Tuesday, April 20th, 2021

Second Circuit upholds conviction for insider trading. United States v.  Chow, No. 19-0325, __F.3d__, 2021 WL 1256649 (2d Cir. Apr. 6, 2021) (C.J.J. Kearse, Carney, Bianco).

Benjamin Chow was a high ranking corporate officer at a couple of Chinese State-owned firms that, in 2016, tried to acquire Lattice Semiconductor Corporation, a manufacturer of a type of semi-conductor used in smart-phones. Op. 4, 5. Mr. Chow was alleged to have tipped off someone he knew, named Michael Yin, about the progress of the negotiations to acquire Lattice. Op. at 4-9 . During a 4-month period from July to November 2016, Yin traded on Lattice stock, purportedly based on this information, and made $5 million. Id. at 15.

A jury convicted Benjamin Chow of one count of conspiracy to commit securities fraud, in violation of 18 U.S.C. § 371; one count of securities fraud, in violation of 18 U.S.C. §§ 1348 and 2; and six counts of insider trading, in violation of 15 U.S.C. §§ 78j(b) and 78ff, 17 C.F.R. §§ 240.10b-5 and 10b5-2, and 18 U.S.C. § 2.  The jury also acquitted him of six other counts of insider trading. Op. at 20.

Sufficiency: On appeal, Mr. Chow argued that the evidence failed to show that he owed a duty of confidentiality to Lattice sufficient for insider trading liability under Section 10(b) of the Securities and Exchange of 1934 (15 U.S.C. § 78j(b)).

His argument apparently was premised on the fact that he wasn’t a company official or an employee of Lattice. But he had signed two nondisclosure agreements (“NDA”) with Lattice — when he, on behalf of his firms, was negotiating for the acquisition of Lattice — and each NDA included a confidential-information provision that stated: “Each Party agrees not to disclose, commercialize, or use any Proprietary Information of the other Party for any purpose, except to evaluate and/or engage in discussions regarding, and potentially pursue and effect, the potential business transaction involving the Parties.” Op. at 6, 9, 29.

The Circuit “characterize[s] individuals who enter into such confidentiality agreements, pursuant to which they are given access to company information that they agree not to disclose, as ‘temporary insiders’[.]” Op. at 27.

It acknowledged that the insider trading provisions of § 10(b) of the Securities Exchange Act of 1934  and Rule 10b-5 (17 C.F.R.  § 240.10b-5) “originally …applied to company officials or employees and employees” who take advantage of their company’s material nonpublic information “to enter into securities transactions” with people lacking such information. But the insider trading provisions are now “viewed as encompassing also persons who are not insiders but who nonetheless owe a duty of nondisclosure to the company and who misappropriate its confidential information for securities-trading purposes[.]” Op. at 24.

Thus, people outside of a company can be subject to insider trading laws under a “misappropriation theory.” Op. at 25, 26. So, “a person commits fraud ‘in connection with’ a securities transaction, and thereby violates § 10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.” Op. at 25 (citation and internal quotation marks omitted).

Here, the NDA’s imposed on Mr. Chow a duty of confidentiality with respect to Lattice. Op. at 24-30. And the timing of Mr. Chow’s communications with Michael Yin, and the timing of Yin’s profitable trades in Lattice stock were sufficient to establish that Chow intentionally disclosed material nonpublic information to Yin. Op. at 30-35. The Circuit also held that the evidence was sufficient to show that Mr. Chow expected some benefit from providing Yin information (to support the personal gain element), even though he did not expect to receive any of the $5 million profit. Id. 35-39.

Jury instruction: Mr. Chow also argued that the district court erred by instructing the jury that the two NDA’s “meant Chow had a duty of nondisclosure” to Lattice. Op. at 29. The Circuit said this argument was meritless because “Rule 10b5-2 itself states, for purposes of § 10(b), that ‘[w]henever a person agrees to maintain information in confidence,’ a ‘duty of trust or confidence’ exists.” Op. at 29-30 (brackets in original) (quoting 17 C.F.R. § 240.10b5-2(b)(1)).

Venue: The evidence was sufficient to establish (by a preponderance of evidence) that venue was  proper in the Southern District of N.Y. because Lattice stock was traded on the NASDAQ, which is located in Manhattan. Op. at 39-42. And “[t]he jury was entitled to infer that [Mr. Chow] would have been aware that the shares of Lattice were listed and traded on the NASDAQ, which was in Manhattan,” given his involvement in the due diligence process required for exploring the acquisition of Lattice and his postgraduate degrees in business. Id. at 42.

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