Insider Trading in Advance of Acquisitions 136.

United States of America vs Chestman Overview:

1. Robert Chestman was a stockbroker and financial advisor for the brokerage house of Gruntal & Co. (Gruntal). Chestman met with Keith Loeb to discus Loebs transfer of various brockerage accounts to Grutal with the aim of consolidating his accounts, particularly his holdings in Waldbaum (a public company with shares trading in the over-the-counter market. 2. During the course of Chestmans relationship with Loeb, Chestman executed for him several transactions involving Waldbaum restricted and common stock. In order to facilitate some of the trades, Loeb had to send Chestman a copy of his wife's birth certificate, which indicated that Susan Loeb was the daughter of Shirley Waldbaum Witkin. 3. On November 26, Keith Loeb telephoned Chestman at 8:58 a.m. but was unable to contact him. Loeb told Chestman that he "had some definite, some accurate information" that Waldbaum was being sold at a "substantially higher" price than the market value of its stock. Loeb "asked [Chestman] what he thought I should do" with the information, but Chestman refused to give him a definite answer. 4. At 9:49 a.m. Chestman purchased 3000 shares of Waldbaum for himself at $24.65 per share. Between 11:31 a.m. and 12:35 p.m. Chestman purchased a total of 8000 shares for his discretionary accounts at prices ranging between $25.75 and $26.00 per share. Included in these purchases were 1000 shares for the Loeb account. 5. The tender offer was announced at the close of trading on November 26 at $49.00. Loeb received the confirmation slip, feigning surprise about the purchase in the presence of his wife. 6. Loeb learned he was likely to be subpoenaed by the SEC. Loeb immediately contacted Chestman, who again stated that he bought the stock on the basis of his research. 7. Trial Court: Chestman was convicted of the following: 10 counts of violation of section 10(b) and rule 10b-5; Count 2 of aiding and abetting Loeb in misappropriating material nonpublic information in breach of Loebs duty to the Waldbaum family: 9 counts for trading as a "tippee of the same material non -public information

He was convicted of mail or securities fraud

Issue: Whether or not rule 14e-3 (modeled after section 10(b) )is invalid? Section 14(e) of the Securities Exchange Act, enacted in 1968, makes it unlawful for any person "to engage in any fraudulent, deceptive, or manipulative acts or practices" in connection with a tender offer.

One violates Section 14(e) of the Securities Exchange Act, enacted in 1968, if he trades on the basis of material nonpublic information concerning a pending tender offer that he knows or has reason to know has been acquired "directly or indirectly" from an insider of the offeror or issuer, or someone working on their behalf. Rule 14e-3(a) is a disclosure provision.
Chestman's contention that rule 14e-3 is invalid because of the following: 1. SEC exceeded its rulemaking authority when it promulgated Rule

14e-3(a).
2. The government presented insufficient evidence to support these

convictions.
3. His convictions should be overturned on due process notice

grounds. We begin with his facial attack on the validity of Rule 14e-3(a).
Held:

SEC exceeded its rulemaking authority when it promulgated Rule 14e-3(a). Several district court judges in this Circuit have concluded that Rule 14e-3(a) represents a valid exercise of rulemaking authority. Acting pursuant to the authority granted by sections 14(e) and 23(a)(1), the SEC promulgated Rule 14e-3 in 1980. Under Rule 14e-3(a), Chestman was convicted. In short, the language and legislative history of

section 14(e), as well as congressional inactivity toward it since the SEC promulgated Rule 14e-3(a), all support the view that Congress empowered the SEC to prescribe a rule that extends beyond the common law.

There is a Sufficiency of Evidence

Chestman knew that Keith Loeb was a member of the Waldbaum family. Chestman knew that the information concerned the Waldbaum family business. He also knew that the information was not publicly available. Furthermore, he had heard Loeb describe the information as "definite" and "accurate."

SC disagree with Chestman's intimation that Loeb had to describe the information to Chestman as "confidential." A description of the information as "definite" and "accurate," together with Chestman's knowledge that Loeb was a Waldbaum relative, provided the crucial basis from which to infer confidentiality.

In

sum,

Chestman's

knowledge

of

Loeb's

status

as

Waldbaum family member and the nature of the information conveyed provided sufficient evidence from which a rational trier of fact could infer that the information originated, "directly or indirectly," from a Waldbaum insider. Due Process Chestman next argues that his Rule 14e-3(a) convictions violate due process because he did not have fair notice that his conduct was criminal. But SC ruled that the purpose of the "fair notice" requirement of due process is "to give a person of ordinary intelligence fair notice that his contemplated conduct is forbidden by the statute. Unlike Rule 10b-5, Rule 14e-3(a) is not a general,

catchall provision. It targets specific conduct arising in a unique context--tender offers. The language of the rule gave Chestman, a sophisticated stockbroker, fair notice that the conduct in which he engaged was criminal. When statutory language provides notice that conduct is illegal, the notice requirements of due process have been met.