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Federal Judge Charles Breyer of the U.S. District Court for the Northern District of California threw out much of an insider trading case last week, ruling that the government cannot prosecute a corporate outsider tipped off through his membership in an exclusive club. Breyer concluded that Keith J. Kim, the former chief executive officer of Oakland, Calif.-based potato chip maker Granny Goose Foods Inc., will not have to face two counts of securities fraud since he did not have a fiduciary-like relationship with the source of the information. Although Breyer alluded that in this case a wrong would go unpunished, he said Kim cannot, as a matter of law, be the guilty party. “While members of a club may feel a special bond, there is nothing so special about their relationship, as alleged in the indictment, that it gives rise to a legal duty not to trade on confidential information,” Breyer wrote. “We are very pleased with this definitive ruling that Keith Kim did not commit insider trading,” said Daniel Bookin, Kim’s defense attorney. Bookin is a partner in the San Francisco office of O’Melveny & Myers. Kim still could face one charge of lying to the SEC about his trades, although the U.S. attorney’s office has not decided on its next course of action. “The decision does not create new law,” Bookin said. “It applies settled law to the government’s attempt to expand the scope of insider trading liability.” Kim was a member of Young Presidents Organization, a national club for CEOs under age 50 who meet to discuss problems and share ideas. All members vow secrecy — what is said in the club stays in the club. Also a member of Kim’s YPO chapter was Gianluca Rattazzi, CEO of Meridian Data Inc. Rattazzi informed the club that he could not attend a retreat because his company was in merger talks. Allegedly based on that information, Kim and members of his family bought Meridian stock. Kim profited $830,000. Kim was charged under the misappropriation theory of insider trading, which holds liable corporate outsiders who learn inside information and trade on it in breach of a duty of trust or confidence. Courts have held that there must be a fiduciary relationship, or something similar to it, between the insider (the source) and the outsider (the trader). It was on that definition that the government and Judge Breyer disagreed. “We’re considering whether we’re going to appeal,” said Matthew Jacobs, spokesman for the U.S. Attorney’s Office. Last week, Breyer stayed the case pending the government’s decision. Breyer relied on U.S. v. Chestman, 947 F.2d 551, a 2nd U.S. Circuit Court of Appeals case which held that simply passing along material, non-public information does not form a fiduciary relationship. Instead, the 2nd Circuit wrote, at “the heart of the fiduciary relationship lies reliance, and de facto control and dominance.” At a hearing on the matter, much of the colloquy between Breyer and Assistant U.S. Attorney Patrick Robbins was spent defining a “fiduciary-like” relationship. Robbins argued that members of the club influence each other and therefore establish a form of control, but Breyer disagreed. The relatively few criminal misappropriation cases that have been brought usually involve relationships where one party has dominion over the other. Cases involving an employee-employer relationship are the most common, but cases involving doctor-patient and attorney-client relationships have also been brought. “As the analysis of Chestman and the examples explored above make clear, the primary essential characteristic of the fiduciary relationship is some measure of superiority, dominance or control,” Breyer wrote. In deciding that this case did not meet Chestman‘s standards, Breyer outlined three factors to consider. “Fiduciary-like dominance generally arises out of some combination of 1) disparate knowledge and expertise, 2) a persuasive need to share confidential information, and 3) a legal duty to render competent aid,” he wrote. The “gratuitous” disclosure of inside information didn’t measure up, Breyer held. He also suggested Rattazzi bears more responsibility than Kim for the alleged insider trades. “Extending misappropriation theory to cover the situation before the court would serve to legitimize the disclosure that took place because it would place primary blame with the defendant rather than the CEO of Meridian,” Breyer wrote. “The law should discourage gratuitous sharing of nonpublic information, by placing responsibility on the sources of that information to share it only for substantial reasons.” Rattazzi was not charged in the case. To charge him under so-called “tipper” liability, the government would have had to show that the disclosure was made for the purposes of a trade. The Securities and Exchange Commission also has a case pending against Kim, although it was not clear how Breyer’s decision would affect it. The SEC lawyer prosecuting it did not return a phone call for comment. Breyer also wrote that a rule recently adopted by the SEC, under which Kim likely would have been liable, was just that — a new rule, not one which merely clarified existing law. “So it does raise the possibility that similar conduct would be illegal under the new rule,” said Jared Kopel, a partner in the Palo Alto, Calif., office of Wilson Sonsini Goodrich & Rosati, and an expert in insider trading law. “He doesn’t say it’s illegal, but he does raise the possibility.”

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