United States v. Pinto-Thomaz

352 F.Supp.3d 287

UNITED STATES of America

v.Sebastian PINTO-THOMAZ and Jeremy Millul, Defendants.

S2 18-CR-579 (JSR)

United States District Court, S.D. New York.

Signed December 6, 2018

Christine Ingrid Magdo, Andrew Mark Thomas, United States Attorney's Office, New York, NY, for United States of America.

Henry Edward Mazurek, Evan Loren Lipton, Meister Seelig & Fein, LLP, E. Scott Morvillo, Morvillo LLP, Jodi Misher Peikin, Morvillo, Abramowitz, Grand, Iason, & Anello P.C., Savannah Stevenson, Orrick, Herrington & Sutcliffe LLP, Glenn Charles Colton, Michelle Jami Shapiro, Arent Fox LLP, Howard S. Weiner, Bachner & Associates, P.C., New York, NY, for Defendants.

OPINION AND ORDER

JED S. RAKOFF, U.S.D.J.

The crime of insider trading is a straightforward concept that some courts have somehow managed to complicate. Essentially, insider trading is a variation of the species of fraud known as embezzlement, which is defined in Black's Law Dictionary as "[t]he fraudulent taking of personal property with which one has been entrusted, especially as a fiduciary." Black's Law Dictionary (10th ed. 2014). In the case of insider trading, the property is a company's material confidential information that has value to the embezzler because of its potential use in the purchase and sale of securities. See United States v. O'Hagan, 521 U.S. 642, 654, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997). Insider trading occurs when someone to whom this property has been entrusted pursuant to a fiduciary or similar relationship secretly embezzles, or "misappropriates," the information in order to take advantage of its securities-related value. If the embezzler, instead of trading on the information himself, passes on the information to someone who knows it is misappropriated information but still intends to use it in connection with the purchase or sale of securities, that "tippee" is likewise liable, just as any knowing receiver of stolen goods would be.

It is just that simple - or, conceptually, should be. But, as described below, some judicial decisions appear to have added complications.

These observations are prompted by the instant motion to dismiss of defendants Sebastian Pinto-Thomaz and Jeremy Millul, who are charged in a superseding indictment ("the Indictment") with substantive securities fraud and conspiracy to commit securities fraud.¹ The Indictment alleges that Pinto-Thomaz, having received in a fiduciary capacity material nonpublic information concerning the forthcoming acquisition of the Valspar Corporation by the Sherwin-Williams Company, secretly misappropriated the information and provided it to Millul "with the intention to benefit" Millul by enabling him to trade profitably on the acquisition prior to its public announcement. See Indictment ¶¶ 5, 20.

In their motion, defendants argue that the Indictment should be dismissed as to both the tipper (Pinto-Thomaz) and the tippee (Millul) because the Indictment fails to allege that they shared a "meaningfully close personal relationship." United States v. Newman, 773 F.3d 438, 452 (2d Cir. 2014). This Opinion and Order first addresses the motion to dismiss, and then turns to a number of additional motions made by one or both defendants.

I. Motion to Dismiss

Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder broadly prohibit any person from using any "scheme or artifice to defraud" "in connection with the sale or purchase of any security." 17 CFR § 240.10b-5 (2016) ; 15 U.S.C. § 78j(b). Embezzlement of a company's confidential information is unquestionably a fraud. As the Supreme Court has stated, "[a] company's confidential information ... qualifies as property to which the company has a right of exclusive use," O'Hagan, 521 U.S. at 654, 117 S.Ct. 2199,² and, accordingly, "undisclosed misappropriation of such information, in violation of a fiduciary duty ... constitutes fraud akin to embezzlement - the fraudulent appropriation to one's own use of the money or goods entrusted to one's care by another." Id. If the embezzlement is for the purpose of using the information to trade, or to have others trade, in the securities market, it would seem to be a straightforward violation of Rule 10b-5.

Historically, insider trading charges were first pursued primarily against company executives who took advantage of their knowledge of the company's confidential information to purchase company stock from their own unwitting shareholders. See, e.g., S.E.C. v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (en banc). Although sometimes referred to as the "classical theory" of insider trading, O'Hagan, 521 U.S. at 652, 117 S.Ct. 2199, this was in fact a rather narrow approach, and the U.S. Securities and Exchange Commission ("SEC") itself had to labor somewhat to apply it even to the situation where a company executive or his agent used the company's negative inside information to sell short. See Chiarella v. United States, 445 U.S. 222, 227 n.8, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980) (briefly describing this development). The Government also was only gradually able to extend the classical theory to "tippees" who traded on inside information supplied by the tipper. See Dirks v. SEC, 463 U.S. 646, 659-61, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983). Thus, by the time the classical theory of insider trading reached its first challenge in the Supreme Court in 1980, it was clear that there were formidable limits on its application. See Chiarella, 445 U.S. at 235, 100 S.Ct. 1108 (reversing attempt to extend the classical theory to embrace fraud on shareholders to whom no fiduciary duty was owed).

After the reversal in Chiarella, however, the Government, acting on a suggestion in Chief Justice Burger's dissent, 445 U.S. at 243, 100 S.Ct. 1108, set about devising a more straightforward theory of insider trading liability - a theory based on the well-established law of embezzlement and known as the "misappropriation theory." In 1997, the Supreme Court in O'Hagan, endorsed this theory and held it broadly applicable to both insiders and outsiders, tippers and tippees, who traded on information they knew to be embezzled. See O'Hagan, 521 U.S. at 652-53, 117 S.Ct. 2199 ("the misappropriation theory outlaws trading on the basis of nonpublic information by a corporate ‘outsider’ in breach of a duty owed not to a trading party, but to the source of the information").³

Well before the approval of the misappropriation theory in 1997, however, the Supreme Court was confronted in 1983 with a rather unusual case brought under the classical theory, Dirks v. SEC, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983). In that case, Ronald Secrist, the "tipper," contacted Raymond Dirks, the "tippee," and provided material nonpublic information concerning a corporation where Secrist formerly worked. Id. at 648-49, 103 S.Ct. 3255. But Secrist was acting solely in a whistleblower capacity, informing Dirks, an investment specialist, that the corporation's assets were "vastly overstated" as the result of fraud and that the SEC had failed to act on reports of the fraud. Id. at 649, 103 S.Ct. 3255. He therefore "urged Dirks to verify the fraud and disclose it publicly." Id. Dirks proceeded to investigate the allegations and to discuss them with a number of individuals, including his firm's investors, the news media and, eventually, the SEC. Id. at 649-50, 103 S.Ct. 3255. The fraud was finally exposed "[l]argely thanks to Dirks," Id. at 652 n.8, 103 S.Ct. 3255 , and several of the company's executives went to prison. Yet the SEC found Dirks liable for insider trading because Dirks had disclosed to some of his firm's clients material information received from Secrist before the information was disclosed to the public. Id. at 650-51, 103 S.Ct. 3255.

The Supreme Court reversed. Rejecting the SEC's determination, the Supreme Court explained that Dirk's disclosure to his firm's clients of the nonpublic information he received from Secrist could serve as the basis of insider trading liability only where Secrist's prior disclosures to Dirks were a breach of Secrist's fiduciary duty. Id. at 654, 103 S.Ct. 3255. Both sides acknowledged as much. But the Court then went further and stated that "[w]hether disclosure is a breach of duty ... depends in large part on the purpose of the disclosure," id. at 662, 103 S.Ct. 3255, and that "the test is whether the insider personally will benefit, directly or indirectly, from his disclosure." Id. Although this was novel law, the Court reasoned that this test was consistent with the "purpose of the securities laws ... to eliminate use of inside information for personal advantage." Id. (citing the SEC's decision in In re Cady, Roberts & Co., 40 S.E.C. 907, 912 n.15 (1961) ).

Thus was born the requirement that the tipper receive a "personal benefit." It should be noted that Dirks- which, quite aside from its unusual facts, was prosecuted under the "classical theory" of insider trading several years before the Supreme Court approved the broader embezzlement theory of insider trading in O'Hagan, 521 U.S. 642, 117 S.Ct. 2199 - could easily have been treated as sui generis. Secrist, after all, arguably had a legal duty to report the company's fraud that overrode any fiduciary requirement. See 18 U.S.C. § 4 (establishing criminal liability for "[w]hoever, having knowledge of the actual commission of a felony cognizable by a court of the United States, conceals and does not as soon as possible make known the same").

In the event, however, Dirks was given wide application. But in some courts it appears to have been misunderstood, especially in regard to what the Supreme Court meant by "personal benefit." On any fair reading, it should have been clear that the Court in Dirks was using the term "personal benefit" simply to distinguish between a lawfully-acting fiduciary and someone who embezzles for personal advantage. In particular, the Court expressed concerns that a...