October 27, 2005
When a "Stupid Mistake" Is Not Enough Proof of Willfulness for Insider Trading
A recent Second Circuit decision in United States v. Cassese (available on court website here) deals with the always-tricky issue of interpreting the "willfully" element in a securities fraud prosecution. The case involves the CEO of Computer Horizons Corp., John Cassese, whose company received a tender offer from Compuware Corp. that it turned down. A few months after rejecting the offer, Compuware's CEO told Cassese that Compuware planned to acquire Data Processing Resources Corp. (DPRC), and might be interested in acquiring Computer Horizons at a future date. Upon learning about Compuware's plans, Cassese purchased 15,000 shares of DPRC and, after the announcement that Compuware would acquired the company through a tender offer, sold his shares for a profit of approximately $150,000. Two months after the DPRC transactions, Cassese discussed the trades with another Compuware officer and said that "he had made a stupid mistake." The SEC filed a civil insider trading action, which Cassese settled, and the U.S. Attorney brought a criminal case based on a violation of Rules 10b-5 and 14e-3, which prohibits trading while in possession of nonpublic information about a tender offer. The district court dismissed the Rule 10b-5 charge because the government could not establish that Cassese breached of fiduciary trading (or other duty or trust and confidence) by misappropriating the information from Compuware.
After being convicted by the jury, the district court granted the defense motion for a judgment of acquittal on the ground of insufficient evidence that the defendant acted with the requisite willfulness to violate the law. The district court held that that the government's evidence did not establish that Cassese knew he was trading in securities that would be subject to a tender offer, a requirement for a Rule 14e-3 violation. The lower court rejected the government's argument that it need only prove that Cassese knew his trading was unlawful, but not that he knew that a tender offer was the method for conducting the transaction.
In affirming the district court, a majority of the Second Circuit held that even under the government's "more expansive" reading of the intent element, its evidence was insufficient to show Cassese knew his conduct was unlawful. At the outset, the court noted:
Before analyzing the Government’s evidence, it is helpful to keep in mind the context in which the trades occurred. In purchasing the DPRC shares, Cassese did not breach any fiduciary duty, nor did he misappropriate any confidential information . . . The information Cassese had received was not related to Computer Horizons or to any company in which he could be considered an insider by virtue of a directorship or otherwise. Accordingly, he was under no legal duty to refrain from trading on the information by virtue of being an insider, or to keep it confidential. Finally, and significantly, the Government did not prove – and does not contend – that, when Cassese traded, he knew DPRC would be the subject of a tender offer. In other words, the Government contends it proved willfulness despite the lack of any of the traditional warning signals that would put one on notice that he ought to refrain from trading.
The Second Circuit rejected the government's argument that Cassese's use of two brokerage accounts to conduct the trades shows knowledge of wrongfulness as "frivolous" Regarding Cassese's statement about doing something "stupid," the court stated: "Viewing this bit of evidence in a light most favorable to the Government, the fact that Cassese may have felt he made a mistake two months after the trades makes, at best, the most modest of contributions to the Government’s responsibility of proving beyond a reasonable doubt that Cassese willfully violated the securities laws." The court concluded:
Since few events in the life of an individual assume the importance of a criminal conviction, we take the "beyond a reasonable doubt" requirement with utmost seriousness. Here, we find that the Government’s evidence failed to reach that threshold. As discussed above, viewed singly, each of the areas of proof by the Government was characterized by modest evidentiary showings, equivocal or attenuated evidence of guilt or a combination of the three. More importantly, when the evidence is viewed in its totality, the evidence of willfulness is insufficient to dispel reasonable doubt on the part of a reasonable fact finder.
Circuit Judge Raggi dissented, arguing that the evidence was sufficient when viewed in the light most favorable to the verdict. (ph)
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