities laws requires a showing that the accused has violated an affirmative duty to speak. Id. at 235, 100 S.Ct. at 1118 (“When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak.”).
The Court in Chiarella stated “the duty to disclose arises when one party has information 'that the other [party] is entitled to know because of a fiduciary or other similar relation of trust and confidence between them.’ ” Id. at 228, 100 S.Ct. at 1114 (quoting Restatement of Torts (Second) § 551(2)(a) (1976)); see also Dirks, 463 U.S. at 656 n. 15, 103 S.Ct. at 3262 n. 15 (“mere possession of nonpublic material information does not give rise to a duty to disclose or abstain ... ”) (construing rule 10b-5).
Here, the trial judge apparently declined to instruct the jury on all the elements of fraud, explicitly rejecting a request to instruct on scienter. See United States v. Chestman, 704 F.Supp. 451, 459 (S.D.N.Y.1989). Instead, the court instructed merely on the “willfulness” standard embodied in 15 U.S.C. § 78ff (1988). Id.; United States v. Chestman, CR-88-455, Trial Transcript at 903-10 (S.D.N.Y. March 13, 1989). A “willfulness” instruction alone is not sufficient. The failure to instruct on all the elements of fraudulent nondisclosure, including that the defendant possessed a mental state embracing an intent to deceive, manipulate, or defraud, that is, that the defendant knew he had a duty to disclose and intentionally failed to do so, is in my opinion fatal to his conviction.
Lastly, I adopt Judge Mahoney’s view of the proper application of the rule of lenity in this case in favor of Chestman.
Accordingly, I conclude that Chestman’s convictions on all counts must be reversed.