SECURITIES AND EXCHANGE COMMISSION
Litigation Release No. 16820 / December 8, 2000
SECURITIES AND EXCHANGE COMMISSION v. MICHAEL G. SARGENT, ET AL., Case No. 00-1293 (1st Cir. October 11, 2000)
On December 4, 2000, the United States Court of Appeals for the First Circuit issued a mandate pertaining to its October 11, 2000 decision holding that the Securities and Exchange Commission's case against defendants Michael G. Sargent, Robert J. Scharn and Dennis J. Shepard should be decided by a jury. The Court of Appeals reversed the contrary decision of United States District Judge Joseph L. Tauro and remanded the case for a new trial.
In its complaint, the Commission alleges that in September 1994 the defendants violated Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 and SEC Rules 10b-5 and 14e-3 by tipping or trading in the common stock of Purolator Products Company while in possession of material nonpublic information about a proposed tender offer for Purolator stock by Mark IV Industries, Inc. Beginning on the first business day after a dinner engagement with Shepard, and in the three weeks before Mark IV's tender offer announcement, Sargent bought a total of 20,400 shares of Purolator at an average price of $17.67 per share.
According to the Court of Appeals, the circumstantial evidence of an illegal tip from Shepard to Sargent was sufficient to get the case to a jury. Rejecting the District Court's reasoning, the Court of Appeals held that the Commission is not required to produce direct evidence of a tip to raise a triable issue of fact. Reviewing the circumstantial evidence, the Court of Appeals held:
After resolving all doubts and credibility issues in favor of the Commission, we conclude that a jury could reasonably infer from this evidence that Sargent was operating on more than just a hunch and that he had received nonpublic information from Shepard about Purolator.
The Court of Appeals was not persuaded by the additional grounds that the defendants raised in support of the lower court's judgment in their favor. For example, the Court of Appeals held that a jury could reasonably find that Shepard and his consulting-firm business partner expected that confidential business matters, even those unrelated to the consulting firm, would be held in trust and that Shepard owed a fiduciary duty not to misappropriate material nonpublic information about Purolator. There was sufficient evidence that Shepard benefitted from the alleged tip to Sargent because the jury could infer that Shepard was trying to effect a reconciliation with his friend and to maintain a useful networking contact. And the Court of Appeals held that Rule 14e-3 does not require that a person charged with violating the rule have knowledge that the nonpublic information in his possession relates to a tender offer.
In 1998, a jury in a related criminal case found Sargent and Scharn guilty of violating 18 U.S.C. § 1001 because they willfully made false statements to the Commission staff during its inquiry of possible insider trading in Purolator. In its recent decision, the Court of Appeals reversed the District Court's exclusion of Sargent's and Scharn's criminal convictions from evidence in the Commission's trial. The Court of Appeals held that the relevant Rule of Evidence "simply does not allow for any judicial discretion on this point. The district court committed error in excluding these convictions."
Finally, the Court of Appeals took issue with the District Court's decision not to allow the Commission to conduct any pretrial discovery. While it was not necessary to decide whether the denial of discovery was "plainly wrong," the Court of Appeals stated that on remand "the district court will have the benefit of our view that discovery should not have been foreclosed to the Commission merely because of its pre-filing investigation or information secured from the Sargent and Scharn criminal trials."