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Media Alerts - United States v. Timothy McGee - Third Circuit
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August 18, 2014
  United States v. Timothy McGee - Third Circuit
Headline: SEC rule on misappropriation of confidential information is a valid interpretation of the Securities Exchange Act provision banning insider trading

Area of Law: Criminal, Securities

Issues Presented: Whether the SEC rule imposing insider trading liability for misappropriation of confidential information is invalid because it extends to non-fiduciary relationships?

Brief Summary: Timothy McGee, a financial advisor, became the confidant of Christopher Maguire through their involvement in the AA program. McGee received information from Maguire, who was an insider, about the unannounced sale of Philadelphia Consolidated Holding Corporation ("PHLY"). Subsequently, McGee's portfolio changed from having 10% to 60% holdings in PHLY stock which were then sold after the sale. When the SEC investigated this unusual trade activity, McGee testified under oath that he knew nothing of the PHLY sale. McGee was found by a jury to be guilty of securities fraud under the misappropriation theory of insider trading in violation of §10(b) of the Securities Exchange Act of 1934, SEC Rules 10b-5 and 10b5-2(b)(1)-(2) and perjury in violation of 18 U.S.C. §1621. On appeal, McGee challenged the validity of Rule 10b5-2(b)(1)-(2) saying that it exceeded the SEC's rulemaking authority. The Third Circuit found that, under Chevron, the SEC had not exceeded its rulemaking authority. Rule 10b5-2(b)(1)-(2) is owed Chevron deference because it has not been congressionally or judicially foreclosed and is "based on a permissible reading" of § 10(b). The conviction was affirmed.

Extended Summary: Timothy McGee appealed his conviction by a jury for securities fraud and perjury. Between 1999 and 2001, McGee, a financial advisor with 20 years of experience, became acquainted with Christopher Maguire through AA meetings. They developed a friendship that extended outside meetings and they would regularly go biking together and train for triathlons. They would share intimate and confidential information, but only as it pertained to their continued sobriety. McGee gave assurances to Maguire that their conversations were confidential and offered his services as a financial advisor. In the beginning of 2008, Maguire was in negotiations to sell Philadelphia Consolidated Holding Corporation ("PHLY"). The stress of the sale caused him to relapse and he started to again attend AA meetings. It was there that he met up with McGee and talked to him about the sale of PHLY, information that had not been released publicly and that Maguire assumed was told in confidence. After this conversation, McGee changed his stock portfolio from 10% of PHLY stock to 60%. He even borrowed money to finance the purchase of such a large amount of shares. After the sale of PHLY, their stock rose from about $35 a share to $58 a share. Due to the suspicious nature of McGee's stock purchases, the SEC began an investigation. In September 2012, he gave a sworn testimony to the SEC in which he claimed no foreknowledge of the PHLY sale before buying the stock.
In May 2012, McGee was indicted by a grand jury for securities fraud under the misappropriation theory of insider trading in violation of §10(b) of the Securities Exchange Act of 1934, SEC Rules 10b-5 and 10b5-2(b)(1)-(2) and perjury in violation of 18 U.S.C. §1621. McGee moved to dismiss the indictment saying that Rule 10b5-2(b)(1)-(2) is invalid because it allows for misappropriation liability without a fiduciary relationship between the perpetrator and his source, but the District Court denied his motion. On November 12, 2012 he was convicted by a jury of the two counts.
On appeal, McGee argued that the SEC exceeded its rulemaking authority by enacting Rule 10b5-2(b)(1)-(2). In reviewing McGee's argument, the Court began by looking at §10(b) of the Securities Exchange Act, the statute that enabled the SEC to create Rule 10b5-2(b)(1)-(2). The Court established that the Act created two kinds of insider trading: traditional and misappropriation. Misappropriation happens when a person, "misappropriates confidential information for securities trading purposes, in breach of a duty [to disclose] owed to the source of the information." The Court emphasized non-disclosure as a main factor in misappropriation violations. To determine whether the SEC overstepped in creating Rule 10b5-2(b)(1)-(2), the Court reviewed the Chevron deference framework which has two steps: (1) it must be determined whether the statute create by Congress was ambiguous on the precise issue in question and (2) if it is determined that it is, the rule will be upheld so long as it is "based on a permissible construction of the statute." McGee argued that the Chevron doctrine did not apply because the statute was not ambiguous. The Court disagreed. The Court reasoned that the statute did not define the term "deceptive" and it also did not address the issue at hand, thus allowing the gap to be filled by the SEC rule. The Court cannot fill the gap since the Chevron doctrine requires the courts to defer to an agency's interpretation, in this case Rule 10b5-2(b)(1)-(2). Therefore, even if the Court disagreed with the rule, it had no authority to overrule it.
The Court determined that §10(b) was ambiguous and so the Court moved to the second part of the Chevron doctrine to determine whether Rule 10b5-2(b)(1)-(2) was based on a permissible construction. The Court reasoned that the Rule was a tool to hold misappropriators accountable. It determined that the Rule was in line with the Act's purpose and thus was permissible. The Court held that Rule 10b5-2(b)(1)-(2) was valid under the SEC's rulemaking authority.
The Third Circuit also rejected McGee's arguments for reversal based on insufficient evidence to support the convictions and newly discovered evidence. McGee argued that no rational trier of fact could have found that McGee and Maguire had the relationship of trust or confidence needed for misappropriation liability, or the inside information was disclosed within the scope of such a relationship. The Court rejected the contention that McGee and Maguire did not have a relationship of trust and confidence. Rule 10b5-2(b)(1)-(2) requires a "history, pattern, or practice of sharing confidences" between the two parties which the jury believed existed between the two men. There were many years of confidences shared between the two men and Maguire testified that he believed that when he was telling McGee about the sale of PHLY, he was telling him in confidence. The Third Circuit agreed with the District Court's determination that there was sufficient evidence to support the conviction.
The Court also agreed with the District Court that McGee's unusual trading activity was enough evidence to corroborate the Maguire testimony. McGee had no previous history of such trades and his activity seems only to stem from the information he acquired from Maguire. The Court rejected McGee's argument there was insufficient evidence that his statement was false asserting that Maguire's testimony was unclear. Although Maguire was unsure of the exact date of his conversation with Maguire, he was able to give enough detail about the timing of it to satisfy the jury. The Court also disagreed that the SEC's questioning was ambiguous. The Court found McGee's attempt to find extreme ambiguity to be flawed. The Court held that Maguire's testimony was corroborated and there was sufficient evidence to support the finding that McGee had committed perjury.
Finally, the Third Circuit rejected McGee's claim that he was entitled to a new trial because of new evidence. The new evidence that McGee cited was a new affidavit from Tyler D. that was discovered during a civil case after his criminal conviction. The affidavit denied the statement "what you hear here, stays here" was made at the AA meetings McGee and Maguire attended. The Court determined that this evidence did not meet the five requirements for a new trial based on newly discovered evidence and would not have been strong enough to overturn McGee's convictions. For all the above reasons, the Court affirmed the District Court's judgment.
To read the full opinion, please visit http://www2.ca3.uscourts.gov/opinarch/133183p.pdf

Panel (if known): Chagares, Schwartz, and Aldisert, Circuit Judges

Argument Date: February 12, 2014

Date of Issued Opinion: August 14, 2014

Docket Number: No. 13-3183

Decided: Affirmed

Case Alert Author: Shanna Lafferty

Counsel: John C. Grugan, Esq., Christine R. O'Neil, Esq. for Appellant; and Jay M. Feinschil, Esq. for Amicus Appellant; and Zane D. Memeger, Esq., Frank R. Costello, Jr., Esq., Bernadette A. McKeon, Esq., for Appellee

Author of Opinion: Judge Aldisert

Circuit: Third Circuit

Case Alert Supervisor: Prof. Susan L. DeJarnatt

    Posted By: Susan DeJarnatt @ 08/18/2014 02:38 PM     3rd Circuit  

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