March 22, 2000
Via e-mail: firstname.lastname@example.org
Jonathan G. Katz, Secretary
Securities & Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549-0609
Re: Reference File No. S7-31-99
Release Nos. 33-7787, 34-42259, IC-24209 (the "Release")
Please consider the following comments as representing personal views and not those of my firm or any legal organizations to which I belong.
I consider the issues raised in the proposed Release of utmost significance.
The proposed selective disclosure provisions of the Release appear reasonable and proportionate to the existing problem. The Release also proposes, however, Rule 10b5-1 which would make "mere possession" of material nonpublic information, now apparently its meaning made even more vague and broad and to be renamed "awareness," sufficient to prove, prima facie, liability in civil matters and guilt in criminal matters. The Release seems to propose a per se rule that illegal trading has occurred so long as one was merely "aware" (unless the defendant fits one of the Releaseís very limited exceptions to its per se rule). The proposed rule is not even a presumption of "use" of material nonpublic information. It is more than simply a presumption or inference which the defendant has a right to rebut by any means possible. It would impose automatic insider trading liability and shift the burden of proof to the defendant to show she meets one of only four permitted affirmative defenses.
Rather than being presumed innocent until a jury of oneís peers hears the full evidence and determines guilt or innocence, the proposal would immediately assume liability in a civil matter, and guilt in a criminal matter, merely because one traded while she was "aware." In effect, even where one may argue the limited exceptions, the defendant would be in a position of having the burden of proof to show her innocence. In criminal matters it appears the burden of showing guilt "beyond a reasonable doubt" would no longer be the governmentís responsibility.
A trier of fact should hear all relevant and admissible argument and determine the facts. The facts ought to require "use" of material nonpublic information as an element of an alleged civil violation or a criminal charge. Simply being "aware" of the information sweeps with much too broad a brush and has the distinct possibility of painting defendants, who may have very reasonable explanations, as liable in civil matters, and as felons in criminal matters.
The government has proven "use" in prior cases by both direct and circumstantial evidence. It should be required to have that as a continuing duty. Proof of all elements of an alleged "crime" should be the prosecutionís burden. This proof should particularly include that the defendant intentionally "used" that information of which she was aware (that is, she traded "on the basis of" or "on" the material inside information). Most courts considering the issue have required, inferred, or assumed "use," either directly or by their dicta. Such use denotes the required scienter, an intentional act, as an element of the violation. "Use" of the information can be tangible proof of an intentional act. Mere possession and then trading, without "use," lacks the requisite showing of scienter.
Before I address elements of the proposals, which I find most troubling, proposed Regulation FD deserves comment.
Too often I have been accused by clients of "working for the SEC" (which, of course, I do not really consider pejorative) when it comes to analyst meetings and "selective" disclosures. I have insisted for years that analyst meetings and information released to institutional or other large and favored investors is frequently "material" and the disclosure is not only selective but bordering on the facilitation and promotion of insider trading. (As a matter of fact "roadshows" for Ď33 Act offerings frequently fit into the same category. That is why lawyers from our office do not attend such shows. Actually, we never get invited.)
Proposed Regulation FD provides lawyers with a tool to persuade clients that meetings with analysts, institutional investors, brokers and any select group of shareholders in which corporate information is to be discussed, be announced in advance or widely available simultaneously, or open to anyone who wants to "listen in" telephonically, or by any other means including a companyís simultaneous website broadcast.
When the analysts call and want (often bait with implied threats of discontinuing coverage) comments from corporate executives on earnings projections, undue pressure is immediately imposed. Regulation FD appears to be a means of freeing executives from this problem. If the analyst calls, and if there is to be any comment whatsoever concerning the analystís projections, such as "thatís in the ballpark," "weíre conformable with that," "quite possible," or "youíre way off base," the public would have to hear the same comments simultaneously. The analyst should also be prohibited from "using" or relaying any information to his clients or his firmís registered representatives until the registrant has had time to release the same comments to the public by means of facilities such as mentioned in the Release. In fact, my experience is that comments by management to these select groups are frequently "material." Regulation FD assures executives that they can either give no comment, or they can inform analysts or any other select group that if they are to comment on the analystís financial prognostications or on any other as-of-yet unannounced material fact or event, such projections and comments will be at least simultaneously disclosed (if not previously disclosed) to the "market."
Its not that analyst meetings or comments by executives on future prospects are necessarily inappropriate, they in fact are necessary to the "full disclosure" the SEC champions. However, selective disclosure has resulted too often in benefiting few and taking advantage of many. Regulation FD, if administered wisely, should help to promote more open procedures assuring that the same information is available to the market at the same time it is disclosed to those who are presently the favored few.
As always, determining what is "material" is more than occasionally difficult. The case law tests referred to in Note 36 to the Release, i.e., TSC Industries v. Northway and Basic v. Levinson, provide some help but even then the issue frequently is extremely troublesome and problematic for the trier of fact. Simultaneous disclosure to all will prevent, or at least lessen, the need to deal with this often-confounding issue.
Regulation FD is long overdue and I agree with its premise and methodology.
Proposed Rules 10b5-1 and 10b5-2
As much as I am in agreement with the premise and methodology of proposed Regulation FD, I find myself equally in disagreement with proposed Rules 10b5-1 and 10b5-2. I find the proposed rules completely contrary to the better thinking of the majority of courts that have considered the elements of a securities violation and who still believe due process has a place in the securities laws. The SECís reaction, perhaps prompted by frustration caused by its failure to prevail in every insider trading case, seems to be disproportionate to the existing problems and has resulted in an agency, highly regarded for it intellectuality and well-considered rules, to have faltered. The dogmatic, virtually per se approach the SEC favors for insider trading cases, especially in criminal prosecutions, would assume guilt and leave it to the defendant to prove her innocence. I hope that not only I, but all lawyers practicing in this field, strenuously object to the Agencyís proposals.
Government with its all encompassing power tends to "go over the line" occasionally and become abusive, motivated Iím sure by thoughts of "for the greater good" but too often taking liberties with notions of due process and protections considered inherent in the Constitution.
"Awareness" is in my view even more vague, more amorphous and even more potentially far-reaching, than the "mere knowing possession" standard the SEC tried to convince courts to adopt. Most courts wisely, regardless of the "inconvenience" to the SEC and Justice Department of having to prove elements of the offense, did not accept such argument.
The majority of courts considering the question have required, implied or assumed the presence of "use," not merely possession ("awareness" in its reborn state) of the material nonpublic information.
In OíHagan and Dirks, as your endnotes 76 and 77 correctly state, the Courtís dicta presumed use was a necessary element. References in each case concerning trading "on" or "on the basis of" clearly implied use as an element of the violation. SEC v. Adler, as the Release points out, suggested what is in effect a presumption of use that would then shift the burden of proof to the defendant, and made clear that the defendant could then rebut the presumption. Adler of course was a civil case. Adler did not limit such rebuttal as the Release would do to any particular defenses as proposed 10b5-1ís "per se" rule would do. The Release proposes that unless the defendant can fit one of the four permitted defenses, she is automatically guilty if she was merely "aware" of some fact or event later considered material. The SEC proposes only defenses it finds convenient to accept and leaves no room for what might be a multitude of other legitimate defenses that might also demonstrate that, although the information was possessed and was material, it was not used as a factor in the trading. That is, the trading, was not "on the basis of" that information. If a defendant can convince a jury of the reasonableness of a defense, i.e., that use of the inside information she possessed was not a factor in her trading decision, she ought to be allowed to present it. Since when does the prosecution get to set the rules, i.e., the defenses, a defendant might present? Undoubtedly defendants will have other defenses and, again, if a jury selected by the prosecution and defense, or the court, as the trier of fact, believes the defendantís defense, that is the way our justice system has been designed to work. It would appear that the only four defenses the Release proposes would not even allow proofs of oneís history of selling before he learned of the information, even if, for instance, in each of the preceding three years he had sold stock for personal motives unrelated to any particular corporate information (i.e., childrenís tuition expenses or unwritten and non-contractual but yet somewhat regular liquidations of stock to diversify investments, or weddings, vacations, medical care emergencies and who knows what else).
The Guidance Provided by the Release Although Helpful Should Not Limit Other Defenses
The Release suggests in its Section III.A.2., certain proposed rules that I agree would be helpful, and would provide some "clarity and certainty" and "guidance" on how one can plan future transactions at a time "before being aware of material and nonpublic information." The proposed Rule 10b5-1(c)ís exceptions to liability (guilt) explained in III.A.2. of the Release, however, while they provide certainty, should not be the only defenses a defendant may argue. She ought to be able to argue any defenses by means of evidence otherwise relevant and permitted by the federal rules of evidence. Then "as it should be" the trier of fact will decide the veracity of the defendant and the credibility of her defense. The exceptions in the Release are helpfully objective and tangible. Counsel advising an insider who is planning a transaction will be able to refer to the excellent guidance the exceptions provide, and give some assurance such transactions planned and committed to before one becomes aware of material nonpublic information, will not incur liability. These proposed rules, while providing guidance, should not, however, be the limit of defenses available. There is no reason not to provide wise guidance. But to deny other legitimate defenses that may arise, and that a jury may find credible, is unwise, unfair and, in my view, constitutionally infirm.
Standard of Proof
Since in civil matters, the courts have ruled that the SEC only need prove its case by a "preponderance of the evidence," the SEC already has a significant advantage. The SEC need only show by a slight measure that its version of what occurred is more believable than the defendantís explanation. To eliminate a defendantís ability to defend herself with reasons other than the proposed Ruleís exceptions, provides the SEC, and the very "punitive" sanctions it can ask a court to impose, even in civil matters, with unwholesome power.
In the past, the SEC has proven its insider trading charges through inferences permitted and properly drawn from "circumstantial evidence and not upon direct testimonial confession." Perhaps the SEC might do even better if it did not have to prove "use" (or even fiduciary duty where the alleged perpetrators fit one of the familial relationships enumerated in proposed Rule 10b5-2). But then why not also do away with the required element of "materiality" and just adopt a per se rule that if the defendant traded while he was aware of the information, it must have been material? In fact, once the SEC and the U.S. Attorneysí Office no longer have to prove use or fiduciary duty, or whatever other elements the SEC finds inconvenient, why even bother with the need for a trial? Let the prosecution set all its own rules for success and then the defendant can "just go directly to [the poor house or] jail, do not pass Go," depending on whether the bureaucracy decided to bring civil or criminal charges, or both. Due process can be inconvenient.
Since the standard of proof in civil enforcement securities fraud cases is not "clear and convincing" (as it was under common law for fraud) but is merely preponderance of the evidence, and because "presentation of circumstantial evidence is a well accepted method for the plaintiff [SEC] to prove his case," the SEC has a low bar to deal with as it is. As the Moran court said, "We have noted elsewhere circumstantial evidence can be more than sufficient." Now, with all that advantage already, the SEC would like to remove from its burden a judicially recognized "use" element that perhaps is more difficult but still can be proved by circumstantial evidence. The government has overwhelming powers to prosecute and finance its enforcement powers. To allow the SEC to increase is powers exponentially, without Congressional approval, is the "crime" I see by any standard of proof. The SECís proposal is a flank attack to vitiate a defense deemed valid after due consideration and deliberation by a number of courts both directly and in dicta.
Rather than being presumed innocent until a jury of oneís peers hears the evidence and determines guilt or innocence, the proposal would immediately assume guilt. In effect, the defendant would be in a position of having the real burden of proof.
An agency such as the SEC which has exercised intellectuality and measured judgment in the past, and has been the quintessential example of fair and wise exercise of governmental power, now appears to be so frustrated that it is attempting to provide itself with a presumptionative (and I believe a constitutionally improper) prosecutorial advantage, relieving it of having to prove wrongdoing, and enabling it to deprive citizens of their property and their liberty.
As the discussion in the Release at Section III.A.2. reiterates, pursuant to the proposed Rule, if the government can merely show by a preponderance of the evidence that a person "was aware of" the insider information when she traded, it will be presumed she traded on the basis of that "material nonpublic information," and that will provide "a sufficient basis for liability." That is, the governmentís burden will be complete. Apparently that would also apply in criminal matters. Although the governmentís burden in such matters is to prove guilt "beyond a reasonable doubt," under the SECís proposal, the defendant would first be deemed guilty and then forced to take the stand to prove her innocence and bear burdens traditionally not imposed on defendants. Even should the defendant fit any of the specific factual defenses permitted by the proposed rules, the Release proposes them as "affirmative defenses" denoting that now the burden will have shifted to the defendant even in criminal cases. Again, while the exceptions proposed by the Release are helpful as guidance, and should be available as defenses, they should not be considered "affirmative" defenses with the burden of proof shifting to the defendant. Especially in criminal matters, in which oneís liberty, besides her money, is at stake, the burden of conviction should be the governmentís. Having to show only a "prima facie" case is not an appropriate burden for the already powerful and well-financed prosecution. That is much too expedient and contrary to traditional rights. Proposed Rule 105b-1(c)ís exceptions should merely be among the defenses a defendant may be able to present, but they should not be deemed "affirmative defenses," nor should they be deemed a defendantís only defenses.
A jury is free to infer from mere circumstantial evidence. That provides the government with enough advantage. It needs no more.
The SECís proposals go too far and are a response disproportionate to the circumstances. These agency-imposed presumptions are very dangerous precedents for a free society. They assume guilt before a fact finder has found that to be the case and impose a burden on a defendant, especially in criminal matters, that has traditionally been, and ought to remain, the governmentís.
Many courts, when making reference to the words "on the basis of," have stated or inferred, or obviously assumed, that these words mandate "use" as a prerequisite to a violation of the insider trading laws. That is, that the defendant first must have had "possession" of the information, or "awareness" as the Release would suggest, and then have used such information as a factor in her trading. The SEC would do away with the need to prove that use "element" and asks that its proposed Rule 10b5-1 provide that "on the basis of" be satisfied now by mere proof she was aware of some material nonpublic information. Use would no longer be an element of the violation for the government to present a prima facie case. The SEC in civil enforcement matters, and the Justice Department in criminal matters, would not have to prove "use," it would be automatically presumed or irrelevant. In either case, this "awareness" or "mere possession" would now be absolute guilt unless one of the four limited exceptions can be satisfied.
"On the basis of" should continue to be interpreted as it has in the past. That is, trading to be "on the basis of" the illegal inside information, should have to be proved by showing that the information was "material," "nonpublic," "possessed," and then, just as importantly as the prior three elements, "used" as a factor in the trading. That is a burden the SEC has been able to bear in the past, and there is no reason to change the rules to make it easier to further facilitate its ability to prevail. The courts have required more than the SEC would like. Government power should be extended only for the most compelling reasons. No such reason exists here to date.
The Releaseís four defenses would allow only proof that prior to trading there existed: (1) a pre-existing "binding contract" (oral or written) to trade; or (2) that she had provided instructions to another person to execute a very precise trade ("in the amount, at the price, and on the date" at the which the trade occurred - no deviations); or (3) a written plan specifying buys or sells, again, at exact prices and exact numbers and on the exact date; and lastly (4) again, a written plan, for trading securities that was designed to correspond to some market index. These defenses are much too limited to take into account any number of real life situations and reasons that a jury could find an appropriate (and innocent) rationale for trading.
In SEC v. Moran, the court was lead to the conclusion, by both direct and much circumstantial evidence, that the defendant, as he had alleged, bought on the basis of what a leader in that industry was doing, i.e., buying and selling, and not based on what his son might have told him in a number of phone calls immediately following board meetings at which material nonpublic information was discussed. A trier of fact should be able to consider this or any other defense even in difficult cases, and legitimacy of defense is to be decided by the trier of fact. Most of the time triers of fact reject concocted stories and do a good job, not perfect of course, weighing the facts and creditability of witnesses. It is up to the trier of fact to determine after observing and hearing the prosecution and defendantís witnesses, liability (in civil matters) and guilt (in criminal matters). To allow the SEC or the Justice Department to limit a defendantís defenses may be convenient but that would exclude what might be other honest, truthful, good faith reasons why the trades occurred. The Federal Rules of Evidence should be the criteria for the introduction of evidence and permissible defenses. Again, believability of defenses should be left to the fact finder. The SECís desire for easier and more predictable wins is understandable, but nonetheless repugnant. The government should continue to have the burden of proving intent to violate the law. Merely because one is "aware" of any particular facts should not seal oneís fate. The better method of determining liability or guilt for alleged illegal insider trading is a hearing by an impartial, independent trier of fact able to consider all data relevant within the rules of evidence (which themselves of course already impose restrictions adopted and structured over several hundred years but with a respect for due process and fairness).
Another issue always looming is determining what is "material." Every company executive is "aware" of many possible upcoming events, possible product introductions that might have been talked about for years, possibilities stemming from hopeful and promising research or other new ideas. Many of these never reached the point of tangibility. However, just because he is "aware" in his daily executive life of many things, that with 20/20 hindsight might later be considered material, he could be charged with a crime under the SECís proposal. This entire area is fraught with danger. The situation is bad enough for executives. Taking away an important "element" of the crime makes it much easier for the prosecution in civil matters to bear its burden of proof by a "preponderance" and in criminal matters by its required "beyond a reasonable doubt." Use is an element that should not be eliminated. Not to leave use to the trier of fact allows prosecutors to have to do no more than show simple "awareness." In the SECís view that should be enough for conviction. A defendantís right to defend herself is virtually abrogated by beaurocratic fiat - not acts of Congress or judicial precedent.
I urge that no rule eliminating "use" be adopted. Furthermore, even though Adler suggested, a presumption of use and the shift of the burden of proof, if knowing possession is shown, in civil matters, it is in my view not acceptable either as even civil penalties can also be very harsh. Certainly such a presumption and shift of the burden of proof is totally unacceptable in criminal matters and the SECís rationale for such a radical change seems quite vague.
The Releaseís endnote #86 repeats OíHagan in which the Supreme Court stated the fraud occurred when the trader "uses the information to purchase or sell securities" without disclosure to his source. The endnote, however, goes on presumptuously to state proposed Rule 10b5-1 "is consistent with this [the Courtís] view." How so? OíHaganís reference can only have meant the court believed the defendant "used" the information as a factor in his trading - in fact, the direct and circumstantial evidence the government presented was extremely persuasive and the element of "use" was met. Although admittedly the Court did not state this directly, its dicta and obvious assumption that "use" was relevant to the crime, and shown to have occurred, does not support proposed Rule 10b5-1ís equation, i.e., awareness equals automatic illegality. (The proposed Ruleís four limited exceptions or "affirmative defenses" as you would prefer to dignify (perhaps better said, sanctify) them, do very little to offset the automatically guilty effect). The supposition of OíHagan does not support possession alone as sufficient for criminal conviction. The Courtís words do not support in any way the proposed Ruleís new "awareness" fiat.
Rule 10b5-2 - The SECís Proposed Attempt to Benefit Society by Bringing the Family Closer Together
Furthermore, proposed Rule 10b5-2ís automatic finding of "trust and confidence" that is, the existence of a fiduciary relationship simply because of a family relationship, would also produce great injustice. Unfortunately, not every familial relationship resembles the Ozzie and Harriet Nelson family. It was fictional. The only thing Rule 10b5-2 "is consistent with" is that fiction. It would be better to let the evidence indicate whether the insider confided the material nonpublic information to the family member with the reasonable expectation confidence would be maintained. As in United States v. Reed, leave it to the court or jury to determine, from the evidence, if a "pre-existing confidential relationship," and other relevant facts peculiar to each case, sufficiently establish the required existence of the duty of trust and confidence and whether any duty was violated. Furthermore, there is no reason the burden of proof to show the fiduciary relationship should not continue to remain with the government.
I would proffer that the analysis and rationale by the courts in Reed and United States v. Chestman were far more balanced and well-considered, and certainly more independent than the SECís views that certain familial relationships automatically create a fiduciary duty (a required element of a Rule10b-5 violation). As the Release itself reiterates, in both Reed and Chestman, neither a father-son relationship or marriage alone suffice to create or prove a fiduciary relationship (i.e., a pre-existing relationship of trust and confidence establishing the fiduciary relationship and the reasonable expectation of the speaker that the listener will not use or divulge the nonpublic confidential material information for trading purposes). Both Reed and Chestman referred to proofs necessary to establish fiduciary duty and the breach thereof, i.e., prior history of sharing confidences, "pre-existing fiduciary like relationship of the parties." Rule 10b5-2 is certainly an utterly profane perversion of Reed and Chestman.
"There are, then no hard and fast rules for determining whether a confidential relationship existsÖ." At Reedís footnote 31, there are helpful words to help define a confidential relationship, i.e., "where actual trust and confidence of a high type creates a corresponding duty." (Emphasis added.) The SECís proposed Rule 10b5-2 would assume the existence of such a relationship from a merely familial situation. That would obviously not satisfy Reed or the majority of the authorities it cites. See especially Reedís discussion of General Principles that may create confidential relationships. In that discussion the court states "the government concedes that the relationship between Reed and father was not inherently fiduciary, but argues instead that such relationship posses sufficient characteristics of a confidential relationship to subject Reed to the strictures of the securities laws." It is apparent that Government knew it had to prove the existence of such a relationship and that the court expected such proof to be presented. There were no assumptions merely from the familial relationship.
In Reed, involving the misappropriation theory, with regard to the governmentís view that the "intimacy of interaction" between father and son "and their repeated disclosure of confidences involving the affairs of business and commerce rendered their relationship Ďinstinct with obligation,í " the court answered,
[i]n the final analysis, the assessment of the existence or absence of such a relationship invariably requires a series of factual findings and generally rests with the finder of fact, i.e., the jury, at trial. ÖHowever, mere kinship does not of itself establish a confidential relationship (numerous citations omitted). Rather, the existence of a confidential relationship must be determined independently of a pre-existing family relationship.
In Reed, the indictment was challenged. First, the court said "[o]f course, none of these charges have been established by evidence" and that the matter concerned only the sufficiency of the indictment: "it is fundamental that an indictment must set forth the elements of the offense sought to be charged."
Reed then cites the Supreme Court in Chiarella v. United States in which the Court said "mere possession of non-public, confidential market information," without the presence of a fiduciary duty to someone, wasnít enough. Of course, that statement was made in the Courtís consideration of the SECís "disclose or abstain" dictum and made clear that a duty to disclose "arises only from a [fiduciary] relationship of trust and confidence between the parties to a market transaction or between the trading party and the source of information." It is clear the duty to disclose under ß10(b) does not arise from the mere possession of nonpublic information if a breach of the fiduciary duty element of a Rule 10b-5 charge is absent.
Attempting to Resurrect a Faulty Premise
Although having lost the applicability of "mere possession" as the heart of its "disclose or abstain" theory in virtually all courts considering the issue, proposed Rules 10b5-1 and 10b5-2 nonetheless pick up the "mere possession" already - disparaged premise in an audacious attempt to codify it in the SECís (not Congressí) "Rules." Under the pretense that Congress gave it unfettered discretion to do whatever the SEC wishes to ensure enforcement of the securities laws, the SEC hopes to negate the balanced, well-considered decisions of the courts. Even though the SECís beaten-up Rule 10b-5 position with respect to possession, i.e., that mere possession creates the duty to "disclose or abstain" (without regard to fiduciary duty), has failed in the courts, the proposed rules attempt to resurrect from its ashes the faulty stringent "disclose or abstain" doctrine in the form of mere "awareness" of inside information as equaling guilt. This time the doctrine arises from the dead, first in the form of proposed Rule 10b5-1 eliminating the governmentís need to prove the heretofore required, assumed, or implied element, under Rule 10b5, of "use" of inside information. Rule 10b5-2 also attempts to do its part to negate prior court decisions by eliminating the need for "fiduciary duty." The courts did not buy the "mere possession" theory as eliminating the need to prove fiduciary duty as an element of a Rule 10b-5 violation. Now mere "awareness" (a/k/a "possession" and the "disclose or abstain" doctrine poorly disguised) should not be allowed to reappear from the dark beyond, this time in the form of yet another attempt to eliminate not only fiduciary duty (at least in familial circumstances) but also "use" as a required element of the governmentís burden of proof.
In Reed, the district court, at its footnote 26 made reference to OíConnor & Assoc. v. Dean Witter Reynolds, Inc., which in explaining the breadth of parties wronged by defendantsí breach of fiduciary duties, referred to trading "on the basis of" insider (material nonpublic) information. Although, not discussing the meaning of "on the basis of" it is clear from the footnote OíConnor was making reference, in effect dicta, to the use of the information as a factor in the improper trading.
Reed also makes reference to SEC v. Materia stating "[i]n Materia, the Second Circuit reaffirmed its holding in Newman Ďthat one who misappropriates nonpublic information in breach of a fiduciary duty and trades on that information to his own advantage violates Section 10(b) and Rule 10b-5.í " (Emphasis added.)
The undersigned does not mean to condone tipping or misappropriating but argues that an element of ß10(b) fraud must involve "use." The direct and circumstantial evidence must prove "use" by a preponderance or beyond a reasonable doubt, as the case may be. Assuming violation of the federal securities laws simply because one is aware (no matter how obtained) of the inside information seems a woefully inadequate legal process by which to take oneís liberty or property or label her as a "convicted felon."
The SEC has in the past been cognizant intellectually and philosophically of the need for fairness and due process. That is why the Agency has had the respect of the bar and bench. There is an inherent conflict of interest, however, concerning balance and due process when a government agency is both promulgator of its own rules and prosecutor of those same rules. A lack of balance, equity and due process are suspiciously absent in Rules 10b5-1 and 10b5-2. The "leg-up" the SEC proposes for itself reflective in both Rule 10b5-1 and 10b5-2 (i.e., no need to prove use in the first or fiduciary duty in the second) presents a most egregious conflict. The bar has frequently in the past been cooperative with the SEC, settling most enforcement actions. These proposed amendments to Rule 10b-5 are a challenge to fairness, the securities bar and the justice system, that will surely interfere in certainly how the bar deals with the Agencyís staff.
It not infrequently occurs that "something" not originally visualized or anticipated comes together later as a result of prior events or facts or the confluence of circumstances already in place. Perhaps separately such events or facts or circumstances were not considered at a prior time as material or even noteworthy. As life goes on, an executive may trade, and a week later a spark ignites in an engineerís or another executiveís mind that puts "two and two" together from the previously existing events or facts or circumstances, and now a new product, idea, revenue opportunity or potential transaction comes into being that of course turns out to be "material."
With prosecutorial 20/20 hindsight it is now "easy" to look back and to see the materiality of those past events, facts or circumstances which hadnít yet been made public when Mr. VP traded. Of course Mr. VP was "aware" of these past events, facts or circumstances but he had also considered them in the past as unimportant, immaterial or insignificant. Neither he nor most of his associates, prior to the realization of the "obvious," had put "two and two" together, or recognized the noteworthiness of such past facts.
Now the stock "pops" because of the public announcement of the now recognized importance of those prior facts or events and Mr. VP who bought shares, is charged with insider trading because "of course anyone could have seen" the importance of those past events, facts or circumstances that existed when he bought and of which he was "aware."
Under todayís law in virtually all federal courts, he could argue that, although he was "aware of" or possessed such facts, he had not used such information because at the time he traded, it meant nothing to him. Further, neither he nor perhaps others, thought it was material at that time, and he gave it little consideration and certainly did not use that information as the basis of his trades. However, he admits he was "aware." Should he be guilty? Of course not. Would any of the four affirmative defenses proposed in the SECís release allow him to plead as a defense the situation as it occurred? Of course not. Under todayís majority view however, he could present the situation as he saw it at the time and attempt to convince the trier of fact of his non-use. Could he do this under the proposal? Apparently not. He was aware, but did he "use" that data when he bought, as the basis for his trade? He should be able to present proof of any facts or circumstances relevant that he did not. He should have the absolute right to present his excuse - his defense - to the trier of fact. The SECís proposal eliminating "use" as a defense and leaving to a defendant only four very restricted affirmative defenses is both unjustified and unfair as it virtually removes the right to defend oneself.
The government has both a common law and constitutional obligation to prove requisite specific criminal intent. There must be proof of a specific intention to commit a violation of the law, especially where one can lose oneís freedom. Furthermore, if the government is to charge one with a crime, it ought to have to show, that is, prove the defendant "did it." Simply because "he was in the neighborhood" or had the wherewithal to commit the crime is not enough. However, under this recent SEC proposal, the government merely initiates a Star Chamber proceeding and the defendant is then forced to take the stand, and to prove a negative, that is, prove she is not guilty. This is a travesty. A reversal of our system of law. The burden of proof to prove both a violation of civil or especially criminal law, must clearly be the obligation of the government. Most Americans still believe a defendant is deemed innocent until "proven guilty"; that is, until the government presents proof of all specific elements of the violation. Mere possession (or certainly the even more encompassing, "awareness") of information without its use and without specific intent to actually engage in a criminal act should be no crime.
The Commissionís proposal that would make mere "awareness" prima facie evidence of liability or guilt while at the same time limiting the defendant to four miserly affirmative defenses falls considerably outside our system of justice. I urge the Commission to abandon its proposals except for proposed Regulation FD.
Very truly yours,