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From Securities Regulation Daily, February 14, 2018

Petition argues for express requirement to apply ‘total mix’ standard

By Rodney F. Tonkovic, J.D.

A petition for certiorari has been filed asking the Supreme Court to address the materiality need for a conviction under Section 10(b). The petitioners were convicted of violations of Rule 10b-5(c) and take issue with the district court's instructions to the jury concerning materiality and the mens rea requirement for convictions under statutes requiring willfulness. The petition argues that the Ninth Circuit's affirmation of the district court's approach places it odds with the Supreme Court and the majority of the circuits (Ellison v. U.S., February 12, 2018).

The petitioners were employees of DBSI, Inc., a real estate investment company that collapsed in the wake of the 2008 financial crisis. In 2013, the Department of Justice investigated DBSI based on a set of investments offered in 2008 and relying on the theory that five misstatements allegedly exaggerated the company's financial stability. At trial, the three petitioners were ultimately acquitted on the counts charging them with violations of the mail and wire fraud statutes, or of subsections (a) or (b) of Rule 10b-5.

The petitioners, however, were also separately charged with, and convicted of, violations of Rule 10b-5(c), which broadly prohibits fraudulent conduct in connection with the purchase or sale of a security. Here, the district court instructed the jury that the government needed to prove that the defendants willfully engaged in fraud, noting further that acting "willfully" does not require knowledge that the conduct was unlawful. The court also issued an instruction on materiality that omitted a proposed instruction, based on Matrixx, that facts must be evaluated in light of the "total mix" of available information. The petitioners argue that this omission was crucial to their convictions because there was evidence showing that DBSI's financial status was correctly disclosed. The Ninth Circuit affirmed.

Total mix. The petition first asks whether a defendant can properly be convicted of violating Section 10(b) of the Exchange Act without proof that the relevant statement or conduct was material, based at least in part on its impact on the "total mix" of information made available to investors. According to the petition, the Supreme Court and most circuits define materiality in terms of the "total mix" of information available to investors. But, fact finders in the Ninth Circuit, plus the Fourth and Sixth circuits, may consider the importance of information in the abstract, without considering the total mix of information. So, the petition asserts, a defendant may be convicted based on an alleged act that had no potential to mislead investors. Other circuits expressly require juries to apply the "total mix" standard and, in those circuits, the petitioners' convictions would have been overturned.

Willfulness. Next, the petition argues that criminal convictions under Section 10(b) and Rule 10b-5 must require some level of mens reawith respect to the illegality of the underlying conduct. The Ninth Circuit's holding, the petition says, conflicts with the standards in the First and Third circuits and, in principle, with several analogous Supreme Court decisions, but at least two other circuits do not impose a mens rea requirement in the Rule 10b-5 context. The First Circuit, the petition explains, has indicated that convictions under statutes requiring willfulness necessarily require a guilty mens rea as to that conduct's lawfulness.

Rule 16. Finally, the petition also disputes whether a criminal defendant is required to produce, in advance, the exhibits he plans to use in cross-examining witnesses during the government’s case-in-chief, on the theory that such cross-examination actually constitutes part of the defendant’s own "case-in-chief" under Fed. R. Crim. Proc 16(b). Here, the Ninth Circuit held that the defendants had to disclose in advance exhibits used for cross-examination, which, the petition maintains is a departure from the meaning of "case-in-chief" as used in numerous Supreme Court opinions.

The petition notes in conclusion that the petitioners were acquitted of specific counts alleging fraudulent statements or omissions. The petitioners claim that they suffered serious prejudice from the omission of a "total mix" instruction since there was a large amount of pertinent information available to investors. And, regarding the mens rea issue, there was little evidence that the petitioners were directly involved in any portion of the fraud and less evidence that they were aware that they were involved in a fraud. Once the Ninth Circuit's erroneous instructions are corrected, the petitioners say, they will likely be acquitted following a directed verdict or new trial.

The petition is No. 17-1134.

Attorneys: Gene Clayton Schaerr (Schaerr Duncan LLP) for Mark Ellison. Noel J. Francisco, U.S. Department of Justice, for the United States.

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