Securities & Exchange Commission v. Musella
748 F. Supp 1028, 1989 U.S. Dist. LEXIS 9285, 1989 WL 225763 (1989)
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Rule of Law:
A tippee who trades on material, nonpublic information is liable for insider trading if they knew or should have known that the information was misappropriated in breach of a fiduciary duty, and this knowledge can be inferred from a totality of circumstantial evidence.
Facts:
- Alan R. Ihne, the manager of office services at the law firm Sullivan & Cromwell, was aware of the firm's strict policy on safeguarding confidential client information.
- Between 1981 and 1982, Ihne knowingly misappropriated confidential information from his employer regarding proposed tender offers, mergers, and leveraged buyouts involving the firm's clients.
- Ihne formed an insider trading scheme with his friend Joseph Palomba and stockbroker James Stivaletti to profit from the stolen information.
- Stivaletti recruited Dominick Musella, who had no prior experience in securities trading, to purchase securities for the group. Stivaletti did not reveal the source of the information, which Musella referred to as 'The Goose that Laid the Golden Egg'.
- Musella and his close friend, Albert DeAngelis, spoke frequently and discussed stocks.
- On three separate occasions (involving Marathon Oil, Penn Central, and Signode Corp.), Musella received tips from Stivaletti about imminent corporate actions and subsequently purchased securities in those companies.
- DeAngelis’s trading in the same three securities closely paralleled Musella’s trades, often occurring on the same day Musella received the tip. DeAngelis's purchases were unusually large for his trading history and were financed with borrowed money.
- When an SEC investigator telephoned DeAngelis as part of an investigation into Marathon Oil trading, DeAngelis falsely denied knowing Musella.
Procedural Posture:
- The Securities and Exchange Commission (SEC) brought a civil enforcement action in the U.S. District Court for the Southern District of New York against Albert DeAngelis and other individuals.
- Other defendants in the scheme either pleaded guilty to related criminal charges, settled the SEC's civil claims, or had summary judgment entered against them in prior proceedings.
- The SEC abandoned its claim against the estate of key tipper Dominick Musella after he died.
- The case against the sole remaining defendant, Albert DeAngelis, proceeded to a three-day bench trial in the district court.
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Issue:
Does a remote tippee violate Section 10(b) of the Securities Exchange Act and Rule 10b-5 by trading on material, nonpublic information when circumstantial evidence indicates he knew or should have known the information was misappropriated in breach of a fiduciary duty?
Opinions:
Majority - Wood, J.
Yes. A remote tippee violates federal securities laws when he trades on misappropriated, material, nonpublic information that he knew or should have known was improperly obtained. The court found that the totality of the circumstantial evidence established that DeAngelis knew or should have known he was trading on stolen information passed to him by Musella. The court's reasoning was based on several factors: (1) the uncanny parallel timing between DeAngelis’s and Musella’s trades; (2) the unusually large and risky nature of DeAngelis’s investments compared to his past trading history; (3) DeAngelis's completely incredible and factually inconsistent explanations for his purchases; (4) the testimony of another individual whom DeAngelis tipped, who believed DeAngelis's information was not public; and (5) DeAngelis's false exculpatory statement to the SEC denying his relationship with Musella, which serves as independent evidence of scienter (consciousness of guilt). Therefore, DeAngelis is liable for violating Section 10(b), Rule 10b-5, Section 14(e), and Rule 14e-3.
Analysis:
This case is a classic application of the misappropriation theory of insider trading liability to a remote tippee. It powerfully illustrates how courts can establish scienter—the requisite intent or knowledge of wrongdoing—through a compelling web of circumstantial evidence in the absence of direct proof. The decision reinforces that a tippee cannot escape liability by claiming ignorance or consciously avoiding the source of illicit information when the surrounding facts strongly suggest they should have known the tip was improper. This holding makes it more difficult for individuals in a tipping chain to use willful blindness as a defense and solidifies the 'knew or should have known' standard for tippee liability.
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