Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 97 C 2661--Ronald A. Guzman, Judge.
Before Bauer, Posner, and Ripple, Circuit Judges.
The opinion of the court was delivered by: Posner, Circuit Judge.
David Lipson appeals from a judgment in favor of the plaintiff, the Securities and Exchange Commission, that followed a jury's verdict that he had traded stock of a publicly traded corporation on the basis of inside information, in violation of the SEC's Rule 10b-5, 17 C.F.R. sec. 240.10b-5. 129 F. Supp. 2d 1148 (N.D. Ill. 2001); see Securities Exchange Act of 1934, sec. 10(b), 15 U.S.C. sec. 78j(b). The appeal challenges the instructions that the judge gave the jury on liability and the relief that he ordered.
Early in 1995, Lipson, at the time the chief executive officer of Supercuts, a chain of hair-cutting salons, learned that Supercuts' revenues were running lower, and its expenses higher, than expected. The company did not make this information public until May, and apparently it didn't leak out. In March and April Lipson sold 365,000 shares of Supercuts stock owned by partnerships that he controlled at prices in excess of $9 per share. When the bad news was finally announced, Supercuts' stock price plummeted from $9 a share, the price the day before the announcement, to $6½ the next day, though by the end of the day it had recovered to $75/8. By selling when he did, Lipson averted a loss of hundreds of thousand of dollars.
The evidence presented at trial was overwhelming that he had inside information when he sold the shares. The jury was not required to believe his implausible testimony that he paid no attention to the financial reports that his subordinates gave him. His inside information gave him an incentive to sell his shares before the information became public because it showed that Supercuts was worth less than its market valuation. Even skeptics about the prohibition of insider trading tend to look askance at an insider who profits from the poor performance of his company-- poor performance for which he may be responsible. See Frank H. Easterbrook & Daniel R. Fischel, The Economic Structure of Corporate Law 274-75 (1991); Henry G. Manne, Insider Trading and the Stock Market 150-51 (1966); but cf. Dennis W. Carlton & Daniel R. Fischel, "The Regulation of Insider Trading," 35 Stan. L. Rev. 857, 872, 873-75 (1983).
Lipson claimed, however, that whatever he may or may not have known about Supercuts' finances and whatever the impropriety of trading on inside information, his sole motive for selling when and how many of his shares he did was to comply with an estate plan that he had set up two years earlier to transfer wealth to his son free of gift or estate tax. The plan required the son to borrow at a specified interest rate $7.5 million from a company controlled by his father and use the borrowed money to buy interests in partnerships, controlled by his father, that owned Supercuts shares. The shares owned by the partnership interests that the son would be buying were worth $10 million, but he was permitted to buy them indirectly, by buying the partnership interests, for only $7.5 million because the interests were not controlling interests and lacked liquidity. (The analogy is to a closed-end mutual fund, whose shares frequently trade at a discount from the market price of the securities owned by the fund.) For him to exploit the difference between the indirect cost of the shares to him and their market value when "liberated" from the partnerships, the partnerships had to redeem his partnership interests by giving him shares in exchange for those interests, shares he could sell to pay down the loan. Had the value of the shares remained at $10 million, he would have ended up paying off the $7.5 million loan with $7.5 million worth of stock, thus retaining stock worth $2.5 million; and that would have been the amount of the wealth transfer from his father, as Lipson intended. Lipson and his tax accountant claimed at trial that Lipson had caused shares owned by the partnerships to be sold in 1995 solely in order to give his son cash that the son could use to pay down the loan and by doing so save some interest expense.
Lipson does not argue that no rational jury could have disbelieved his claim that he was motivated by the estate plan rather than by inside information in deciding to sell the shares. But he contends that the jury was improperly in structed on the issue. Although the jury was properly instructed that it could find a violation only if Lipson's trades had been motivated by inside information, another instruction, the one Lipson is complaining about, said that
if you find that Defendant Lipson possessed material, non-public information at the time that he sold . . . Supercuts stock, you may infer that Defendant Lipson used such information in selling . . . [it]. However, this inference may be rebutted by evidence that there was no connection between the information that the defendant possessed and the trading, in other words, that the information was not used in trading . . . . If you conclude that the trades . . . would have occurred on the same dates and involving the same amounts of stock regardless of whether Mr. Lipson possessed the inside information . . . , then you should find that Mr. Lipson did not use the inside information in selling . . . Supercuts stock.
Lipson contends that the instruction improperly shifted the burden of persuasion from the SEC to himself.
That would indeed have been improper. The weight of authority, scanty thought it is, supports the position that the Commission had the burden of persuading the jury that Lipson's trades had been influenced by the inside information that he possessed--the burden, in other words, of proving that inside information had played a causal role in Lipson's decision to sell the shares in the amount, and when, he did. SEC v. Adler, 137 F.3d 1325, 1340 (11th Cir. 1998); United States v. Smith, 155 F.3d 1051, 1066-69 (9th Cir. 1998). A considered dictum in United States v. Teicher, 987 F.2d 112, 120-21 (2d Cir. 1993), argues to the contrary that the knowing possession of such information should be enough to base guilt on: "one who trades while knowingly possessing material inside information has an informational advantage over other traders. Because the advantage is in the form of information, it exists in the mind of the trader. Unlike a loaded weapon which may stand ready but unused, material information can not lay [sic] idle in the human brain." Id. at 120. However sensible the Second Circuit's position may seem, the Commission is not pushing it in this case, and so we need not wrestle the issue to the ground. We note, however, that several months after Lipson's trial, the Commission promulgated a regulation that is in the spirit of the Teicher dictum and also follows a suggestion in SEC v. Adler, supra, 137 F.3d at 1337 n. 33. See 17 CFR sec. 240.10b5-1(b); 65 Fed. Reg. 51716. The regulation, however, as we're about to see, preserves a diminished requirement of causality.
The last sentence of the instruction we quoted gave Lipson a safe harbor, and is unobjectionable. The new SEC regulation creates a similar safe harbor. See 17 CFR sec. 240.10b5-1(c)(1). All the last sentence of the instruction says is that if Lipson would have sold the shares in the same amounts and on the same dates that he did sell them even if he had not possessed any inside information, then he would be home free, because then the existence of a causal connection between his inside information and the challenged sales would be negated. Cf. Conn v. GATX Terminals Corp., 18 F.3d 417, 420 (7th Cir. 1994).
Lipson can't reasonably object to the first sentence, either. It allows the jury to infer that if he had inside information, the trades were influenced by it. To infer Y from X just means that, if X happened, Y probably happened. If Lipson possessed nonpublic information which showed that Supercuts stock was overpriced, and having this information he sold a large quantity of that stock shortly before the information became public and the stock dropped sharply in value, common sense tells us that it is probable that his decision to sell when he did and how much he did (rather than sell later or sell less) was influenced by the information. SEC v. Adler, supra, 137 F.3d at 1340; 2 Alan R. Bromberg & Lewis D. Lowenfels, Securities Fraud & Commodities Fraud, sec. 7.4(625), pp. 7:160.42-45 (2d ed. Supp. 1999). The Ninth Circuit refused to allow such an instruction in a criminal case, United States v. Smith, supra, 155 F.3d at 1069, mindful of the Supreme Court's concern with the use of prosecution-favoring presumptions, see, e.g., Sandstrom v. Montana, 442 U.S. 510, 524 (1979), but did not challenge the presumption adopted in Adler for civil insider-trading cases. United States v. Smith, supra, 155 F.3d at 1069 n. 27.
The inference is sufficiently compelling to shift to a defendant in Lipson's situation the burden of production, that is, the burden of presenting some rebuttal evidence, on pain of suffering an adverse judgment as a matter of law if he does not. Allan Horwich, "Possession Versus Use: Is There a Causation Element in the Prohibition on Insider Trading?" 52 Business Lawyer 1235, 1276-77 (1997). And that is all the middle sentence in the instruction did. Lipson did present some evidence in rebuttal (the estate plan), enough to satisfy his burden of production and thus require the jury to decide whether to infer from the inside information and the timing of the trades whether his decision on when and how much to sell was indeed influenced by the information. Cf. St. Mary's Honor Center v. Hicks, 509 U.S. 502, 506-07 (1993); Texas Dept. of ...