Appeal from a conviction, after a jury trial, in the United States District Court for the Southern District of New York, Richard Owen, District Judge, for willfully misusing material nonpublic information in connection with the purchase and sale of securities, in violation of §§ 10(b) and 32(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78ff(a), and Rule 10b-5. Affirmed.
Before Kaufman, Chief Judge, and Smith and Meskill, Circuit Judges.
The draftsmen of our nation's securities laws, rejecting the philosophy of Caveat emptor, Created a system providing equal access to the information necessary for reasoned and intelligent investment decisions. It is apodictic that betting on a "sure thing" is anathema to the ideal of "fair and honest markets" established as the foundation of this statutory edifice.*fn1 The present case requires us to apply these principles in the context of a criminal prosecution for trading on advance knowledge of stock market events. Vincent Chiarella used confidential information obtained through his job in a financial printing house to anticipate impending tender offers. He bought cheap and, soon after, sold dear. For these activities, he stands convicted of willfully violating § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. On appeal, he contends that his operations, however nefarious, do not fit the statutory definition of criminal conduct and, moreover, that the trial judge erred in instructing the jury on the crucial issue of intent. He also challenges numerous other aspects of Judge Owen's charge and a host of his rulings on evidentiary matters. We affirm.
Hostile tender offers are the high drama of Wall Street, but they have their tedious aspects. Chief among the latter is the vast amount of paper they generate even before the offer is made. Offering and transmittal letters, newspaper announcements, and disclosure statements to be filed in Washington must be prepared before the offeror may invite tenders. These documents are produced by the specialized printing firms that cluster around our centers of finance.
Appellant was a "markup man" in the composing room of one such establishment, Pandick Press. Located in downtown Manhattan, Pandick was readily accessible to law firms and banking houses. When copy from a customer arrived in the shop, it went first to Chiarella. He selected type fonts and page layouts and then passed the manuscript on to be set into type.
Between September 1975 and November 1976, in addition to preparing more mundane documents such as annual reports and proxy statements, Chiarella handled the raw material for five separate takeover bids.*fn2 To preserve confidentiality for as long as possible and, most particularly, to avoid an anticipatory rise in the market price of the target company's stock should news of the impending tender offer become public the type was initially set with certain vital information absent or in code. Thus, when Emhart Corp. sought to purchase control of USM Corp., the documents originally delivered to Pandick read "Arabia Corp." and "USA Corp." Not until the final press run on the night before release were the true names inserted.
The lawyers and investment bankers who coded the documents, however, reckoned without Chiarella. Appellant was not merely an ordinary printer, but a knowledgeable stock trader who spoke with his broker as often as ten or fifteen times a day. In each of the five cases, he was able to deduce the name of the target company from other information in the documents price histories, par values, and the number of letters in the mock corporate names. Then, disregarding notices posted throughout Pandick that use of customer information for personal gain was both illegal and against company rules, he would call his broker and buy shares of the target's stock.
Of course, when each tender offer was publicly announced, the market price of Chiarella's recently purchased shares increased sharply. Chiarella quickly sold out and turned a handsome profit. In the Emhart tender offer, for example, Emhart's lawyers brought the first set of documents to Pandick on September 3, 1975. By September 5, Chiarella had concluded that "Arabia" was Emhart and "USA" was USM. On that day, he bought 200 shares of USM common stock for his own account and 100 shares for his father's. On September 9, after the tender offer was announced, he sold all the stock at a profit of $1019.11. Over the five takeover bids covered by the indictment, Chiarella netted more than $30,000.*fn3
Unfortunately for Chiarella, this "sure bet" did not last forever. In early 1977, the SEC initiated an investigation into Chiarella's activities. In May, he agreed in a consent decree to disgorge his profits to those who had sold him target stock*fn4 and, the same day, was discharged by Pandick. Finally, on January 4, 1978, he was indicted on seventeen counts of willful misuse of material*fn5 nonpublic information in connection with the purchase and sale of securities, purportedly in violation of § 10(b) and Rule 10b-5.*fn6 After moving unsuccessfully to dismiss the indictment on the ground that it did not charge a crime, he was convicted by the jury on every count.*fn7 This appeal followed.
Chiarella admits to the activities outlined above. He recognizes, moreover, that since SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (En banc ), Cert. denied, 394 U.S. 976, 89 S. Ct. 1454, 22 L. Ed. 2d 756 (1969), it has been black letter law that
anyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed. Id. at 848.
But because he was not an insider of the target corporations, he argues, he did not owe a fiduciary duty to target shareholders who sold before the tender offer was announced. Thus, he claims, he was not subject to the "disclose or abstain" rule of Texas Gulf Sulphur, and, consequently, the indictment fails to charge a violation of Rule 10b-5. We disagree.
That appellant was not an insider of the companies whose securities he traded is true, but irrelevant. A financial printer such as Chiarella is as inside the market itself as one could be.
In practical terms, the services of a financial printing firm are a prerequisite for the successful execution of a tender offer. These auxiliaries of the securities industry are a central, though generally unheralded, cog in the vital machinery for disseminating information to investors. From his vantage point in the composing room of Pandick Press, Chiarella had access on a regular basis to the most confidential information in the world of finance. Five times in less than fifteen months he obtained knowledge of facts that, when released, would have an immediate and dramatic effect "on the Street."
For the securities markets to function properly, it is essential that those who occupy such strategic places in the market mechanism be forbidden to reap personal gains from information received by virtue of their position. Indeed, Rule 10b-5 prohibits Corporate insiders from trading on nonpublic Corporate information only because their ready access to the intimate details of their companies' problems and prospects gives them an unfair advantage over persons with whom they deal. See, e. g., Texas Gulf Sulphur, supra, 401 F.2d at 848 ("(T)he Rule is based in policy on the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information."); Speed v. Transamerica Corp., 99 F. Supp. 808, 829 (D.Del.1951); Fleischer, Mundheim & Murphy, An Initial Inquiry into the Responsibility to Disclose Market Information, 121 U.Pa.L.Rev. 798, 818 (1973). Yet even the most unscrupulous officer or director could scarcely have a greater opportunity to reap sure profits than market insider Chiarella had by virtue of the market information at his disposal.*fn8 Accordingly, we believe that the principle underlying Texas Gulf Sulphur is not so narrow as Chiarella contends. In enacting the securities laws, Congress did not limit itself to protecting shareholders from the peculations of their officers and directors. A major purpose of the antifraud provisions was to "protect the integrity of the marketplace in which securities are traded." United States v. Brown, 555 F.2d 336, 339 (2d Cir. 1977). Anyone corporate insider or not who regularly receives material nonpublic information may not use that information to trade in securities without incurring an affirmative duty to disclose. And if he cannot disclose,*fn9 he must abstain from buying or selling.
The American Law Institute's Federal Securities Code Has suggested a category of "quasi-insiders" that bears a strong resemblance to the concept of market insider developed above. See id. § 1603, comment 3(d), at 538-39 (Proposed Official Draft 1978). In rejecting a Per se disclose-or-abstain rule for quasi-insiders, the ALI appeared primarily concerned with defining the scope of the category. Id. It therefore chose not to include these individuals in the "insider trading" section of the Code (s 1603). But the Institute specifically indicated that "egregious" cases would fall under the proscription of § 1602, its recodification of Rule 10b-5. Code, supra, at 539. Compare Fleischer, Mundheim & Murphy, Supra, 121 U.Pa.L.Rev. at 819-24. A test of "regular access to market information" appears to us to provide a workable rule. There should be no greater difficulty in resolving close cases than is inherent in determining who is a "corporate insider" under Texas Gulf Sulphur. See Code, supra, § 1603, comment 3(e), at 540. In any event, we believe Chiarella's conduct was sufficiently egregious to fit the most restrictive definition of a quasi-insider who would be barred from trading by the general provisions of § 1602.
A duty to disclose arising out of regular access to market information is not a stranger to the world of 10b-5. In Affiliated Ute Citizens v. United States, 406 U.S. 128, 92 S. Ct. 1456, 31 L. Ed. 2d 741 (1972), the First Security Bank of Utah acted as transfer agent for shares of the Ute Development Corporation, which was created by the federal government to hold assets for a group of mixed-blood Ute Indians. There were effectively two separate markets for the shares a primary market consisting of Indians selling to whites through the Bank, and a resale market consisting entirely of whites. The price per share was significantly higher in the resale market, but the Indians did not know of the existence of the resale market nor, of course, of the price differential. Gale and Haslem, two employees of the Bank, bought from Indians and sold to whites, thereby realizing substantial profits. The Supreme Court held that the employees' position at the center of the two markets gave rise to a Rule 10b-5 affirmative duty to disclose. 406 U.S. at 153, 92 S. Ct. 1456, 31 L. Ed. 2d 741.*fn10
We are not to be understood as holding that no one may trade on nonpublic market information without incurring a duty to disclose. Indeed, as Chiarella has persistently reminded us, a would-be tender offeror may purchase up to 5% Of the stock of its prospective target without making any disclosure at all. General Time Corp. v. Talley Industries, Inc., 403 F.2d 159, 164 (2d Cir. 1968), Cert. denied, 393 U.S. 1026, 89 S. Ct. 631, 21 L. Ed. 2d 570 (1969); See 15 U.S.C. § 78m(d); Kennecott Copper Corp. v. Curtiss-Wright Corp., 584 F.2d 1195, 1205-1207 (2d Cir. 1978). Because offerors may trade, and because he obtained his information from them, appellant would have us conclude that he, too, could purchase target stock before the tender offer is announced, subject only to the 5% Limitation of the Williams Act, 15 U.S.C. §§ 78m(d), 78n(d). But the offerors and Chiarella occupy entirely different positions with respect to trading on news of an impending tender offer.
It is clear, at the outset, that an offeror is not a "market insider" as this term has been defined above. It does not regularly receive nonpublic information concerning any stock but its own.*fn11 Indeed, with respect to tender offers, it does not receive information but creates it.
Moreover, in making a tender offer at a premium above the pre-offer market price, the offeror is undertaking a substantial economic risk that his tempting target will prove to be a "white elephant." Although it knows that the price of the target stock will rise when the takeover bid is announced, the offeror has no alchemic power to transform this knowledge into a certain profit. The only reason it can be confident that its purchases will soon appreciate in value is that it will soon place a much greater sum of money at risk. When the price goes up, the offeror will be Buying, not selling.
The offeror's pre-offer market purchases thus represent its willingness to back its judgment that target stock is undervalued by the market. This course of action is entirely consistent with the principles underlying the ...