Saturday, July 10, 2010
I wrote here last week about the Second Circuit's opinion in United States v. Kaiser, which overturned a long line of Second Circuit precedent establishing that willfulness in the context of criminal Exchange Act prosecutions requires the government to prove a defendant's awareness of the general unlawfulness of his/her conduct under the securities laws. I pledged to post again and focus a little more on the specifics of the opinion.
The Kaiser Court states that "[m]ore recently, we seemed to endorse a higher standard for willfulness in insider trading cases." This is misleading on several counts.
First, the higher standard for willfulness in criminal cases brought under the Exchange Act was established 40 years ago in United States v. Peltz, 433 F.2d 48 (2nd Cir. 1970). Since when is an opinion from 40 years ago considered recent? Peltz is older that any of the opinions cited by the Court in support of the lower standard of proof.
Second, not one of the higher standard cases cited by the Court explicitly confines the higher standard of proof to insider trading cases. Indeed, Peltz itself was not an insider trading case.
Third, the Court ignored published and unpublished Second Circuit case law that unequivocally applies the higher standard outside of the insider trading context. See United States v. Becker, 502 F.3d 122 (2nd. Cir. 2007); United States v. Schlisser, 168 Fed. Appx. 483 (2nd Cir. 2006) (unpublished).
The Kaiser Court states that "Unlike securities fraud, insider trading does not necessarily involve deception, and it is easy to imagine an insider trader who receives a tip and is unaware that his conduct was illegal and therefore wrongful." (emphasis added).
First, insider trading is quintessentially a species of securities fraud. Most insider trading cases are brought under Section 10(b) of the Exchange Act and SEC Rule 10b-5. These are securities fraud provisions by definition and Rule 10b-5 is well known as the classic catch-all securities fraud regulation. As the Supreme Court stated in Chiarella v. United States, "Section 10(b) is aptly described as a catch-all provision, but what it catches must be fraud." 445 U.S.222, 234-35 (1980).
Second, the essence of insider trading is fraudulent deception through failure to disclose. What Section 10(b) of the Exchange Act outlaws on its face is a "manipulative or deceptive device or contrivance." The Supreme Court in designating insider trading a "manipulative device" has stated that inside traders "deal in deception." See United States v. O'Hagan, 521 U.S. 642, 653 (1997). In fact, all insider trading prohibited by the criminal law involves deception of some party or parties by the inside trader.
The Kaiser Court also at numerous points conflates, deliberately or negligently, case law discussing Exchange Act Section 32(a)'s willfulness requirement with case law discussing Section 32(a)'s provision that "no person shall be subject to imprisonment under this section for the violation of any rule or regulation if he proves that he had no knowledge of such rule or regulation." As noted in my prior post, the Second Circuit precedent does not hold that the government must establish the defendant's knowledge of the particular rule, regulation, or statute that he/she has allegedly violated in order to prove willfulness under Section 32(a) the Exchange Act. But the government must prove the defendant's knowledge that his/her conduct was illegal in general or "wrongful under the securities laws."
As a general proposition in the Second Circuit, one panel cannot overturn another panel's recent precedent. Here, the Kaiser panel appears to have overturned recent and longstanding precedent of myriad other panels. Maybe the higher willfulness standard under Section 32(a) should go. Clearly, the case law on this issue has not always been clear or entirely consistent. But the bench and bar deserved better here.