United States v. Chestman
903 F.2d 75 (1990)
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Rule of Law:
A family relationship, without a history of sharing business confidences or an explicit acceptance of a duty of confidentiality, does not create a fiduciary duty or similar relationship of trust and confidence sufficient to support a securities fraud conviction under the misappropriation theory of Rule 10b-5.
Facts:
- Ira Waldbaum, president and controlling shareholder of Waldbaum, Inc., entered into negotiations to sell the company to A&P.
- On November 21, 1986, Waldbaum and A&P executed an agreement for A&P to purchase Waldbaum shares for $50 per share.
- Ira told his sister, Shirley Witkin, about the sale to tender her shares, cautioning her that the information was confidential and "not to be discussed."
- Shirley Witkin then told her daughter, Susan Loeb, about the sale, stating it was important not to tell anybody because it could ruin the sale.
- Susan told her husband, Keith Loeb, about the impending sale and admonished him not to tell anyone.
- The next morning, Keith Loeb telephoned his stockbroker, Robert Chestman, and told him he had "definite, some accurate information" that Waldbaum was being sold at a price substantially higher than its market value.
- Shortly after the call, Chestman purchased 3,000 shares of Waldbaum stock for his own account and later purchased another 8,000 shares for his discretionary client accounts, including an account for Loeb.
- Following the public announcement of the sale, Waldbaum's stock price rose from approximately $25 per share to $49 per share.
Procedural Posture:
- The U.S. government indicted Robert Chestman in the United States District Court for the Southern District of New York.
- Following a trial, a jury convicted Chestman on ten counts of securities fraud (Rule 10b-5), ten counts of fraudulent trading in connection with a tender offer (Rule 14e-3), ten counts of mail fraud, and one count of perjury.
- The district court entered a judgment of conviction against Chestman.
- Chestman (appellant) appealed the judgment of conviction to the United States Court of Appeals for the Second Circuit.
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Issue:
Does a family relationship, without evidence of a history of sharing business confidences, create a fiduciary duty or similar relationship of trust and confidence sufficient to support a securities fraud conviction under the misappropriation theory of Rule 10b-5?
Opinions:
Majority - Miner, Circuit Judge
No. A family relationship alone is insufficient to establish a relationship of trust and confidence required for Rule 10b-5 liability under the misappropriation theory. The government failed to present evidence that Keith Loeb had ever accepted a duty of confidentiality from his wife or her family; there was no history of them reposing business confidences in one another. Because the tipper, Keith Loeb, did not breach a fiduciary duty to the source of the information (the Waldbaum family), the tippee, Robert Chestman, cannot be held liable for securities fraud. The conviction is also reversed on mail fraud and perjury grounds due to insufficient evidence. [Note: This reasoning was joined by the other judges. However, Judge Miner's reasoning in Part IV, which would have affirmed the Rule 14e-3 conviction, did not command a majority and is effectively a dissent on that specific issue.]
Concurring-in-part-and-dissenting-in-part - Mahoney, Circuit Judge
The reversal of the convictions is correct, including the conviction under Rule 14e-3. The SEC exceeded its statutory authority by promulgating Rule 14e-3 without requiring a breach of fiduciary duty. Section 14(e) of the Securities Exchange Act is modeled on Section 10(b), and authoritative Supreme Court interpretations require a breach of duty for an act to be 'fraudulent.' An administrative agency does not have the power to redefine the core meaning of fraud to eliminate this essential element.
Concurring-in-part-and-dissenting-in-part - Carman, Judge
The convictions must be reversed in their entirety. The Rule 14e-3 conviction cannot stand because a conviction under the rule requires substantive proof of fraudulent acts. The rule should be read to imply the common law elements of fraud, including scienter and a breach of duty. Since the trial court failed to instruct the jury on all the elements of fraudulent nondisclosure, the conviction is fatally flawed and must be reversed.
Analysis:
This decision significantly narrowed the application of the misappropriation theory of insider trading, particularly in cases involving family members. It established that a familial relationship alone is not a substitute for a demonstrable fiduciary or similar relationship of trust and confidence. The court's demand for evidence of a pre-existing pattern of sharing business secrets or an explicit acceptance of a duty of confidentiality made it more difficult for the government to prosecute insider trading cases based on tips passed among relatives. The fractured opinions on Rule 14e-3 also highlighted a deep judicial division over the scope of the SEC's rulemaking authority to define fraud without a breach of a fiduciary duty, setting the stage for further litigation on the issue.
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