United States v. Smith
155 F.3d 1051 (9th Cir. 1998)
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Rule of Law:
A conviction for insider trading under § 10(b) and Rule 10b-5 requires the government to prove the defendant actually used material nonpublic information when trading, not merely that the defendant was in knowing possession of it. Furthermore, 'soft' forward-looking information, such as internal earnings projections, can be legally 'material' depending on a fact-specific inquiry into its significance to a reasonable investor.
Facts:
- Richard Smith was the Vice President for North American Sales at PDA Engineering, Inc. ('PDA'), a publicly traded company.
- By early 1993, Smith had accumulated over 51,000 shares of PDA stock.
- Between June 10 and June 18, 1993, Smith sold all of his PDA stock.
- On June 19, 1993, Smith left a voicemail for a colleague, Angela Bravo de Rueda, stating that he had learned of a '$1.5 million mistake in the budget' from other executives.
- In the voicemail, Smith also stated he 'sold all my stock' and was 'going to short the stock because I know its going to go down' once the company released information about its earnings.
- A different PDA employee, Linda Alexander-Gore, guessed Bravo's voicemail password, accessed Smith's message, forwarded it to her own voicemail box, and recorded it on a handheld audiotape recorder.
- Gore gave the recording to another co-worker, Robert Phillips, who then contacted the U.S. Attorney's Office and played the tape for them.
- In subsequent weeks, Smith and his parents proceeded to sell short tens of thousands of shares of PDA stock.
Procedural Posture:
- The Securities and Exchange Commission (SEC) launched an investigation into Richard Smith after the FBI relayed a tip from an informant about a recording.
- The SEC referred the case to the U.S. Attorney's Office for criminal prosecution.
- Smith was indicted in the United States District Court on eleven counts of insider trading and one count of obstruction of justice.
- Smith moved to suppress the voicemail recording and all evidence derived from it, arguing it was the fruit of an illegal wiretap.
- The district court suppressed the voicemail tape itself but denied the motion to suppress the rest of the government's evidence, finding the connection was too attenuated.
- The district court dismissed the obstruction of justice count.
- Following a trial, a jury found Smith guilty on all eleven insider trading counts.
- The district court denied Smith's post-trial motion for acquittal or a new trial.
- Smith (appellant) appealed his conviction to the U.S. Court of Appeals for the Ninth Circuit.
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Issue:
Does a conviction for insider trading under § 10(b) of the Securities Exchange Act and SEC Rule 10b-5 require the government to prove that the defendant actually used material nonpublic information in making a trade, or is proof of knowing possession of such information sufficient?
Opinions:
Majority - O’Scannlain, J.
Yes, a conviction for insider trading requires proof that the defendant actually used the material nonpublic information. The plain language of § 10(b) and Rule 10b-5 prohibits manipulative and deceptive practices, which requires 'scienter'—an intent to deceive, manipulate, or defraud. Mere possession of inside information while trading does not necessarily equate to an intent to defraud, as an investor might trade for reasons completely independent of the information, such as a pre-existing plan to sell. The Supreme Court's precedent consistently uses language like 'trading on the basis of' or 'uses the information,' suggesting a causation requirement. While this 'use' standard makes prosecution more difficult, the government can prove use through circumstantial evidence, such as unusual trading patterns or quantities. The court also held that (1) retrieving a stored voicemail message is an 'interception' under the Wiretap Act, not merely 'access' under the Stored Communications Act, but that the evidence here was admissible because its connection to the illegal recording was too attenuated; and (2) 'soft' information like internal projections can be material under the fact-specific balancing test from Basic Inc. v. Levinson.
Analysis:
This decision established the 'use' test for insider trading liability in the Ninth Circuit, creating a split with the Second Circuit's dicta in United States v. Teicher, which favored a 'knowing possession' standard. By requiring prosecutors to prove a causal link between the inside information and the trade, the court heightened the government's burden of proof in this influential circuit. The decision's analysis of the Wiretap Act also provided important clarification on its application to modern technology like voicemail, holding that retrieving stored messages is a more serious 'interception.' Finally, the case reinforced the fact-intensive standard for the materiality of 'soft' information, preventing defendants from arguing that internal projections are immaterial as a matter of law.
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