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The securities fraud conviction of Joseph Falcone for stealing prerelease confidential information in a column in BusinessWeek has been upheld by the 2nd U.S. Circuit Court of Appeals. In so ruling, a three-judge panel said the Circuit’s misappropriation theory for fraud or deception “in connection with the purchase or sale of securities” — as required for a violation of Section 10(b) of the Securities Exchange Act of 1934 — remains intact under a recent U.S. Supreme Court decision. Falcone had claimed on appeal that his convictions in the Eastern District of New York on conspiracy to commit securities fraud and 13 counts of securities fraud should have been overturned because the legal landscape had been changed by the U.S. Supreme Court before his trial in United States v. Falcone, 00-1768. Investigators caught Falcone after learning that an employee of Hudson News had faxed a stockbroker acquaintance of Falcone’s a copy of the BusinessWeek column “Inside Wall Street,” before the close of trading on Thursdays, but before the magazine hit the news stands. The facts in the case, 2nd Circuit Judge Sonia Sotomayor said, were “virtually identical” to those in United States v. Libera, 989 F.2d 596 (2d Cir. 1993), in which defendants received pre-release copies of the “Inside Wall Street” column, a violation of BusinessWeek‘s confidentiality policy with distributors. “In Libera, the information was passed to the defendants after it had been misappropriated by an employee of BusinessWeek‘s printer,” Sotomayor said. “Here, an employee of entities further down the chain of distribution were the misappropriators.” The convictions in Libera were sustained under the 2nd Circuit’s misappropriation theory, which holds, in part, that the duty owed by traditional insiders who trade on nonpublic information is not the sole basis for liability under Rule 10(b), or, as Sotomayor said, “the duty that had been breached no longer was a duty owed to a party to a securities transaction.” Sotomayor cited the seminal case, United States v. Carpenter, 791 F.2d 1024 (2d Cir. 1986), in which the 2nd Circuit noted that “investors are endangered equally by fraud by noninside misappropriators as by fraud by insiders.” Following Libera, the U.S. Supreme Court decided United States v. O’Hagan, 521U.S. 642 (1997). “In O’Hagan, the Supreme Court resolved an intercircuit conflict regarding the validity of the misappropriation theory and held that a lawyer who traded in shares of the target company of a proposed acquisition based on information misappropriated from his law firm and his client, the company seeking to acquire the target, violated Section 10(b),” she said. “But it did not fully endorse the broad rationale this Circuit provided in Carpenter for why the deception of a source of confidential information was ‘in connection with’ the purchase or sale a security.” Falcone’s appeal, Judge Sotomayor said, argued that “under the misappropriation theory as defined by O’Hagan, it is not sufficient for the purposes of Section 10(b) liability that a misappropriation ultimately result in securities trading. Instead, he argues, the misappropriation in breach of a duty must itself have a certain nexus with securities trading that is lacking in the scenario at issue in Libera and the instant case.” AFTER ‘O’HAGAN’ The panel disagreed, with Sotomayor saying that Libera and Carpenter still provide the governing rule after O’Hagan. “While … the coincidence of a securities transaction and breach of duty — identified in O’Hagan as contributing to the satisfaction of the ‘in connection’ requirement — is not present where, as here, the misappropriator tips the information to an outsider but does not trade or have others trade on his or her behalf, the Supreme Court in O’Hagan did not purport to set forth the sole combination of factors necessary to establish the requisite connection in all contexts,” she said. “Accordingly, this Circuit after O’Hagan has applied the misappropriation theory to schemes involving nontrading tippers, albeit without discussion of the ‘in connection with’ requirement.” In sum, Judge Sotomayor said, “application of Libera to the instant case is therefore not undermined by the lack of a trading tipper here, notwithstanding the intervening decision in O’Hagan.” Senior Judges Wilfred Feinberg and Ellsworth A. Van Graafeiland joined in the decision. John Laurence Kase and Paula Schwartz Frome of Kase & Drucker represented Falcone. Eastern District Assistant U.S. Attorneys Michael Cornacchia, Peter Norling and Demetri M. Jones represented the government.

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