By Gene C. Schaerr, a Partner with Schaerr Duncan LLP in Washington, DC. Mr. Schaerr is Counsel of Record for the petitioners on the certiorari petition discussed here.
The U.S. Supreme Court may be about to resolve two issues of enormous importance to anyone involved, directly or indirectly, in the sale of securities. The case that may provide the vehicle for such a ruling, Ellison v. United States, was recently the subject of an order directing the U.S. Solicitor General to file a response to the defendants’ petition for certiorari by May 21. That petition challenges a U.S. Court of Appeals for the Ninth Circuit decision that, as the Cato Institute, Reason Foundation, and a group of law professors explained in a supporting amicus brief, exacerbates a “system” already “stacked in favor of the government.”
The facts are straightforward: Following the 2008 financial meltdown, the U.S. Department of Justice understandably sought to hold accountable those who had engaged in the questionable business practices that led to the Great Recession. But here, the Department went too far, arresting and charging the petitioners for alleged violations of § 10(b) of the Securities Exchange Act that simply are not crimes under the Supreme Court’s interpretation of the law. Indeed, the petitioners were actually acquitted of all the counts of alleged securities fraud and wire fraud involving specific statements or omissions.
But they were nevertheless convicted of violating the vague “catchall” provision of the SEC’s Rule 10b-5, which purports to interpret § 10(b), and which makes it unlawful, directly or indirectly, to “engage in any act, practice, or course of business that operates or would operate as a fraud or deceit upon any person.”
In affirming the convictions, the Ninth Circuit exacerbated two serious circuit splits. First, the circuits are divided over whether a defendant can properly be convicted of violating § 10(b) without a showing that the statement, omission, or conduct on which the conviction was based was material, based at least in part on its impact on the “total mix” of information made available to investors.
Six circuits—following Supreme Court precedent—hold that a showing of materiality based on the “total mix” of information is necessary for a violation. A more stringent rule, the Supreme Court has said, would risk burying the investor in irrelevant information. But three other circuits—including the Ninth here—hold that a showing of materiality based on the “total mix” of information isn’t necessary, but that it’s enough if the information might have been of interest to investors.
Second, the circuits are divided on whether a defendant can properly be convicted under any federal criminal statute requiring willful misstatements or fraud—such as § 10(b)—without a showing that the defendant was at least generally aware that his conduct was unlawful. Here, the Ninth Circuit affirmed the defendants’ convictions despite their not having any such mens rea.
But this conflicts with several Supreme Court and appeals court cases holding that “willful” violations require mens rea as to the illegality of the conduct. Moreover, as the amici explained, “when Congress explicitly calls for” requirements of willfulness, that requirement must be enforced “without dilution.”
Last year, the Court unfortunately denied review in a similar mens rea case, Todd Farha v. United States, which was also supported by legal policy groups and law professors. In Farha, the conviction of the CEO of a Medicaid provider, Todd Farha, was upheld by the Eleventh Circuit, holding that a “knowing” violation of the law was satisfied by the circuit court’s standard jury instruction on “deliberate indifference” even though that lower standard of mens rea—more of a negligence standard—was expressly rejected by the High Court several years ago in a civil patent case (Global-Tech Appliances, Inc. v. SEB S.A.) as being insufficient to show a knowing intent to violate the law.
Ellison provides an excellent vehicle to do what was left undone in Farha—clarify that, to willfully violate a law, there must be some mens rea as to the unlawfulness of the underlying action. Ellison also gives the justices a chance to clear up the lower courts’ confusion about the proper application of the Supreme Court’s “total mix” standard of materiality. Resolving those two issues will substantially reduce the uncertainty in and, indeed, the over-criminalization, of the law governing all who are involved in selling securities.