                                 United States Court of Appeals,

                                         Eleventh Circuit.

                                           No. 96-6084.

  SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Counter-Defendant-Appellant,

                                                 v.

                            Richard F. ADLER, Defendant-Appellee,

Phillip L. Choy, Magatronic Trading, Limited, Domer L. Ishler, Defendants-Counter-Claimants-
Appellees,

                             Harvey L. Pegram, Defendant-Appellee.

                                         March 27, 1998.

Appeal from the United States District Court for the Northern District of Alabama. (No. 94-P
T-2018-S), Robert P. Propst, Judge.

Before ANDERSON and COX, Circuit Judges, and ALARCON*, Senior Circuit Judge.

       ANDERSON, Circuit Judge:

       In this case, the appellant Securities and Exchange Commission ("SEC") brought a civil

action against appellees Harvey L. Pegram, Richard F. Adler, Philip L. Choy, Magatronic Trading

Limited,1 and Domer L. Ishler, alleging violations of § 10(b) of the Securities Exchange Act of 1934,

15 U.S.C. § 78j(b); SEC Rule 10b-5, 17 C.F.R. § 240.10b-5; and § 17(a) of the Securities Act of

1933, 15 U.S.C. § 77q(a). The SEC seeks treble damages for these alleged violations under the

Insider Trading Sanctions Act of 1984, 15 U.S.C. § 78u-1. The SEC argues that Pegram engaged



   *
    Honorable Arthur L. Alarcon, Senior U.S. Circuit Judge for the Ninth Circuit, sitting by
designation.
   1
   Magatronic Trading, Limited is a company owned by Philip Choy and on behalf of which
Choy traded his Comptronix stock. A default judgment was entered against Magatronic on
November 30, 1995, in the amount of $75,000. This default judgment has not been appealed.
in illegal insider trading in September 1989. The SEC argues that not only Pegram, but also the

other appellees engaged in illegal insider trading in November 1992. We reverse and remand.

                           I. FACTS AND PROCEDURAL HISTORY

A. Pegram's 1989 Transactions

       In 1984, Harvey Pegram, along with two business associates, founded Comptronix

Corporation ("Comptronix"), which provides contract manufacturing services to original equipment

manufacturers in the electronics industry. At that time, Pegram was made Vice President of

Purchasing and Material Management for Comptronix, and a member of its Board of Directors.

Pegram was also issued 869,897 shares of Comptronix Common Stock. In May 1989, Comptronix

made an initial public offering of its stock. In the years prior to the initial public offering, the

relationship between the Comptronix founders "disintegrated." In July 1989, Pegram was removed

from his position as Vice President of Purchasing and Material Management and made Vice

President of Marketing. On August 23, 1989, Pegram sued Comptronix and William Hebding, who

was at that time the Chairman and CEO of Comptronix, seeking a declaratory judgment and

damages.2 Immediately after Pegram's complaint was filed, Hebding asked Pegram to take an

indefinite leave of absence from Comptronix and to cease contact with Comptronix customers.

Pegram was eventually terminated in December 1989.

       During the early part of 1989, Comptronix began receiving decreased orders from one of its

largest customers, Conner Peripherals ("Conners"). On August 31, 1989, Comptronix issued a press

release stating that it had "received less than anticipated orders from another major customer for disk

drive products. As a result, management expects that sales and earnings for the second half of 1989


   2
    In his complaint, Pegram alleged that Comptronix had breached its employment contract
with him, that Hebding had misrepresented facts to Pegram concerning the operation of
Comptronix, and that Hebding had tortiously interfered with Pegram's employment contract.
will be lower than previously anticipated, but still significantly higher than the levels of the previous

year." On September 14, 1989, Pegram attended a meeting of the Comptronix Board of Directors.

Pegram contends that "nothing new of a material nature" was said regarding the Conners account

at this meeting, other than a statement reflected in the notes of Joe Ritch, the secretary and general

counsel of Comptronix, that "Conners shaky possibly all business offshore." The SEC contends, and

the revised minutes of the Board meeting reflect,3 that Comptronix's CEO, William Hebding,

reported to the Board that

        The Company was expecting either a complete termination or a substantial reduction in the
        orders from Conners, which is the largest customer of the Company due to Conner moving
        much of its manufacturing off-shore. Mr. Hebding stated that because Conners was the
        Company's largest customer, when the information was disseminated the stock of the
        Company would likely drop substantially.

Therefore, during the September 14 Board meeting, the Board adopted a resolution authorizing the

company to purchase up to one million shares of its own stock in order to support public confidence

in the company.4

        On September 19 through September 26, 1989, Pegram sold 20,000 shares of Comptronix

stock. On October 6, 1989, Comptronix issued a press release stating that the company "had

received less than anticipated orders from a major customer for disk drive products," the company

"expect[ed] orders from this customer to decline even further in the fourth quarter [of 1989]," and

that "[a]s a result, Comptronix anticipates that sales and earnings in the fourth quarter will be below


   3
   Pegram alleges that the revised minutes of the Board meeting were "doctored" by William
Hebding in order to make it appear that Pegram obtained material nonpublic information at the
Board meeting.
   4
    Pegram introduced evidence that at the September 14 Board meeting, Comptronix did not
know with certainty how many orders Comptronix would or would not receive from Conners,
and that after the September 14 Board meeting, Hebding met with Conners' president who
reassured Hebding that Comptronix would still be able to compete for Conners' orders.
However, Comptronix soon learned that they would receive little or no business from Conners.
the levels in the same period of 1988."5 In response to the Comptronix press release, the price of

Comptronix stock dropped from $3.63 to $2.63 over the next two trading days. The SEC maintains

that by selling 20,000 shares of Comptronix stock before the October 6 press release, Pegram

avoided $17,625 in losses.

       Pegram contends that his September 1989 sales of Comptronix stock were not made as a

result of any alleged material nonpublic information, but were part of a preexisting plan to sell

Comptronix stock in order to buy an eighteen wheel truck for his son's business. First, Pegram

emphasizes that he waited until September 19 to sell 20,000 shares of Comptronix stock because of

a 120-day "lock-up" period following the initial public offering of Comptronix stock on May 19.6

In an affidavit, Kenneth M. Sproul, Pegram's stockbroker, stated that on September 1, 1989, Pegram

discussed his intention of selling 20,000 shares of Comptronix stock and that Sproul informed

Pegram that the 120-day lockup agreement with Comptronix's underwriters would expire on

September 14, 1989. Furthermore, as required by Comptronix company policy, Pegram obtained

approval for a sale from Joe Ritch, Comptronix's general counsel on August 4, and September 16,

1989.7 Finally, Pegram emphasizes that he sold only 20,000 of his 869,897 shares of Comptronix



   5
    Pegram contends that an amended press release was issued by Comptronix on that same day
which stated that 1989 fourth quarter sales for Comptronix were expected to be higher than 1988
fourth quarter sales. The SEC alleges that no such amended release was issued and Pegram did
not produce any evidence of this purported amended press release.
   6
    This lock-up agreement prevented Comptronix officers and directors from selling any shares
of Comptronix stock until 120 days after the initial public offering of Comptronix stock on May
19, 1992.
   7
     Joe Ritch was also a board member and the corporate secretary of Comptronix. Ritch
attended and prepared the minutes of the September 14 Board meeting. When asked why he
interposed no objection when told of Pegram's proposed sale, and whether he believed Pegram
possessed material nonpublic information at the time, Ritch stated that he "really did not think of
it in those terms."
stock.

         The district court granted Pegram's motion for summary judgment regarding the 1989

transactions in an unpublished order on May 2, 1995. After concluding that it was "questionable"

whether the information Pegram acquired at the September 14 Board meeting was "material," the

district court found that Pegram "rebutted any reasonable inference that he acted with scienter as is

required under § 10(b), § 17(a), and Rule 10b-5" because (1) Pegram did not sell a significant

portion of his stock; (2) Pegram's intention to sell was known by the general counsel of Comptronix;

and (3) Pegram sold the Comptronix stock immediately after the lock-up period following

Comptronix's initial public offering.

B. 1992 Transactions of Pegram, Choy, and Ishler

         On November 15, 1992, the Comptronix Board of Directors held a special meeting that was

attended by Richard Adler, an outside director of Comptronix, by telephone from Taiwan. None of

the other appellees were present at this meeting. At the Board meeting, the Comptronix directors

were informed about potential fraud in which Comptronix CEO and President William Hebding,

President Allen Shifflet, and Treasurer Paul Medlin allegedly made $4 million in false accounting

entries in order to support certain capitalized costs of the company. At this meeting, the Comptronix

Board designated a Special Committee, of which Adler was a member, to oversee an investigation

into the scheme.8 After a week of investigation, another meeting of the Board of Directors was held

on November 23, 1992, and the directors were informed that $16 million in false accounting entries

had actually been made, that there were not legitimate capitalizable costs to offset these false entries,

and that Comptronix's sales records and earnings had been misstated. Therefore, on November 25,



   8
    The Comptronix directors were expressly advised that they must keep the information they
learned at the Board meeting secret and confidential.
1992, Comptronix publicly announced that Hebding, Shifflet, and Medlin were suspended from all

decision-making responsibilities at Comptronix and that the

       Board of Directors has formed a Special Committee to investigate certain matters relating
       to the Company's financial statements. Based upon preliminary findings, the Special
       Committee believes that since 1989, certain members of the Company's senior management
       have caused the Company to overstate gross profit by improperly recording certain assets
       on its balance sheet and either overstating current sales or understating current cost of sales
       on its income statement. There will likely be material adjustments to the Company's
       historically audited financial statements.

This announcement resulted in a suspension of trading in Comptronix securities. When trading

resumed by the end of the day, Comptronix common stock had lost 72 percent of its value, dropping

from a closing price of $22 per share on November 24 to a closing price of $6 1/8 per share on

November 25.

       Richard Adler has maintained a social and business relationship with Harvey Pegram for

over thirty years. On November 16, 1992, the day after Adler first learned of the potential fraud at

Comptronix, Pegram, who was no longer an officer or director of Comptronix, placed a call to

Adler's home in Taiwan at 7:53 a.m., Central Standard Time. Phone records indicate that this call

lasted 72 seconds.9 At 7:55 a.m., Pegram called his wife, Margie Pegram, at home. Margie Pegram

called the Pegrams' stock broker at approximately 8:07 a.m. and placed an order to sell 50,000 shares

of Comptronix stock at a limit price of $21 per share or better from a joint account she held with her

husband. Between November 16 and November 24, 1992, the Pegrams sold 150,000 shares of

Comptronix common stock. The SEC contends that Adler tipped Pegram in the early morning call

on November 16, 1992, and that the Pegrams avoided losses of $2,315,375.

       Harvey Pegram contends that the Pegrams' sale of Comptronix stock in November 1992 was



   9
    Later that same day, Pegram placed a second call to Adler at 4:26 p.m. that lasted 114
seconds.
made pursuant to a preexisting plan to sell 150,000 shares of Comptronix after the November 3

presidential election. During the summer of 1992, the Pegrams decided to sell 150,000 of their

400,000 shares of Comptronix stock based on their stockbroker's recommendation that they

"diversify" their stock holdings.10 In August of 1992, the Pegrams' tax planner computed the taxes

on selling 150,000 shares and advised them to sell the shares in the fourth quarter of 1992. There

is evidence that the Pegrams were planning to sell the shares after the November 3 presidential

election, but the illness and death of Mrs. Pegram's father delayed the sale. Mrs. Pegram returned

from her father's funeral on Friday, November 13, and she testified that November 16, the date of

their first sale of Comptronix stock, was the first opportunity she had to contact her stockbroker.

The Pegrams also emphasize that their 1992 sale of 150,000 shares of Comptronix stock was

"consistent" with their sale of 60,000 Comptronix shares in 1990 and 380,000 Comptronix shares

in 1991.

        The Pegrams also testified that Mr. Pegram's phone call to Mrs. Pegram on November 16

was a "wake-up" call and that Mr. Pegram made no mention of a phone call to Adler nor of any

fraud at Comptronix.11 Pegram testified that between December 1991 and December 1992, he

frequently contacted Adler concerning requests for price quotes on electronic parts and materials

that Pegram needed for his business, BST Manufacturing,12 and that his phone calls to Adler on


   10
     Both Mr. and Mrs. Pegram testified that the Pegrams debated about whether to sell 250,000
or 150,000 shares of Comptronix stock. Mrs. Pegram wanted to sell 250,000 shares, but they
eventually decided to sell only 150,000 shares.
   11
    The Pegrams testified that their first knowledge of any fraud at Comptronix came on
November 25, 1992, the date of Comptronix's public announcement, and at that time, they still
owned approximately 250,000 shares of Comptronix stock. The value of the Pegrams' remaining
shares dropped approximately $4 million the day of Comptronix's public announcement.
   12
   After being discharged by Comptronix in December 1989, Pegram purchased BST
Manufacturing, Inc., a small company which assembled electronic control boards, in December
November 16 related to these price quotes.13 Therefore, Pegram argues that he did not possess

material nonpublic information about Comptronix when he and his wife sold 150,000 shares of

Comptronix stock between November 16 and November 24, 1992.

          The SEC also contends that Pegram tipped two business associates, Philip L. Choy and

Domer L. Ishler,14 who then traded on the information. On November 16, 1992, the same day of the

call from Pegram to Adler, Pegram made a call to Choy at Magatronic Trading, Ltd. in Hong Kong

at 8:02 p.m.15 At 9:39 p.m. that evening, Choy telefaxed the brokerage firm for his company and

directed its stockbroker to sell 5000 shares of Comptronix stock at a price of "US$21/22" per share.

This order was executed on November 17 and 19, and the SEC contends that Choy and Magatronic

avoided losses of approximately $75,000 by selling Comptronix stock while in possession of

material nonpublic information. Choy and Pegram both testified that Pegram's phone call to Choy

on the evening of November 16 was related to price quotes for Pegram's business and that

Comptronix was not discussed by the parties. Pegram testified that he frequently contacted Choy,

a Hong Kong businessman, from December 1991 through January 1993 in order to obtain prices on

electronic parts for BST Manufacturing.

          The SEC contends that Domer Ishler was tipped by either Pegram or Adler. On November



1991.
   13
     On November 5, 1992, Adler sent a facsimile to Pegram regarding an earlier facsimile from
Pegram in which Pegram sought price quotes on electronic parts. Pegram testified that he did
not have an opportunity to review and respond to Adler's facsimile until November 16 because
of the death of his father-in-law. Pegram testified that the electronic parts, which were scarce
and difficult to obtain, were ultimately purchased by BST from a company which Adler worked
with to obtain and supply "difficult to locate" electronic parts.
   14
    Pegram, Adler, Ishler, and Choy, in addition to being business associates, also saw each
other socially on occasion.
   15
        This call lasted 4 minutes and 42 seconds.
15, 1992, Ishler called Adler while Adler, by telephone, was participating in the special Comptronix

Board meeting regarding the potential fraud at Comptronix. Adler and Ishler both testified that

Adler put the Board meeting on hold and told Ishler that he could not talk with him and that Adler

would call Ishler later. After a series of missed connections, Ishler reached Adler on November 23

while Adler was in the U.S. for a Comptronix board meeting. Ishler and Adler both testified that

in this call Adler told Ishler that he was in a meeting and that as soon as he knew his schedule, Adler

would call Ishler so they could "get together". The SEC contends that Ishler was tipped about the

fraud at Comptronix during one of his two phone calls with Adler or during a November 23, 1992,

phone call with Pegram,16 and that on November 24, Ishler purchased 300 "put options" in

Comptronix stock based on this inside information.17 Ishler eventually realized gains approximating

$368,750 when he exercised the options after Comptronix's public announcement on November 25,

1992.

        In its May 2, 1995, order granting summary judgment to Pegram in regard to his 1989


   16
     On November 23, 1992, one week after Pegram was allegedly tipped by Adler, Ishler called
Pegram at his home at 11:23 p.m., and they had a conversation that lasted approximately
twenty-five minutes. The SEC contends that Pegram revealed inside information about the fraud
at Comptronix during this call. Pegram and Ishler both contend Ishler called Pegram in order to
determine the whereabouts of Adler.
   17
     Ishler purchased these put options for approximately $21,000. The put options gave Ishler
the right to sell 30,000 shares of Comptronix stock at $20 a share and the options expired in
three weeks. When Ishler purchased the options, Comptronix was trading at $221/2 per share
and thus unless the price of the stock fell below $20 a share, Ishler would lose his $20,000
investment. Ishler testified that he went to the stockbroker on November 24 in order to sell a
thousand shares of Comptronix "short" because he believed the price of Comptronix stock would
drop a few dollars a share. Ishler and his broker both testified that they discussed the stock of
two other companies that were in a similar line of business as Comptronix. After writing out the
ticket to sell Comptronix short, either the broker or Ishler mentioned buying put options because
selling short would not have been nearly as profitable as buying put options. Ishler had
purchased put options in 1990 with the same broker, and the broker testified that Ishler had a
history of buying "highly speculative, high risk, leverage type" stocks in industries similar to
Comptronix.
transactions, the district court denied Pegram's motion for summary judgment with regard to the

1992 transactions because the timing of the telephone calls between the appellees raised "a

reasonable inference of materiality and scienter on the part of the defendant [Pegram]." Therefore,

the 1992 claims went to trial. However, after a seven day jury trial, the jury was unable to reach a

verdict and the district court declared a mistrial. The appellees then filed renewed motions for

judgment as a matter of law and the district court granted the motions in an October 24, 1995,

order.18 In granting Pegram's motion for judgment as a matter of law, the district court concluded

that the calls from Pegram to Adler, from Pegram to his wife, and from Pegram's wife to her

stockbroker, raised a "possible reasonable inference" that Pegram received inside information from

Adler, but "any such inference" was rebutted by the evidence of Pegram's preexisting plan to sell

150,000 shares of Comptronix stock in November 1992. The district court also granted judgment

as a matter of law to Adler and Choy and summary judgment to Ishler because the district court

concluded that "the facts and circumstances related to the other defendants [were] similar [to

Pegram] and the principles [were] the same."19



   18
     In this order, the district court allowed Ishler time to convince the court that he had timely
filed an initial motion for judgment as a matter of law and/or to file a motion for summary
judgment. In order for a court to consider a renewed motion for judgment as a matter of law, the
moving party must have made a motion for such a judgment under Rule 50(a) at the close of all
the evidence. Austin-Westshore Const. Co., Inc. v. Federated Dept. Stores, Inc., 934 F.2d 1217,
1222 (11th Cir.1991); Fed.R.Civ.P. 50(b). Because the SEC alleged that Ishler had not timely
filed his initial motion for judgment as a matter of law at the close of evidence, Ishler filed a
submission to establish that his initial motion for judgment as a matter of law had been timely
filed. Ishler also filed a motion for summary judgment. On December 6, 1995, the district court
entered an order granting Ishler's motion for summary judgment based on all the evidence
introduced at trial.
   19
     The district court noted that the revealed jury split was 6-1 in favor of Ishler and that there
was "no need to discuss the evidence as to the other parties in detail" because the SEC had "built
its case on a domino theory" and thus "[i]f the Adler-Pegram domino is not significant, the others
lose significant position."
                                          II. DISCUSSION

       We first discuss Pegram's 1989 transactions, and then discuss the 1992 transactions involving

all four appellees.

A. Pegram's 1989 Transactions

       A district court's grant of summary judgment is reviewed de novo, applying the same

standards utilized by the district court. Konst v. Florida East Coast Ry. Co., 71 F.3d 850, 852 (11th

Cir.1996). Summary judgment should be granted only "if the pleadings, depositions, answers to

interrogatories, and admissions on file, together with the affidavits, if any, show that there is no

genuine issue as to any material fact." Fed.R.Civ.P. 56(c).

1. The SEC's Legal Argument: The Knowing Possession Test

       The SEC argues that the district court erred as a matter of law in granting summary judgment

for Pegram in regard to his 1989 transactions in Comptronix stock because, in concluding that

Pegram's preexisting plan to sell stock rebutted any reasonable inference of scienter created by the

suspicious timing of his sales, the district court improperly considered whether Pegram used inside

information in his trading. The SEC argues that the district court incorrectly adopted a causal

connection standard for insider trading violations that allows a trader to avoid liability if the trader

proves that he did not purchase or sell securities because of the material nonpublic information that

the trader knowingly possessed. The SEC argues that it presented evidence that Pegram knowingly

possessed material nonpublic information, and thus Pegram, as a corporate director, violated the

prohibition against insider trading found in § 10(b), Rule 10b-5, and § 17(a) because, "whether or

not Pegram used the inside information," Pegram traded in his company's stock while in possession

of material nonpublic information.

       At the time of Pegram's September 1989 sales, it is clear that Pegram possessed nonpublic
information. Pegram had attended the September 14, 1989, Comptronix Board meeting at which

nonpublic information was disclosed to Comptronix Board members. There is a genuine issue of

fact as to whether this nonpublic information was material. In determining whether knowing

possession of material nonpublic information, without regard to whether this information was used

or was an actual cause of the sale or purchase of securities,20 is sufficient to establish liability under

§ 10(b), Rule 10b-5, and § 17(a), we must first consider the language of these provisions. See Ernst

& Ernst v. Hochfelder, 425 U.S. 185, 197, 96 S.Ct. 1375, 1383, 47 L.Ed.2d 668 (1976) (quoting

Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 756, 95 S.Ct. 1917, 1935, 44 L.Ed.2d 539

(1975) (Powell, J., concurring)). Section 10(b) of the Securities Exchange Act of 1934 provides that

        It shall be unlawful for any person ... [t]o use or employ, in connection with the purchase or
        sale of any security ..., any manipulative or deceptive device or contrivance in contravention
        of such rules and regulations as the Commission may prescribe as necessary or appropriate
        in the public interest or for the protection of investors.

Pursuant to its rulemaking power under § 10(b), the SEC promulgated Rule 10b-5, which provides

that it is unlawful for any person

        (a) To employ any device, scheme, or artifice to defraud,

        (b) To make any untrue statement of a material fact or to omit to state a material fact
        necessary in order to make the statements made, in the light of the circumstances under
        which they were made, not misleading, or

        (c) To engage in any act, practice, or course of business which operates or would operate as
        a fraud or deceit upon any person, in connection with the purchase or sale of any security.

Section 17(a) of the Securities Act of 1933 provides that it shall be unlawful for any person in the

offer or sale of any securities:

        (1) to employ any device, scheme, or artifice to defraud, or


   20
    We refer to the two competing tests in the following shorthand: the SEC's position is "the
knowing possession" test, while the position advocated by Pegram is the "use" or "causal
connection" test.
       (2) to obtain money or property by means of any untrue statement of a material fact or any
       omission to state a material fact necessary in order to make the statements made, in the light
       of the circumstances under which they were made, not misleading, or

       (3) To engage in any act, practice, or course of business which operates or would operate as
       a fraud or deceit upon the purchaser.

Although § 10(b), Rule 10b-5, and § 17(a) do not explicitly address whether mere possession of

material nonpublic information at the time of trading is sufficient for establishing liability of a

corporate insider, the language suggests a focus on fraud, deception, and manipulation.

       Several Supreme Court decisions are relevant to our discussion. In Chiarella v. United

States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), the Supreme Court repeated the

familiar maxim that under § 10(b) a corporate insider has a duty to disclose material nonpublic

information or to abstain from trading on the information. Id. at 226-28, 100 S.Ct. at 1114 (quoting

In re Cady, Roberts & Co, 40 S.E.C. 907, 911 (1961)). This "disclose or abstain" rule derives from

the fiduciary duty that corporate insiders owe to the shareholders of the corporation. The SEC

argues that the "disclose or abstain" rule supports its position that knowing possession of material

nonpublic information while trading is sufficient to establish liability under § 10(b). However,

immediately after reciting the "disclose or abstain" rule, the Chiarella court stated that an insider's

duty arises from "the unfairness of allowing a corporate insider to take advantage of [inside]

information by trading without disclosure," id. at 226-28, 100 S.Ct. at 1114 (emphasis added) (citing

In re Cady, Roberts & Co., 40 S.E.C. at 912, and n. 15), and that "[t]he federal courts have found

violations of § 10(b) where corporate insiders used undisclosed information for their own benefit."

Id. at 229-30, 100 S.Ct. at 1115 (citing SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir.1968)).

       In Dirks v. SEC, 463 U.S. 646, 662, 103 S.Ct. 3255, 3265, 77 L.Ed.2d 911 (1983), the Court

found that a tippee's duty to disclose or abstain "is derivative from that of the insider's duty," and

thus a tippee is only liable under § 10(b) or Rule 10b-5 for trading on the basis of material nonpublic
information if the inside tipper breached a fiduciary duty in disclosing to the tippee. In determining

whether the disclosure constituted such a breach of duty, the Court considered whether the inside

tipper personally benefitted directly or indirectly from the disclosure to the tippee. Id. at 659-62,

103 S.Ct. at 3264-65 (concluding that "[a]bsent some personal gain [to the corporate insider], there

has been no breach of duty to stockholders").21 The Court stated that "[n]ot only are insiders

forbidden by their fiduciary relationship from personally using undisclosed corporate information

to their advantage, but they also may not give such information to an outsider for the same improper

purpose of exploiting the information for their personal gain." Id. at 659-60, 103 S.Ct. at 3264

(emphasis added). This language and the Dirks Court's holding that an inside tipper must gain some

personal advantage in order for an outside tippee to be liable for trading on material nonpublic

information, suggests that knowing possession of material nonpublic information at the time of

trading may not be enough to establish liability for insider trading. Furthermore, the majority and

the dissent in Dirks disagreed about whether motivation is relevant to proving scienter as an element

of an insider trading violation.      Responding to the dissent's contention that "[t]he scienter

requirement addresses the intent necessary to support liability; it does not address the motives

behind the intent," Dirks, 463 U.S. at 674 n. 10, 103 S.Ct. at 3271 n. 10 (Blackmun, J., dissenting),

the Court stated that "contrary to the dissent's suggestion ... motivation is not irrelevant to the issue

of scienter. It is not enough that an insider's conduct results in harm to investors; rather a violation

may be found only where there is "intentional or willful conduct designed to deceive or defraud

investors.' " Dirks, 463 U.S. at 663 n. 23, 103 S.Ct. at 3266 n. 23 (quoting Ernst & Ernst v.

Hochfelder, 425 U.S. at 199, 96 S.Ct. at 1383). Finally, in United States v. O'Hagan, --- U.S. ----,


   21
     The Court also stated that "a purpose of the securities laws was to eliminate "use of inside
information for personal advantage.' " Dirks, 463 U.S. at 662, 103 S.Ct. at 3265 (quoting In re
Cady, Roberts & Co., 40 S.E.C. 907, 912 n. 15 (1961)).
117 S.Ct. 2199, 138 L.Ed.2d 724 (1997), the Court stated that "[u]nder the "traditional' or "classical

theory' of insider trading liability, § 10(b) and Rule 10b-5 are violated when a corporate insider

trades in the securities of his corporation on the basis of material, nonpublic information. Trading

on such information qualifies as a "deceptive device' under § 10(b)." Id. at ----, 117 S.Ct. at 2207

(emphasis added).22 We acknowledge that the Supreme Court's language in Chiarella, Dirks, and

O'Hagan is dicta, because in those cases there was no question that the material nonpublic

information was actually used in trading.

        Surprisingly, few courts have directly addressed whether § 10(b), Rule 10b-5, and § 17(a)

require a causal connection between the material nonpublic information and the insider's trading or

whether knowing possession of material nonpublic information while trading is sufficient for

liability.23 In United States v. Teicher, 987 F.2d 112, 119 (2d Cir.1993), the two defendants, who

were convicted by a jury of securities fraud, argued on appeal that "the district court's jury charge

erroneously instructed the jury that the defendants could be found guilty of securities fraud based


   22
     In O'Hagan, the Court held that liability may be based on the "misappropriation theory"
because "misappropriators ... deal in deception. A fiduciary who "[pretends] loyalty to the
principal while secretly converting the principal's information for personal gain ' ... defrauds the
principal." O'Hagan, --- U.S. at ----, 117 S.Ct. at 2208 (emphasis added).
   23
      Although few courts have directly addressed the issue, a number of commentators have
expressed their views on the use versus possession debate, with the majority appearing to favor a
causal connection/use standard. See Allan Horwich, Possession Versus Use: Is There A
Causation Element in the Prohibition on Insider Trading?, 52 Bus. Law. 1235, 1268 (1997)
(ultimately concluding, after a careful and thorough analysis of the relevant case law, that the use
test is "the better rule"); 2 A. Bromberg & L. Lowenfels, Securities Fraud & Commodities
Fraud, § 7.4(600), at 7:159, 7:160.14 (1996) (ultimately concluding, after significant analysis,
that a corporate insider can introduce evidence of nonuse of material nonpublic information as an
affirmative defense); 3 Arnold S. Jacobs, Litigation and Practice Under Rule 10b-5, § 66.02[c],
at 3-657 (1981) (concluding that one of the "exceptions" to the "general" disclose or abstain rule
is that an "insider's decision to buy or sell must be based on his inside information"); but see 7
L. Loss & J. Seligman, Securities Regulation 3504-3505 (3d ed.1991) (concluding, after brief
analysis, that "[t]he very difficulty of establishing actual use of inside information points to
possession as the test").
upon the mere possession of fraudulently obtained material nonpublic information without regard

to whether this information was the actual cause of the sale or purchase of securities." In discussing

the issue of whether a "causal connection" is a required element of a Rule 10b-5 violation, the court

listed several factors which tended to support the SEC's position that a "causal connection" is not

required and that a violation is established merely upon proof that a trade was conducted while the

trader knowingly possessed material nonpublic information.24 Although it is fair to say that the

Teicher court appeared to look favorably upon the SEC's suggested test, the court's discussion was

clearly dicta. The court expressly found that it was "unnecessary to determine whether proof of

securities fraud requires a causal connection." Id. at 121.25

        In addition to the Supreme Court's language in Chiarella, Dirks, and O'Hagan, several cases



   24
     The factors discussed included (1) the language of § 10(b) and Rule 10b-5 "require only that
a deceptive practice be conducted "in connection with the purchase or sale of a security' " and
the "in connection with" clause has been interpreted "flexibly"; (2) a "knowing possession" test
"comports" with the disclose or abstain rule; (3) an inside trader "has an informational
advantage over other traders;" and (4) the difficult task that the SEC would face in attempting to
prove that the inside information actually impacted the insider's investment decision. Teicher,
987 F.2d at 120-21. We find it difficult to understand how the first factor is relevant to the
choice between a knowing possession and a use test. In light of Chiarella and Dirks, we do not
believe that the third factor, an informational advantage, can be considered a significant factor in
establishing a Rule 10(b) violation. See Chiarella, 445 U.S. at 232-35, 100 S.Ct. at 1116-18
(rejecting the lower court's theory that the use by anyone of material nonpublic information
results in unequal access to information, creates an unfair advantage, and thus is fraudulent; the
Court held that not every instance of financial unfairness constitutes fraud under § 10(b)); Dirks,
463 U.S. at 656-57, 103 S.Ct. at 3262-63 (also rejecting the equal access to information theory).
We discuss the second and fourth factors below and conclude that they do not persuade us to
adopt the knowing possession test.
   25
     The court in Teicher obviously found the defendants' alleged motivations for trading to be
unpersuasive. The court stated, "It strains reason to argue that an arbitrageur, who traded while
possessing information he knew to be fraudulently obtained, knew to be material, knew to be
nonpublic—and who did not act in good faith in so doing—did not also trade on the basis of that
information." Teicher, 987 F.2d at 121. By considering the defendants' alleged motivations for
trading, the Teicher court applied a use/causal connection-type standard for insider trading
liability.
arguably provide support for the proposition that there is no violation of § 10(b) and Rule 10b-5 in

the absence of some causal connection between the material nonpublic information and an insider's

trading. In a number of cases, courts have allowed insiders to introduce evidence of preexisting

plans or other "innocuous" reasons for sales in order to rebut an inference of scienter. In In re

Worlds of Wonder Securities Litigation, 35 F.3d 1407, 1427-28 (9th Cir.1994), the court concluded

that "[e]ven if the evidence was sufficient to permit an inference that one or more of the defendants

had access to inside information, the defendants' actual trading would conclusively rebut an

inference of scienter." Furthermore, the court emphasized that some of the insiders "sold their

shares pursuant to a predetermined plan," one insider sold "because it faced a pressing need to

service a huge debt incurred from overinvesting in real estate," and another insider only sold a small

percentage of his shares. Id.; see also Dura-Bilt Corp. v. Chase Manhattan Corp., 89 F.R.D. 87,

94-95 (S.D.N.Y.1981) (In the context of a class certification and the defendants' argument that

individual issues of fact predominated, the court indicated that a relevant issue was whether the

defendants "relied on inside information in making ... trading decisions." The court stated that

"[d]efendants' reliance on inside information ... may be inferred from a showing of defendants'

possession of the information ... [w]hile defendants may introduce evidence to rebut this inference

of use....").26


   26
     Pegram cites a number of other cases in support of the proposition that a trader in possession
of material nonpublic information is able to rebut an inference of use by producing evidence of a
preexisting plan to sell or another "innocuous" reason for trading. See, e.g., Searls v. Glasser, 64
F.3d 1061, 1068 (7th Cir.1995); Acito v. IMCERA Group, Inc., 47 F.3d 47, 54 (2d Cir.1995);
Rubinstein v. Collins, 20 F.3d 160, 169 n. 38 (5th Cir.1994); In re Apple Computer Sec. Litig.,
886 F.2d 1109, 1117 (9th Cir.1989). The SEC argues that these cases are not applicable to the
use versus possession debate because the cases were not actions for inside trading violations, but
instead involved actions in which the insiders' trading was introduced as evidence of the insiders'
failure to make timely public announcements of unfavorable corporate information or as
evidence that the insiders' disclosure of positive information was a misrepresentation. We agree
with the SEC that these cases cited by Pegram are not clearly applicable because the relevant
        The SEC's position on whether knowing possession of material nonpublic information while

trading is sufficient to establish insider trading liability under § 10(b), Rule 10b-5, and § 17(a) has

undergone some fluctuation over time. In In re Investors Management Company, Inc., [1970-71

Transfer Binder] Fed. Sec. L. Rep. (CCH), ¶ 78,163, at 80,514 (SEC Ruling July 29, 1971), the SEC

concluded that one of the elements of an insider trading violation under § 10(b) and Rule 10b-5 is

that the material nonpublic information "be a factor in [the insider's] decision to effect the

transaction." Id. at 80,519. In evaluating this element, the SEC stated that when an insider engages

in a sale just prior to public dissemination of adverse inside information, then an inference arises that

the information was a factor in the investment decision, but "the recipient [of the inside information]

of course may seek to overcome such evidence by countervailing evidence." Id. at 80,522 n. 28

(finding that the defendants' claims that they traded based on "unconfirmed rumor" and "careful,

painstaking analysis" of the corporation were not sufficient to meet the defendants' "burden").27 In

Report of the Investigation in the Matter of Sterling Drug, Inc., [1978 Transfer Binder] Fed. Sec.

L. Rep. (CCH), ¶ 81,570, at 80,295 (SEC Ruling April 18, 1978), the SEC, without mentioning its

prior ruling and without stating any rationale for its change of position, stated that "Rule 10b-5 does

not require a showing that an insider sold his securities for the purpose of taking advantage of

material non-public information." Id. at 80,298 (rejecting evidence of an insider's preexisting plan

to sell because the SEC found that trading while in knowing possession of material nonpublic




issues did not involve whether the allegedly unfavorable inside information was the basis or
cause of the insider trading, but instead involved whether the insiders actually possessed
"negative" material nonpublic information.
   27
     Commissioner Smith found that a corporate insider would not be liable under § 10(b) and
Rule 10b-5 "where a firm decision to effect a transaction had been clearly made prior to the
receipt of the information and the information played no substantial role in the investment
decision." Investors Management Co., Inc., ¶ 81,570 at 80,524 (Smith, concurring in result).
information is sufficient for an insider trading violation).28

        We also must consider whether the provision allowing the SEC to seek treble damages, the

Insider Trading Sanctions Act of 1984 ("ISTA"), helps resolve whether possession or use is the

proper standard for an insider trading violation under § 10(b), Rule 10b-5, and § 17(a). See Aaron

v. SEC, 446 U.S. 680, 700, 100 S.Ct. 1945, 1957, 64 L.Ed.2d 611 (1980). In ISTA, Congress

amended the Securities Exchange Act of 1934 to give the SEC authority to seek a civil penalty of

up to three times the amount of profit gained or loss avoided by a person who violates the federal

securities laws "by purchasing or selling a security while in possession of material, nonpublic

information." 15 U.S.C. § 78u-1(a) (1997). Although Congress used the language "in possession"

in ISTA, numerous statements in the legislative history of ISTA disclaim any intent to modify the

common law definition of an insider trading violation. H.R.Rep. No. 98-355 (1984), reprinted in

1984 U.S.C.C.A.N. 2274 (report of House version of ISTA, H.R. 559);29 Insider Trading Sanctions


   28
     The SEC apparently has advocated a knowing possession standard for insider trading
liability since 1978. In testimony before Congress regarding the Insider Trading Sanctions Act
of 1984, the SEC General Counsel asserted that the SEC's "consistent position has been that
possession of material inside information is the test", but the SEC Chairman noted that "in terms
of court decisions" the SEC has not "always won on that ground." Insider Trading Sanctions and
SEC Enforcement Legislation, Hearing on HR 559 Before Subcommittee on
Telecommunications, Consumer Protection and Finance of the House Committee on Energy and
Commerce, No. 98-33, 98th Cong., 1st Sess., 48-49 (1983). In a 1983 address, the SEC General
Counsel stated that the SEC "will continue to consider trading while in possession of inside
information as the test of liability, not the more stringent [use] test," but acknowledged that
"where the trader has a "plausible argument that complicates proof', the SEC will be "cautious'
about bringing the case." 15 Sec. Reg. & L. Rep. (BNA) 1820, 1821 (1983).
   29
      The House Report stated that "[t]he legislation does not change the underlying substantive
case law of insider trading as reflected in judicial and administrative holdings.... The Committee
believes that the law with respect to insider trading is sufficiently well-developed at this time to
provide adequate guidance .... the adoption of a statutory definition could reduce flexibility; and
... any new definition which might be adopted would be likely to create new ambiguities, thereby
increasing rather than limiting uncertainty." H.R.Rep. No. 98-355 at 2286. Congress resisted
arguments from many members of the bar to define insider trading and heard much conflicting
testimony regarding whether possession or use was the correct standard for § 10(b) and Rule
and SEC Enforcement Legislation, supra, at 49 (testimony of John M. Fedders, SEC Director of

Enforcement).30 We find that ISTA's "possession" language only sets a condition for the SEC to

seek a treble damages civil penalty that is discretionary with the court and that is "implicitly

dependent on the court finding a violation." Bromberg & Lowenfels, supra, at 7:160.3.31 Therefore,

the "in possession" language of ISTA does not resolve whether possession or use is the proper

standard for an insider trading violation under § 10(b), Rule 10b-5, and § 17(a).

        We view the choice between the SEC's knowing possession test and the use test advocated

by Pegram as a difficult and close question of first impression. It is apparent from the foregoing

discussion that there is no definitive guidance on this issue from the Supreme Court. However, we

believe that Supreme Court dicta and the lower court precedent suggest that the use test is the

appropriate test. The strongest argument that has been articulated in support of the knowing

possession test is that a strict use test would pose serious difficulties of proof for the SEC. It is true

that it often would be difficult for the SEC to have to prove that an insider used the inside




10b-5 liability under the case law of that time. See Bromberg & Lowenfels, supra, at 7:160.2-
160.4.
   30
    Mr. Fedders testified before the House Committee, which was considering the possession
versus use issue, that "[t]he proposed legislation in my view goes to a remedy. It does not at the
present time at all impact the existing case law with regard to insider trading. It is strictly a
remedy saying that if a person engages in this insider trading, however defined, that then the
amount of disgorgement can be three times the ill-gained profit. And the proposed language that
you have before you, presented by the Commission, does not impact the "based on,' "in
possession of,' or a "knowing' standard at all." Insider Trading Sanctions and SEC Enforcement
Legislation, supra, at 49.
   31
     Bromberg and Lowenfels state that "Congress clearly opted for possession over use as a
necessary condition for the civil penalty. Congress did not go so far as to make possession a
sufficient condition for the penalty, much less for the violation." Bromberg & Lowenfels, supra,
at 7:160.4
information,32 i.e., that the inside information has a causal connection to a particular trade.

However, we believe that the SEC's problems in this regard are sufficiently alleviated by the

inference of use that arises from the fact that an insider traded while in possession of inside

information.

        We believe that the use test best comports with precedent and Congressional intent, and that

mere knowing possession—i.e., proof that an insider traded while in possession of material

nonpublic information—is not a per se violation. However, when an insider trades while in

possession of material nonpublic information, a strong inference arises that such information was

used by the insider in trading. The insider can attempt to rebut the inference by adducing evidence

that there was no causal connection between the information and the trade—i.e., that the information

was not used.33 The factfinder would then weigh all of the evidence and make a finding of fact as

to whether the inside information was used.

        We adopt this test for the following reasons. First, of the several arguments in support of the

knowing possession test, the strongest is the fact that it often would be difficult for the SEC to prove

that an alleged violator actually used the material nonpublic information; the motivations for the

trader's decision to trade are difficult to prove and peculiarly within the trader's knowledge.

However, we believe that the inference of use, which arises from the fact that the insider traded




   32
    We sometimes use "inside information" in this discussion as shorthand for material
nonpublic information.
   33
     We note that if experience shows that this approach unduly frustrates the SEC's enforcement
efforts, the SEC could promulgate a rule adopting the knowing possession standard, as the SEC
has done in the context of tender offers, see infra note 36, or a rule adopting a presumption
approach in which proof that an insider traded while in possession of material nonpublic
information would shift the burden of persuasion on the use issue to the insider.
while in knowing possession of material nonpublic information, alleviates the SEC's problem.34 The

inference allows the SEC to make out its prima facie case without having to prove the causal

connection with more direct evidence.

        Second, we believe that our approach best comports with the language of § 10(b) and Rule

10b-5, and with Supreme Court precedent.          Section 10(b) of the 1934 Act prohibits "any

manipulative or deceptive device." Rule 10b-5 and § 17(a) of the 1933 Act prohibit "any device,

scheme, artifice to defraud" and "any act, practice, or course of business which operates or would

operate as a fraud." Similarly, the Supreme Court has repeatedly emphasized this focus on fraud and

deception. See O'Hagan, --- U.S. at ----, 117 S.Ct. at 2209 (stating that " § 10(b) is not an

all-purpose breach of fiduciary duty ban; rather it trains on conduct involving manipulation or

deception") (citing Santa Fe Industries v. Green, 430 U.S. 462, 473-76, 97 S.Ct. 1292, 1300-02, 51

L.Ed.2d 480 (1977)); Dirks, 463 U.S. at 667 n. 27, 103 S.Ct. at 3268 n. 27 (concluding that "to

constitute a violation of Rule 10b-5, there must be fraud"); Chiarella, 445 U.S. at 234-35, 100 S.Ct.

at 1118 (stating that "[s]ection 10(b) is aptly described as a catchall provision, but what it catches

must be fraud"); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199, 96 S.Ct. 1375, 1383-84, 47

L.Ed.2d 668 (1976) (concluding that "manipulative," "device," and "contrivance" in § 10(b)

"connot[e] intentional or willful conduct designed to deceive or defraud investors"). When an

insider trades on the basis of material nonpublic information, the insider is clearly breaching a

fiduciary duty to the shareholders and deriving personal gain from the use of the nonpublic

information. On the other hand, we do not believe that the SEC's knowing possession test would

always and inevitably be limited to situations involving fraud. Indeed, O'Hagan, in its discussion



   34
    Thus, the fourth factor that Teicher listed as supporting the knowing possession test is
undermined. See supra, note 24.
of the knowing possession test which has been adopted by the SEC in Rule 14e-3(a)35 for the tender

offer context, recognized that the knowing possession test may prohibit actions that are not

themselves fraudulent. O'Hagan, --- U.S. at ----, 117 S.Ct. at 2217 (holding that "under § 14(e), the

Commission may prohibit acts, not themselves fraudulent under the common law or § 10(b), if the

prohibition is "reasonably designed to prevent ... acts and practices [that] are fraudulent' ").

        The SEC argues that the knowing possession test is supported by the familiar maxim that an

insider has a § 10(b) duty to disclose material nonpublic information or to abstain from trading.

However, a trade by an insider with such information does not always and inevitably constitute a

breach of the duty. Indeed, in the very case in which the SEC articulated the "disclose or abstain"

rule, In re Cady, Roberts & Co., 40 S.E.C. 907, 911 (1961), the SEC also acknowledged a

preexisting plan to sell defense; the defense was rejected for failure of proof, not as a matter of legal

principle. Id. at 916 (finding that "we do not accept [the defendants'] contention that [one of the

defendants] was merely carrying out a program of liquidating the holdings in his discretionary

accounts-determined and embarked upon prior to his receipt of the [material nonpublic]

information.... The record does not support the contention that [one of the defendant's] sales were

merely a continuance of his prior schedule of liquidation.") We construe In re Cady, Roberts & Co.

as an acknowledgment by the SEC that the analysis we embrace today is not inconsistent with the




   35
    Rule 14e-3(a) provides that "[i]f any person has taken a substantial step or steps to
commence, or has commenced, a tender offer ..., it shall constitute a fraudulent, deceptive or
manipulative act or practice within the meaning of section 14(e) of the ACT for any other person
who is in possession of material information relating to such tender offer ... to purchase or sell or
cause to be purchased or sold any of such securities ... unless within a reasonable time prior to
any purchase or sale such information and its source are publicly disclosed by press release or
otherwise." 17 C.F.R. § 240.14e-3(a) (1997) (emphasis added).
"disclose or abstain" rule.36

        It is true that the SEC has stated its preference for the knowing possession test, both in its

brief to this court and in the Report of Investigation in the Matter of Sterling Drug, Inc.. We decline

to accord much deference to the SEC position for three reasons.37 First, the SEC has not contended

in this case that we should defer to its position. Second, as noted above, the SEC position has not

been consistent. In In re Investors Management, the SEC initially utilized a test similar to the test

we adopt today, and then in Sterling Drug the SEC adopted a different position with no mention of

its prior ruling and no discussion of the rationale for the change.38 Third, the SEC has had ample

opportunity to adopt a rule or amend Rule 10b-5 so as to provide that a trade with knowing

possession of material nonpublic information triggers insider trading liability. However, although

the SEC has adopted such a rule in the context of tender offers,39 it has not formally adopted the

knowing possession test for insider trading. Rather, the SEC has articulated its knowing possession

test only in the context of a "report of investigation," which provided no reasoning and was not even

binding on the parties to that matter. Report of Investigation in the Matter of Sterling Drug, Inc.,

¶ 81,570, at 80,295 (stating that "[t]he investigation on which this Report is based was in no sense

an adjudicatory proceeding ... [n]or is the report a determination of the rights or liabilities of any

   36
      Thus, the second factor listed by the court in Teicher as supporting the knowing possession
test is undermined.
   37
     In Skidmore v. Swift & Company, 323 U.S. 134, 140, 65 S.Ct. 161, 164, 89 L.Ed. 124
(1944), the Court concluded "the weight of such a[n] [agency's] judgment in a particular case
will depend upon the thoroughness evident in its consideration, the validity of its reasoning, its
consistency with earlier and later pronouncements, and all those factors which give it power to
persuade."
   38
    Even now, the SEC apparently is "cautious" about bringing cases where a trader has a
plausible argument that he did not use the inside information. See supra, note 28.
   39
     In Rule 14e-3, the SEC adopted a knowing possession test for trading on information related
to tender offers. See supra, note 35.
person").

       In sum, we believe that the strong inference of use which arises from the fact that an insider

traded while in possession of material nonpublic information suffices to alleviate the SEC's

difficulties in proving use. We believe that our approach best comports with the statutory focus on

fraud. See Chiarella, 445 U.S. at 243-35, 100 S.Ct. at 1118 ("[s]ection 10(b) is ... a catchall, but

what it catches must be fraud"). Furthermore, we do not believe our approach is inconsistent with

the "disclose or abstain" doctrine, and we do not believe deference to the SEC position in Sterling

Drug is warranted.

2. The SEC's Factual Argument

         We turn now to the application of the test to the facts involved in Pegram's 1989

transactions. On the dates of Pegram's 1989 sales, it is clear that Pegram was in possession of

whatever information was dispensed at the September 14, 1989, Board meeting. Although there is

a genuine issue of fact as to the materiality of this information, we agree with the district court that

in the summary judgment posture of this case, we must assume that the factfinder could find that

Pegram possessed material nonpublic information. Under the test we adopt today, the fact that

Pegram traded while he possessed material nonpublic information gives rise to a strong inference

that such information was used. Of course, the inference can be rebutted. Pegram has adduced

strong evidence that he had a plan to sell 20,000 shares of Comptronix stock and that the plan

predated his acquisition at the September 14, 1989, board meeting of the material nonpublic

information. However, after a careful review of this summary judgment record, and in light of the

strong inference that Pegram would have used that information in finalizing his sale decision, we

conclude that genuine issues of material fact remain for a jury to decide (e.g., whether the

information hastened the timing of Pegram's decision to sell or affected the price at which he was
willing to sell). Accordingly, the grant of summary judgment in favor of Pegram as to the 1989

transactions is reversed.

B. 1992 Transactions of Pegram, Choy, and Ishler

        Unlike the action against Pegram regarding his 1989 transactions, the SEC's action against

Pegram, Choy, Ishler, and Adler regarding their 1992 transactions in Comptronix stock went to trial.

After a seven day jury trial, the jury's inability to reach a verdict, and the district court's declaration

of a mistrial, the district court granted judgment as a matter of law to Pegram, Choy, and Adler and

summary judgment to Ishler.40

        We review a decision to grant a motion for judgment as a matter of law de novo, applying

the same standards utilized by the district court. Isenbergh v. Knight-Ridder Newspaper Sales, Inc.,

97 F.3d 436, 439 (11th Cir.1996), cert. denied, --- U.S. ----, 117 S.Ct. 2511, 138 L.Ed.2d 1014

(1997). A judgment as a matter of law is warranted "[i]f during a trial by jury a party has been fully

heard on an issue and there is no legally sufficient evidentiary basis for a reasonable jury to find for

that party on that issue." Fed.R.Civ.P. 50(a)(1). When evaluating a motion for judgment as a matter

of law, the court "must consider all of the evidence and reasonable inferences arising therefrom in

the light most favorable to the nonmoving party" and "may not weigh the evidence or decide the

credibility of witnesses." Isenbergh, 97 F.3d at 439. However, the nonmoving party "must provide

more than a mere scintilla of evidence to survive a motion for judgment as a matter of law; "there

must be a substantial conflict in evidence to support a jury question.' " Id. (quoting Carter v. City

of Miami, 870 F.2d 578, 581 (11th Cir.1989)).

1. Pegram's 1992 Transactions



   40
     The district court granted Ishler's motion for summary judgment based on all the evidence
introduced at trial, see supra, note 18.
        The SEC contends that during the 72 second telephone call from Pegram to Adler on

November 16, 1992, Adler tipped Pegram about the potential fraud that was disclosed at

Comptronix's November 15 Board meeting. This telephone call is the primary alleged source of

material nonpublic information for Pegram. The issue before us is whether a reasonable jury could

find on this evidence that Adler tipped Pegram during that telephone call. The SEC contends that

the timing of the telephone calls between Pegram and Adler, and Pegram and his wife, and his wife's

immediate sale of the stock, as well as the similar scenario preceding Choy's sale of Comptronix

stock, combine to raise an inference that Pegram possessed material nonpublic information. The

SEC argues that a jury issue remained notwithstanding Pegram's preexisting plan to sell Comptronix

stock in November 1992.

        In order to establish liability under § 10(b), Rule 10b-5, and § 17(a)(1), the SEC must prove

that the inside trader acted with "scienter." E.g., Aaron v. SEC, 446 U.S. 680, 695-696, 100 S.Ct.

1945, 1955, 64 L.Ed.2d 611 (1980). Scienter is defined as "a mental state embracing intent to

deceive, manipulate, or defraud." Id. at 686 n. 5, 100 S.Ct. at 1950 n. 5. Scienter necessarily

requires that the insider have possession of material nonpublic information at the time the insider

trades. See SEC v. MacDonald, 699 F.2d 47, 49 (1st Cir.1983). Moreover, as we hold today in Part

II.A.1, the SEC must also prove that the material nonpublic information was used in the trade.

However, proof of an insider's possession of material nonpublic information at the time of a trade

gives rise to a strong inference of use. With respect to the 1992 transactions, we discuss first the

issue of Pegram's possession of the information, and then the use issue.

       Pursuant to well established law, the SEC raised a reasonable inference that Pegram

possessed nonpublic information by producing evidence of the suspicious timing of Pegram's 1992

sale of Comptronix stock and evidence of the phone calls between Adler, Pegram, and Pegram's
wife. See, e.g., Freeman v. Decio, 584 F.2d 186, 197 n. 44 (7th Cir.1978); In re Apple Computer

Sec. Litig., 886 F.2d 1109, 1117 (9th Cir.1989) ("Insider trading in suspicious amounts or at

suspicious times is probative of bad faith and scienter."). This inference that Pegram possessed

inside information also finds support in the Pegram-Choy telephone call and the immediately

following sale by Choy.

       However, it is also well established that this inference of possession is rebuttable. In

Freeman v. Decio, 584 F.2d 186 (7th Cir.1978), a stockholder of a corporation brought a derivative

action against certain officers and directors of the corporation for allegedly trading in the stock of

the corporation on the basis of material inside information. After concluding that the plaintiff could

not maintain a derivative action for insider trading under state law, the court considered the

plaintiff's argument that "the district erred in considering evidence of the defendants' past patterns

of sales of [the corporation's] stock and their motivations for making the sales in question." Id. at

197. In rejecting the plaintiff's argument, the court concluded that

       When it is shown that an insider made a sudden sale of a significant portion of his holdings
       of his corporation's stock and that subsequently, material adverse information became public
       concerning the corporation which led to a significant drop in the price of the stock, an
       inference arises that the insider was "bailing out" on the basis of material inside information.
       However, this inference can be nullified by a showing that sales in question were consistent
       in timing and amount with a past pattern of sales or that other circumstances might
       reasonably account for their occurrence. Hence, the district court was correct to consider
       these factors.

Id. at 197 n. 44. See also In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1427-28 (9th Cir.1994)

(concluding that where an inference of possession of material nonpublic information and scienter

arises from sales of stock prior to financial collapse, credible and wholly innocent explanations for

the sales—e.g., sales pursuant to a predetermined plan, because of a pressing need to service a huge
debt or sale of only a small fraction of holdings—can rebut the inference of possession).41

        Thus, precedent and common sense indicate that where an inference of possession of inside

information arises from the suspicious timing of the sale, a credible and wholly innocent explanation

for said sale and timing tends to rebut the inference. In applying this legal principle, we have

carefully reviewed the evidence adduced at trial. Considering all reasonable inferences in favor of

the SEC, as we must in the posture of this motion by Pegram for judgment as a matter of law, we

conclude that a reasonable jury could find that Adler tipped Pegram and thus that Pegram possessed

material nonpublic information. The SEC first emphasizes the evidence that Adler possessed

material nonpublic at the time of the November 16, 1992, telephone call with Pegram.42 Although

the telephone call lasted only 72 seconds, a jury could find that sufficient time existed for Adler to

convey material nonpublic information to Pegram. The following suspicious chronology raises a

reasonable inference that Pegram received such information from Adler:

               — the 7:53 a.m. telephone call between Pegram and Adler on November 16, 1992;

               — the 7:55 a.m. telephone call on the same day from Pegram to his wife;

               — the 8:07 a.m. telephone call on the same day from Mrs. Pegram to her stockbroker
        placing the order to sell 50,000 shares of Comptronix stock;

             — the Pegrams' sale of an additional 100,000 shares between November 18 and
        November 24, 1992.


   41
     Although in Worlds of Wonder, the court affirmed the grant of summary judgment in favor
of the alleged inside trader, the different facts of the instant case leave a jury issue. In Worlds of
Wonder, the inference of possession was based primarily on the fact that the insiders sold stock
shortly before the public announcement of unfavorable information; in the instant case, in
addition to the fact that the defendants sold stock shortly before the public announcement of
unfavorable information, the inference is supported by the phone calls from Pegram to Adler,
Pegram to his wife, and Pegram to Choy.
   42
     We conclude without need for further discussion that there is a jury issue as to whether the
information that Adler learned during the November 15, 1992, Comptronix Board meeting was
material.
This inference that Pegram possessed material nonpublic information is also supported by the

chronology of telephone calls relating to Choy and Choy's stock sale:

                — Pegram's telephone call to Choy at 8:02 p.m. on November 16, 1992, the same day
        as the Pegram-Adler call;

               — Choy's 9:39 p.m. fax on the same day to his stockbroker directing the sale of
        Choy's 5000 shares of Comptronix stock.

        Thus, based on this suspicious sequence of events, an inference arises that Pegram received

material nonpublic information from Adler. However, the inference can be rebutted. Pegram has

adduced strong evidence that he and his wife had a plan to sell Comptronix stock, and that the plan

predated the alleged tip on November 16, 1992. In addition, Pegram has adduced evidence of

innocent explanations for each of the relevant telephone calls. Although Pegram's evidence is

strong, we cannot conclude that a reasonable jury was required as a matter of law to believe every

detail of the plan as asserted by Pegram,43 nor was the jury required to believe the allegedly innocent

explanations for the telephone calls.

        Having concluded that a reasonable jury could find that Pegram received material nonpublic

information from Adler, we also conclude, for similar reasons, that a reasonable jury could find that

Pegram used the information in connection with his November 1992 sale of 150,000 shares of

Comptronix stock (e.g., that there was a causal relationship between the inside information and the

time of Pegram's sale or the price at which Pegram was willing to sell).

        We conclude that these fact-intensive issues should be decided by a jury, which is in the

position to observe the demeanor of witnesses and make appropriate credibility determinations.



   43
     As noted above, the inference that Pegram possessed the inside information arises not only
from the chronology surrounding the Pegrams' sales, but also from the chronology of the
Pegram-Choy call and the immediately following sale by Choy. The preexisting plan to sell by
the Pegrams does nothing to rebut the latter inference.
Accordingly, the judgment as a matter of law in favor of Pegram as to the 1992 transactions is

reversed.

2. Choy's 1992 Sale of Comptronix stock

        As indicated above, at 8:02 p.m. on the evening of November 16, 1992, Pegram called

Phillip Choy. At 9:39 p.m. that same evening, Choy telefaxed the brokerage firm for his company,

Magatronic Trading Limited, and directed his stockbroker to sell 5000 shares of Comptronix stock.

This order was executed on November 17 and 19. Choy contends that he had a preexisting plan to

sell his Comptronix stock in late 1992.44 Having held that a reasonable jury could find that Pegram

possessed and used material nonpublic information in connection with his 1992 trading, we readily

conclude that Choy's relatively weak evidence of a preexisting plan is not sufficient to rebut the

inference that he received material nonpublic information from Pegram and then used that

information in connection with his decision to sell 5000 shares of Comptronix stock. Therefore, the

district court's grant of judgment as a matter of law in favor of Choy is reversed.

3. Ishler's 1992 Transaction; Adler's Judgment as a Matter of Law

        The SEC alleged that Domer Ishler received material nonpublic information from either

Pegram or Adler, and that Ishler purchased 300 "put options" in Comptronix stock on the basis of




   44
     Choy introduced evidence indicating that in September 1992, Choy contacted his
stockbroker at Prudential Securities regarding the price of 5000 shares of Comptronix stock that
Prudential held on behalf of Choy's company, Magatronic Trading Limited. Choy's stockbroker
replied that he had received internal approval from Prudential for the sale of the Comptronix
stock and that Choy should contact him if he wanted to sell. Choy's stockbroker also sent Rule
144 forms to Choy and informed Choy that he would have 90 days from the date of submitting
the forms to sell the Comptronix stock. Choy faxed his stockbroker and stated that he would
submit the Rule 144 forms when he wished to sell the shares. In mid-October, Choy's
stockbroker informed Choy that Comptronix stock had reached a new high. However, it was not
until the evening of November 16, that Choy placed his order to sell the 5000 shares and then
submitted the Rule 144 forms on the next day.
this inside information.45 In granting judgment as a matter of law to Ishler, the district court relied

on its rejection of the Pegram-Adler allegation. Because we have found a jury issue in that regard,

the district court's reasoning has been undermined. Ishler has proffered no evidence of a preexisting

plan to buy Comptronix put options, and argues only that his purchase of the put options was

consistent with evidence of his prior trading in options and other high-risk investments. This

evidence is clearly not sufficient to rebut the reasonable inference that Ishler possessed and traded

on the basis of material nonpublic information. This inference arises from the evidence of the

multiple calls between Ishler and Adler during mid-November 1992, the November 23, 1992, phone

call from Pegram to Adler, and the timing of Ishler's purchase of Comptronix put options after the

telephone calls and immediately before the Comptronix press release that caused the stock price to

plummet dramatically.46 Therefore, we conclude that there is a genuine issue of fact as to whether

Ishler possessed and traded on material nonpublic information, and we reverse the district court's

grant of summary judgment in favor Ishler.

           Finally, based on the above evidence and reasoning, we also conclude that the district court

erred in granting judgment as a matter of law to Adler. In other words, a reasonable jury could find

that Adler communicated material nonpublic information to Pegram and/or to Ishler, who then

traded upon it.47 Accordingly, we reverse the grant of summary judgment to Ishler and reverse the


   45
        See supra note 17 for a discussion of Ishler's purchase of Comptronix put options.
   46
   We note that Ishler's purchase of Comptronix put options was a bet that the price of
Comptronix would fall.
   47
     Ishler and Adler argue that the district court's grant of summary judgment to Ishler and
judgment as a matter of law to Adler should be affirmed because the full extent of the fraud at
Comptronix was not known at the time of the November 15, 1992, Board meeting, and thus the
information learned by Adler at this meeting was not material. We reject this argument as
without merit because there is a genuine issue of fact as to the materiality of the nonpublic
information learned by Adler at the Board meeting. Furthermore, we also note that the SEC
grant of judgment as a matter of law to Adler.48

                                        III. CONCLUSION

        For the foregoing reasons, we reverse the grant of summary judgment in favor of Pegram

with respect to the 1989 transactions; and with respect to the 1992 transactions, we reverse the grant

of judgment as a matter of law in favor of Pegram, Choy, and Adler, and we reverse the grant of




produced evidence that Ishler and Adler communicated on both November 15 and November 23
and that by November 23, Adler had learned the full extent of the fraud at Comptronix.
   48
     We also reject the appellees' argument that the SEC must prove any claims for treble
damages under the Insider Trading Sanctions Act of 1984 ("ISTA") by clear and convincing
evidence. In Herman & MacLean v. Huddleston, 459 U.S. 375, 388-91, 103 S.Ct. 683, 690-92,
74 L.Ed.2d 548 (1983), the Court established that plaintiffs in civil actions under § 10(b) of the
Securities Exchange Act of 1934 need prove their cases only by a preponderance of the
evidence. The Court concluded that clear and convincing evidence should be required only in
proceedings "where particularly important individual interests or rights are at stake" and that
"imposition of even severe civil sanctions that do not implicate such [individual] interests has
been permitted after proof by a preponderance of the evidence." Id. at 388-90, 103 S.Ct. at 691.
Although Huddleston was decided before Congress passed ISTA, Congress expressed approval
for the preponderance standard in the legislative history of ISTA:

                       Some commentators expressed the view that, in light of the potential for a
               large penalty, the appropriate burden of proof in a civil penalty action brought by
               the Commission under the legislation should be more than the "preponderance of
               the evidence" standard applicable to Commission injunctive actions. The
               Committee rejects this notion because a higher proof standard could hamper
               Commission penalty actions. The Supreme Court has expressly approved of the
               preponderance of the evidence standard in governmental civil penalty suits. The
               civil penalty proposed here is distinct in nature from those types of judicial action
               on which higher proof standards have been imposed.

                       The Committee believes that, since the bill provides a new sanction, and
               makes no change to the underlying law, no additional language is required in the
               statute to express the intent of Congress that the preponderance of the evidence
               standard be applied to penalty actions brought under the legislation.

        H.R.Rep. No. 98-376 (1984), reprinted in 1984 U.S.C.C.A.N. 2274, 2288-89 (citations
        omitted).
summary judgment in favor of Ishler.49 We remand for further proceedings not inconsistent with

this opinion.

        REVERSED AND REMANDED.




   49
     In light of our disposition of this case, we also briefly address the SEC's evidentiary
arguments. First, we conclude that the trial court did not abuse its broad discretion under
Fed.R.Evid. 403 by excluding evidence relating to Pegram's alleged insider trading in 1989 from
the trial regarding the 1992 transactions. Second, in regard to the other evidentiary rulings
challenged by the SEC on appeal, we also conclude that the district court did not abuse its broad
discretion.
