US v. Nacchio (En Banc): The Defendant Speaks (A Precedented Unprecedented Case)

We note one odd aspect of the Defendant's brief.  The brief begins by a statement about the unprecedented nature of the prosecution of Joe Nacchio.  As the brief notes:

• Most insider trading cases involve accusations of trading ahead of merger news or earnings releases, or other “hard” nonpublic information that anyone would recognize as material. This case is completely different; indeed, unprecedented. The government’s sole theory of materiality was that Nacchio somehow knew, eight months in advance, that Qwest would not meet its year-end 2001 revenue projections.

Is this case really that unusual?  Qwest made projections about expected earnings for 2001.  Nacchio repeated the forecasts in a number of instances, including, according to the government, in April 2001, the period when he engaged in trades that resulted in his conviction.  Thus, the convictions are, apparently, based upon Nacchio trading while aware that projections issued by the company (and repeated by Nacchio) were no longer achievable. 

Is this really an "unprecedented" fact pattern?  To decide, we took a quick stroll through the SEC litigation release file and found the following cases:   

• Insider trading allegations based upon knowledge that guidance provided to the investing public was no longer valid. 

• SEC v. Bruce E. Snyder, Jr., Civil Action No. 03 CV 4658, LITIGATION Release No. 19557  (S.D.Tx.) (February 1, 2006)(discussing jury verdict against defendant for insider trading and noting that "The Complaint also alleged that Snyder sold WMI stock again on June 9, 1999, when, in addition to the aforementioned information, Snyder possessed material, nonpublic information that WMI's internal earnings projections showed a large shortfall against the second quarter 1999 EPS guidance WMI had provided to the investing public."); 

• SEC v. Salvador Chavarria, Glenn D. Leftwich and John A. Nieto, Civil Action No. 1:07-CV-820-LY, LITIGATION Release No. 20313, United States District Court for the Western District of Texas (Austin Division), Sept. 28, 2007 ("The Commission alleges that the three accountants engaged in unlawful insider trading in the securities of Dell in advance of a public announcement on August 11, 2005 that Dell's second quarter 2006 revenues had fallen short of the company's earlier guidance and analyst' expectations.")
  

• SECURITIES AND EXCHANGE COMMISSION v. MICAHEL A. OFSTEDAHL, ET AL., United States District Court for the Northern District of California, Civil Action No. C-02-3685 RS, LITIGATION Release No. 17645 (July 12, 2002)("With regard to Puma, which is based in San Jose, California, the SEC complaint alleges that Rutner and Kuncz engaged in insider trading in advance of an August 10, 1998 press release in which Puma announced that its quarterly revenues would be below analysts' expectations.")
  

• Insider trading allegations based upon knowledge that company would not meet earnings forecasts.
  

• SEC v. Smith, Civil Action No. 95-6440 - MRP (BQRx), LITIGATION Release No. 16092 (March 19, 1999C.D. Cal.)("In this position, Smith learned that the company's management expected fiscal fourth quarter 1993 revenues to fall below expectations and, later, that revenues had fallen below projections.");
  

• SEC v. FIRST NATIONAL ENTERTAINMENT CORP., MILTON J. VERRET, RICKY D. BUSBY, MICHAEL D. SWINGLER, RICHARD C. MAESTRE, AUBURN R. BUSBY, AND MICHAEL B. BYRD, Civil Action No. A 95CV371 (AA), LITIGATION RELEASE NO. 15820 (July 24, 1998 W.D. Tex., Austin Division)("The Commission sought disgorgement of illegal insider trading proceeds from Verret and Busby, who sold stock prior to release of the movie while allegedly in possession of material non-public information concerning more realistic revenue projections for the film, avoiding more than $ 4 million in losses.").
  

Of course, the facts in the Nacchio case are different.  But it is not the case that insider trading cases are always about "hard" information.  Knowledge that a company will not meet forecasts or guidance given to the market appears to be a not uncommon basis for allegations of insider trading. 

US v. Nacchio (En Banc): The Defendant Speaks

As we have come to expect, the Defense has written a powerful brief.  It mostly takes the position that the testimony offered by Daniel Fischel was extraordinarily relevant.  It was, after all, the "heart of Nacchio's defense."   As the brief describes: 

• The heart of Nacchio’s defense, indeed the only substantive defense witness on the key issues, was Professor Daniel Fischel, one of the nation’s leading experts on these subjects who is frequently retained by the government, including DOJ, and has testified more than 200 times and never before been excluded. Fischel would have explained, inter alia, that the sales for which Nacchio was convicted were consistent with his previously announced plan and did not accelerate in 2001 as the government alleged, that the government’s basic premise that investors discounted the value of revenues attributable to IRUs was demonstrably incorrect, that the market did not react negatively to the eventual disclosure of the information that the prosecution thought was material, and that other market forces explained the decline in Qwest’s stock price, particularly the massive economic decline in the entire telecommunications sector. Rule 702 itself describes the presentation of this exact testimony as a “venerable practice.”
  

The argument, however, requires a certain delicacy.  It is true that Fischel was the only "substantive defense witness" (Phillip Anschutz and a Catholic Abbot were the only other witnesses called by the Defendant).  But this can cut against the Defendant.  The decision to present one witness was not compelled by the case but an affirmative strategy. 

In other words, with its entire affirmative case built around a single substantive witness, one might expect a high degree of thought and attention to the circumstances surrounding the admissibility of the testimony.  Yet the Defendant was unable to meet the requirements imposed by the trial judge for admissibility and unable to find the opportunity to request a hearing.  The inability was, apparently, related to the onset of Passover.  See Brief at n. 27  ("The response was not only prepared in less than a day, but also on the first day and second night of Passover. Nacchio’s counsel had requested a brief adjournment during Passover so that his lawyers could observe the holiday with their families in New Jersey, but the judge, after consulting with “[m]y Jewish friends,” Supp. App. 68, adjourned only one-hour early on the first night, so “[y]ou can go to eat gefiltefish [sic],”). 

US v. Nacchio (En Banc): The Government Speaks (In A Churlish Manner)

The brief takes some shots directly at Herbert Stern, counsel for Defendant, Joe Nacchio.  To support its position, it cites Herbert Stern, lead counsel for the Defendant.  As the brief notes:

• Nacchio’s trial counsel has written that Kumho “makes it clear that whether to hold a hearing * * * is left to the discretion of the trial judge.” HERBERT J. STERN ET AL., TRYING CASES TO WIN: EVIDENCE, WEAPONS FOR WINNING, Vol. 3 at 223(2004); see id. at 213 (observing that, after Kumho, “appellate courts * * * will defer to the trial judge’s decision on how to determine reliability (e.g., to hold a hearing)”).
  

In one sense, the strategy could be construed as little more than a dig at Stern, something out of place in a dispassionate legal argument.   On the other hand, the meaning of Kumho is critical to the case and cited frequently by both parties. 

Having said that, it was a churlish thing to do.  Whatever Stern's past views, they carry no weight in the disposition of the legal issue before the Tenth Circuit.  The brief would have been better without the citation.

The entire brief is posted on the DU Corporate Governance web site.

US v. Nacchio (En Banc): The Government Speaks (And Disagrees with the Order to Change the Trial Judge)

One of the oddities in the case was the decision by the majority on the panel to change trial judges.  The Defense asked for the change but provided little rational, simply requesting that the court "exercise its inherent power … to reassign this case to a different district judge." 

Despite the absence of any significant argument, the majority took it upon itself to review the transcript and remove the trial judge.  As the majority concluded:  "After reading the trial transcript, we have concluded that it would be unreasonably difficult to expect this judge to retry the case with a fresh mind."   This was nothing short of a slap to Judge Nottingham with the two judges in the majority (McConnell and Kelly) all but concluding that he was biased against the Defendant, despite the absence of any such argument by Defendants themselves. 

In the Government's en banc brief, there is a subtle argument that this decision should be reversed.  As noted in footnote 16:

• The panel’s decision to “assign a new trial to a new district judge” (Add.59) would exacerbate the costs inherent in a retrial, contrary to the panel’s assurance (Add. 60). The new judge would not have any experience with this case, which, though not byzantine, is much more complicated and fact-intensive than the average case. Getting the new judge up to speed would take time. Even assuming the new judge would handle any limited remand, the judge’s review of and rulings on the admissibility issue would be far less time-consuming than a full-blown retrial.
  

In other words, if the case is sent back for any reason, it should be given to the same judge. 

US v. Nacchio (En Banc): The Government Speaks

On August 29, the parties in the en banc hearing of US v. Nacchio filed briefs.  The briefs are, as usual, posted on the DU Corporate Governance web site.

The Government argued, unsurprisingly, that the trial judge did not commit error in excluding the testimony of Daniel Fischel, relying primarily on the failure of the Defendant to request a hearing.  To the extent error was found, however, reversal of the verdict was not an appropriate remedy.  For one thing, the Government contends that the error was harmless.  Even if it was not, remand was the more appropriate remedy.  As the brief noted:

• But even if this Court were unable to conclude on the record to date that the alleged error did not affect the verdict, the appropriate course would be a limited remand. The panel did not conclude that Fischel’s opinions were reliable under Rule 702, such that they would be admissible at any new trial. Instead, it held that the defense had been given no opportunity to establish reliability, such that the district court, on an incomplete record, “abuse[d] its discretion [in] mak[ing] a Daubert finding of unreliability.” Add. 26; see Add. 21-26. The most tailored remedy for that alleged error would be to remand the case for particularized evidentiary proceedings, permitting the district court to decide admissibility in the first instance. See infra Argument Point III (pertaining to the second half of Question 4 of this Court’s order granting rehearing en banc).
  

In other words, even if the court agrees there was error by the trial judge, the matter should go back for a hearing on the evidentiary issue not a new trial.  Even this, however, the brief argued strenuously, was a "windfall" for Defendant.

• To be clear, the government does not in any way believe that Nacchio is entitled to relief of any sort. Rather, in the government’s view, a close examination of the record will confirm that, for all the reasons stated above, a limited remand would itself be a windfall. In any event, if the Court does order a remand, it should make clear that the district judge need only review for admissibility the opinions that the defense mentioned in its Rule 16 disclosures. In reviewing evidentiary decisions,  an appellate court must “evaluate the trial court’s decision from its perspective when it had to rule.” Old Chief, 519 U.S. at 182 n.6. No different approach should apply where a district court, on remand, is reviewing its own determination. To hold otherwise here would confer a tactical advantage on the defense for having disclosed Fischel the day before trial and having withheld throughout the trial the full scope of,and bases for, his opinions.

We will note a couple of other interesting things about the Government's brief in the course of the day.

U.S. v. Nacchio: Government Chooses New Attorney for Rehearing En Banc

The Race to the Bottom previously followed Joe Nacchio’s trial. Earlier this year a Tenth Circuit panel overturned Nacchio’s conviction. As covered by the Race to the Bottom, the Tenth Circuit recently decided to hold an en banc review of that decision, which is scheduled to begin next month.

Last week, U.S. Attorney Troy Eid announced that Edwin Kneedler, Principal Deputy Solicitor General in the U.S. Department of Justice, will argue the government’s case before the Tenth Circuit. According to Eid, the government wanted Kneedler because he is considered the best attorney to handle the appeal. In March, Kneedler argued his 100^th case in front of the Supreme Court: Philipinnes v. Pimental. Other Supreme Court cases Kneedler has participated in include INS v. Chadha, Sosa v. Alvarez-Machain, Bowsher v. Synar, and the recent First Amendment case Morse v. Frederick. He was also involved in the Elian Gonzalez case in 2000.

Kneedler is a 1974 graduate of the University of Virginia Law School. He clerked for Judge Browning of the Ninth Circuit from 1974 to 1975 before joining the Department of Justice’s Office of Legal Counsel in 1975. Kneedler joined the Solicitor General’s office in 1979, becoming Deputy Solicitor General in 1993.

The Appeal of Joe Nacchio and The 10th Circuit En Banc Hearing: A Prediction

We are sure that the Tenth Circuit agreed to rehear the case because of its possible impact on the trial courts in the circuit.  We also note that going into the case, Nacchio is at a disadvantage.

In the original panel, he drew an unusually good draw.  First, the panel heard the motion for bail pending appeal and granted it, a clear indication that at least two of the judges saw reversible error.  Then, as we have noted, in an extraordinary fashion, the panel opted to retain control over the case, arguably in violation of the traditional notion of random assignment of cases, and hear it on an accelerated basis that only disadvantaged the government.  It was not the kind of treatment that could be expected of, say, a defendant in a drug conviction. 

Second, one judge (McConnell) graduated from the University of Chicago (as we have noted, the same law school as appellate counsel for Nacchio, Maureen Mahoney, and the excluded expert, Daniel Fischel).  You probably can't graduate from that law school without an accentuated belief in the importance of economic analysis, the very type of information excluded by the trial judge.  It was no real surprise that he would look for a way to reverse a case that excluded this type of evidence.  Another, Judge Kelly, viewed the case as government overreaching and evidenced clear hostility towards the trial judge calling his ruling on Fischel's testimony "the most simplistic thing I've ever seen."

But in the en banc hearing, these advantages will be gone.  The Chicago connection is gone.  Of the judges who will hear the case, only McConnell has gone to Chicago.  The respective law schools?  HENRY, Chie f Judge (Oklahoma), TACHA (Michigan),  KELLY (Fordham), BRISCOE (Virginia), LUCERO (George Washington), MURPHY (Wyoming), HARTZ (Harvard), McCONNELL (Chicago), and HOLMES (Georgetown).  The accentuated importance for the excluded information that comes from three years of indoctrination during law school will not predominate among the judges hearing the case en banc.  Similarly, the implacable hostility shown by Judge Kelly for the government and the trial judge is not likely to be present to any significant degree.  It probably helps that a fair amount of time has elapsed since the terrible publicity surrounding Judge Nottingham.  

With these advantages gone, Nacchio will see a different outcome.  The Court will reverse the panel and remand to the trial judge for a hearing.  The hearing will either address the facts and circumstances surrounding the failure to request the hearing (did the Defendant really have adequate opportunity given the fast paced nature of the process) or to determine the appropriate remedy should a hearing have been required.  The interesting question will be whether the court en banc sends the case back to Judge Nottingham for the evidentiary hearing or, consistent with the panel decision, requires that another judge be assigned to the case.

Joe Nacchio and the Tenth Circuit: A Handicap

Last week we were posting daily on the CSX case and the proposed changes to the formula used by US News to rank law school.  As a result, we have been a bit remiss in commenting on the decision of the Tenth Circuit to hear en banc aspects of the appeal of Joe Nacchio.  Oral argument will be held in Denver at 1:00 pm on September 25. 

For most, the decision to take the case was a surprise.  After all, the case takes up the time of the entire circuit, something the judges agree to only grudgingly.  Indeed, the rules of the appellate procedure provide specifically that hearings en banc are not "favored" (Fed. R. App. Rule 35) and the local rules of the 10th Circuit note that a rehearing will only be granted for "an issue of exceptional public importance or on a panel decision that conflicts with a decision of the United States Supreme Court or of this court."  Since this case doesn't conflict with the Supreme Court or precedent in the circuit, it can be assumed that the circuit voted to hear it because of its "exceptional importance."  And that tells you something about the judges in this circuit. 

This is a circuit that in general does not view itself with much pretense.  It is right of center but has never been caught up in the huge ideological debates that have plagued other circuits.  There are not many judges, Michael McConnell, the author of the panel opinion a possible exception, who seriously aspire to be on the Supreme Court.  As a result, the judges in this circuit are generally not motivated by publicity or the need to demonstrate their intellectual acumen by writing ground breaking opinions. 

Much of this can be seen from the decision with respect to Joe Nacchio.  The place to make ground breaking law is on the substantive elements of the alleged criminal behavior.  On appeal, Nacchio sought not just reversal but acquittal, arguing that, among other things, the information he knew before trading was not material.  Had the court agreed with Nacchio, some insider trading cases would have been more difficult to bring.  More importantly, however, such an opinion would have crippled many shareholder class actions based upon only modest understatements of earnings.   In setting the case for en banc hearing, the circuit declined to consider this issue.

The circuit, however, ignored the issue and instead opted to examine a more procedural issue, examining when a defendant has an obligation to request a hearing (otherwise waiving the right to challenge the contested point) and, where a hearing is required, the appropriate remedy (reversal or remand and an evidentiary hearing).  In the more politicized places like the DC circuit, this would hardly be viewed as a matter of "exceptional importance."  But in the Tenth Circuit it is.  Why?  The case goes to the proper functioning of the trial courts.  The panel decision (finding that the failure to hold an unrequested hearing was reversible error) affects every trial judge in the circuit.  If the panel opinion remains in place, trial courts in the circuit will likely be forced to hold hearings sua sponte even when not requested in order to insulate their decision from reversal.  It will be an inefficient, time consuming addition to the work load of already busy courts. 

And it is this impact, not the publicity surrounding the Defendant, that has caused the entire circuit to take up the case.  The Tenth Circuit may ultimately decide that the trial judge should have held a hearing but it is clear that the entire circuit will not impose this burden on trial courts without seriously weighing the consequences.

The briefs and other materials filed in connection with the appeal and the request for hearing en banc can be found at the DU Corporate Governance web site. 

The Saga of Joe Nacchio Continues

The ruling is in.  The Tenth Circuit voted to hear the appeal of Joe Nacchio en banc.  The Race to the Bottom argued that the case should be reheard.  The issues to be briefed en banc?

• 1 . Was the defendant sufficiently on notice that he was required either to present evidence in support of the expert's methodology or request an evidentiary hearing in advance of presenting the expert ’s testimony?
• 2 . Did the defendant have an adequate opportunity to present such evidence or request an evidentiary hearing in advance of presenting the expert ’s testimony?
• 3. Did the defendant bear the burden of requesting an evidentiary hearing?
• 4 . Did the district court abuse its discretion in disallowing the evidence, and if so, is the appropriate remedy necessarily a new trial or is a remand for purposes of conducting an evidentiary hearing adequate?

The choice of issues are indicative.  It was the evidentiary issues (the exclusion of testimony from Daniel Fischel) that resulted in reversal of the conviction by the 10th Circuit panel.  Nacchio argued, however, that if the case went en banc, all of the issues addressed in the appeal should be reopened, including the issue of the materiality of the nonpublic information.  The 10th Circuit, however, rejected that approach. 

The en banc panel will consist, apparently, of only nine judges (including the two in the majority in the panel opinion) since Judges O ’Brien, Tymkovich, and Gorsuch are listed as not participating and therefore presumably recused.  That means that the panel majority need only find three more votes to affirm its position.   

The Motion for Rehearing En Banc: Nacchio Responds

The Defense has replied to the Government's motion for a rehearing en banc. The brief makes a number of points (all opposing en banc reconsideration). The most salient argument seems to be the contention that the Defendant was denied an opportunity to provide evidence under the Daubert standard. As the brief noted:

• the petition repeatedly but incorrectly suggests that Nacchio had a full and fair opportunity to defend Fischel’s methodology under Daubert. Pet. 1, 4–5. As the Court explained, “the defense was never permitted to speak to the issue in court. When Professor Fischel was called, the district judge immediately announced that he was excluding the testimony. A defense lawyer asked to speak. The judge silenced him immediately, saying that once the court had ruled, the trial was ‘[n]ot … an interactive process where you get to argue later on.’ App. 3921. When the court does not allow a lawyer to present arguments, we will not penalize him for failing to present them.”

While it is true that there was no Daubert hearing, the issue was whether the Defense should have asked for one.  As the majority on the panel noted: 

• The defense had only one day to respond to the government's 63-page motion, and did not have clear notice that it had to present its Daubert defense at that time. . . Only then did the government file its lengthy motion, which combined an argument that Rule 16 requires disclosure of methodology with an attack on the witness's methodology under Daubert. The defendant may reasonably have interpreted the references to Daubert as arguments about Rule 16, as a request for a Daubert hearing, or perhaps as notice that the government intended to move for such a hearing. The defendant had no reason to think that the Daubert issue would be resolved on the basis of memoranda of law addressed to the Rule 16 issue, which is not the usual procedure.

In other words, the panel concluded that the defense was not on notice that Daubert was at issue and that there needed to be a hearing.  The dissent on the panel had an entirely different view of the matter.

• The district court's exclusion of Professor Fischel's testimony was about Daubert. True, the government first framed its challenge to Professor Fischel's proffered expert testimony as an objection to the sufficiency of Mr. Nacchio's Rule 16 disclosure. However, by the time the district court ruled to exclude Professor Fischel's testimony, it was clear that the court was asking about Daubert. 

• The district court had repeatedly questioned Professor Fischel's methodology--an issue that it must examine under Daubert, not Rule 16.  Thus, Mr. Nacchio should have known that he had to either make the requested showing or request a Daubert hearing. Furthermore, it was incumbent upon Mr. Nacchio, who was offering Professor Fischel as an expert witness, to demonstrate that his proffered expert was qualified to render an expert opinion. Thus, when the district court was asking about methodology, Mr. Nacchio was required to rise to meet his burden of demonstrating that the expert testimony was admissible.

• Mr. Nacchio was on notice that Professor Fischel's qualifications were at issue. As early as the government's first motion regarding Professor Fischel, the government argued that Rule 702 was implicated. Supp. App. at 39. At a March 22, 2007 hearing, both the government and the court raised the concern that there could be issues arising from the Daubert line of cases. Mr. Nacchio's counsel responded, "forewarned is forearmed."

• One week following this exchange, Mr. Nacchio provided his revised expert disclosure, and again, the government responded by raising Daubert concerns. The government filed a 63-page motion to exclude Professor Fischel's expert testimony based on deficiencies in the Rule 16 disclosure and based on Mr. Nacchio's failure to meet his burden to demonstrate that Professor Fischel's testimony was admissible. See App. at 363. The government argued that, in addition to Rule 16, there were numerous grounds for excluding Professor Fischel's testimony, including Rules 401, 403, 602, 702, and 703 of the Federal Rules of Evidence.  

• When Mr. Nacchio responded to this motion the next day, in substance, he addressed Daubert issues in discussing Rule 702 and Professor Fischel's qualifications. See App. at 463-68. Thus, as of his response on April 4, Mr. Nacchio was not only on notice that Daubert was in play, but he also had responded to the Daubert issues.

In other words, the Defense was on notice that Daubert was at issue and did not provide adequate written support for admissibility or request a hearing on the issue.  As Judge Holmes concluded, "The district court made a ruling excluding that testimony because Mr. Nacchio had not met his burden of demonstrating admissibility." 

This is a straight up dispute not about whether the Fischel testimony ultimately met the Daubert standard but whether the Defense met its burden of establishing admissibility.  Should the 10th Circuit hear the case en banc?  To leave the matter standing is to suggest the need for evidentiary hearings even when not requested by the relevant party.  It is a ruling that could potentially result in great inefficiency and interfere with the trial court's discretion. 

But mostly it should be heard because of the appearance of favoritism that exists in this case.  The panel put the government on an accelerated briefing schedule that benefited the Defendant.  The panel that heard the petition for bail pending appeal also kept the merit appeal, raising issues about the neutral assignment of the case.  The case could easily have been returned to the ordinary assignment process and randomly assigned to another panel.  Instead, the oral argument date was scheduled outside the ordinary schedule and the panel allowed to keep the case.  For a discussion of the case and panel assignment in the Tenth Circuit, see The Neutral Assignment of Judges at the Court of Appeals. 

Finally, one has to wonder whether the opinion would have come out the same way had a drug defendant argued for reversal despite having asked for a hearing on the relevant evidentiary issue.  It seems to be a case that provides particular deference to the type of economic analysis often applicable in white collar cases. 

The Defense has requested that if the case is reheard en banc, all of the issues on appeal should be reopened.  Specifically that: 

• it should review the entire case and not artificially limit its review to particular issues selected by the government. Mr. Nacchio’s arguments about the jury instructions, the sufficiency of the evidence, and the limitations on discovery and admissibility of certain classified information were rejected by the panel, but each is a substantial and “close” question, and each was entwined with the Court’s conclusion that the exclusion of Fischel was not harmless because “[t]he record does not otherwise contain ‘overwhelming evidence of guilt.’” Add. 30 (citation omitted). In the interests of justice, if the government’s petition for rehearing en banc is granted, Mr. Nacchio should have the opportunity to present this case in its entirety to the en banc Court.  For example, the panel considered it a “close question,” whether the “risk” of a shortfall in results more than eight months in the future was immaterial as a matter of law.

The Government and Defense briefs on the rehearhing en banc can be found at the DU Corporate Governance web site.

US v. Nacchio: The Government Seeks Rehearing En Banc

The Government has requested rehearing en banc by the entire 10th Circuit with respect to the panel decision in US v. Nacchio.  The brief takes issue with the decision to reverse on the basis of the trial judge's decision not to hold a hearing before excluding the testimony of Daniel Fischel. 

The brief is dry and procedural but takes the position that "the panel majority broke new ground in requiring a district judge, sua sponte, to call for a hearing or additional submissions about an expert’s reliability under Rule 702 where a motion to exclude has already raised that issue and the proponent, in his written opposition, has neither made a showing of reliability nor asked for a hearing."  In addition to arguing that the holding is inconsistent with 10th Circuit precedent, the Government also argues that it conflicts with better reasoned case law in the Third Circuit.  See Oddi v. Ford Motor Co., 234 F.3d 136 (3d Cir. 2000).   To the extent the court upholds the panel, the Government asks for a less drastic remedy than reversal.  As the brief notes:

• The Supreme Court has recently indicated that, where it is not clear from the record whether exclusion was actually erroneous, a limited remand for an admissibility inquiry by the district judge in the first instance is a more appropriate remedy than reversal for a new trial.

The argument is one of judicial economy (it is wasteful to always require a hearing) and judicial discretion ("The panel’s decision will likely have a chilling effect on judges who understandably read it to disfavor or prohibit exclusion of 'contextual' economic opinions — even ones that are superfluous or confusing."). 

En banc hearings can only be ordered by a majority of the court and are not favored.  The 10th Circuit rules provide that it is an "extraordinary procedure" intended for matters "of exceptional public importance."  We'll make a prediction on the resolution of this motion but will wait until Nacchio and his team has filed a response (due May 15).

The Government's brief will be posted on the DU Corporate Governance web site later today. 

US v. Nacchio: The Last Word (For Now)

The good news for Joe Nacchio is that the conviction was reversed. The bad news is almost everything else in the opinion.

On appeal, the defendant challenged various jury instructions and argued that the evidence was insufficient to sustain a conviction. On all counts, the unanimous opinion (the dissent was only one the one issue that resulted in reversal) emphatically rejected the arguments.  The court likewise rejected arguments based upon the black box defense. 

All of this must be viewed in the context of a case that was apparently not ahard one for the jury.  To the extent it goes back for retrial, another conviction has to be seen as a high risk, testimony from Daniel Fischel notwithstanding.  The case will also be more focused, the jury having acquitted on the insider trading counts relating to the January and February trades. 

Time to think plea.   

US v. Nacchio: The SEC Wins One

One thing is for certain about the decision in US v. Nacchio, the SEC came out a winner. In reviewing the sufficiency of the evidence, the main issue was the materiality of the non-public information known to Nacchio at the time he traded. undisclosed information, an amount equal to 4.2% of the company's revenue. The court not only found the amount material, but blessed Staff Accounting Bulletin No. 99. SAB 99 is a document that reflects the views of the staff and contains an expansive interpretation of materiality. It is now persuasive authority in the 10th Circuit.

The court also made clear (consisting with SAB 99) that determining the percentage threshold was only the "beginning of an analysis of materiality." As the opinion noted:

• The use of a percentage as a numerical threshold, such as 5%, may provide the basis for a preliminary assumption that—without considering all relevant circumstances—a deviation of less than the specified percentage with respect to a particular item on the registrant’s financial statements is unlikely to be material. The staff has no objection to such a “rule of thumb” as an initial step in assessing materiality. But quantifying, in percentage terms, the magnitude of a misstatement is only the beginning of an analysis of materiality; it cannot appropriately be used as a substitute for a full analysis of all relevant considerations.

In other words, putative defendants arguing that information was not material will not be able to rest on the percentage alone. This has long been the position of the Commission and is now the law in the 10th Circuit. Moreover, in finding the 4.2% of revenue material, the court relied on a "skittish" market. As the opinion noted:

• The government argued that the shortfall had particular salience given the state of the economy and the industry. Mr. Nacchio himself had said in January that the “skittish market” was so “mercurial” that even a $50 million shortfall could create a 15–20% drop in stock price.

In other words, the court did not rely on evidence that the numbers were necessary to meet analyst forecasts or suggested that Qwest was avoiding problems befalling others in the industry, both factors likely to not be present in most other cases. Instead, it was enough that the market was "skittish."

Finally, the court noted that the jury instruction for insider trading may have been incorrect because it was too favorable to the defendant.  The instruction essentially required that the inside information be the basis (or at least a substantial factor in the reason for) the trade.  The Commission in Rule 10b5-1 adopted a different standard, that required merely that the insider trade while in possession of the inside information.  As the court noted:

• This instruction was arguably incorrect because it was too favorable to Mr. Nacchio. Since 2000, Rule 10b5-1 has provided that an insider trades “on the basis of” information so long as he is “aware” of it, 17 C.F.R. §240.10b5-1(b), unless he falls into one of the rule’s safe-harbors—the creation of an automatic trading plan or some other binding contract or election to sell stock in advance of acquiring the information. Id. § 240.10b5-1(c). This would make Mr. Nacchio liable even if he could prove that he had unrelated reasons for his sales (such as the need to dispose of options before their expiration date) and thus that he did not trade “on the basis of” the information.

This case, therefore, benefits the particular defendant but will, in the long-term, provided the greatest benefit to the SEC, providing the agency with very favorable law on materiality and the standard for establishing insider trading. 

US v. Nacchio: Curing an Affront to the Law and Economics Movement

The dispositive issue in the case was the decision to exclude Daniel Fischel, the former dean of the University of Chicago Law School as an expert. Ultimately, the two judges in the majority (Michael McConnell and Paul J. Kelly) concluded that the trial judge erred by not holding a hearing on whether to exclude the testimony. The majority did so despite the fact that the defendant did not request one until after the testimony had been excluded and only in a footnote to a motion for reconsideration. The dissent vigorously disagreed with the outcome of the decision.

Judge Kelly's vote was predictable. He noted inoral argument that the failure to hold a hearing was "the most simplistic thing I've ever seen." Judge McConnell's view is a bit more interesting. He is a University of Chicago graduate, the law school that has more or less dominated the law and economics movement. He has written an article with Judge Posner, one of the leading proponents of the movement. He appears, therefore, quite sympathetic to economic analysis.

Judge Nottingham's ruling with respect to Daniel Fischel under the Daubert standard was effectively a decision that the defendant had not established the reliability of the testimony. In other words, it was to some degree a rejection of economic analysis.  It is perhaps unsurprising that a judge steeped in the area would not allow the ruling to stand.

The opinion did not conclude that the judge was wrong but it did find a procedural deficiency. As the opinion noted:

• The judge could have put Professor Fischel on the stand to ask him about his methodology, allowed the government to do so, asked Mr. Nacchio’s lawyers if they would like to address the issue for the first time, or even simply let them speak to see if they had a meritorious objection. Having permitted none of those things, however, it would have been an abuse of discretion to make a Daubert finding of unreliability.

The tone of the opinion, however, suggests that had the trial judge done so, the appellate court viewed the testimony as admissible.  As the opinion noted:  

• We are persuaded that the exclusion of Professor Fischel was not inconsequential under any standard. The theory of Mr. Nacchio’s defense was that the stock price was not affected by his disclosures, that his conduct had an innocent explanation, and that a reasonable investor would not have found his inside information very important. Professor Fischel’s testimony, as described in the disclosure, could have addressed each of these issues, and if credited by the jury, might have changed the jury’s mind.

Any judge reading this will be loathe to exclude this type of testimony again.  It wasn't really about the process, therefore, it was about the merits. It isn't about just any testimony.  It is about economic analysis.  With the ruling, a slight to the law and economics movement was effectively expunged. 

For primary materials on this case, including the appellate briefs, go to theDU Corporate Governance web site.

US v. Nacchio: Replacing the Trial Judge

The panel voted to replace the trial judge, Judge Nottingham. The reasoning was not lucid. Here is the entire discussion of the issue.

• Finally, the defendant asks us to assign any new trial to a new district judge. In this Circuit, we exercise our power to do so only where we find either that the judge harbored “personal bias” or on the basis of circumstances laid out in a three-part test:  (1) whether the original judge would reasonably be expected upon remand to have substantial difficulty in putting out of his or her mind previously-expressed views or findings determined to be erroneous or based on evidence that must be rejected, (2) whether reassignment is advisable to preserve the appearance of justice, and (3) whether reassignment would entail waste and duplication out of proportion to any gain in preserving the appearance of fairness. Mitchell v. Maynard , 80 F.3d 1433, 1448–50 (10th Cir. 1996) (quoting United States v. Sears, Roebuck & Co. , 785 F.2d 777, 780 (9th Cir. 1986)).
• We do not suggest that the assigned district judge harbored personal bias against Mr. Nacchio, but we do conclude that the factors outlined in Mitchell militate in favor of retrial before a different judge. After reading the trial transcript, we have concluded that it would be unreasonably difficult to expect this judge to retry the case with a fresh mind. Because the government will have to retry the case from scratch either way, there is no unnecessary “waste [or] duplication” in reassigning it.

Changing the trial judge is an unusual move.  It can only be viewed as a signal of disapprobation.  Moreover, it comes with little more than a request by the defendant, asking that the court exercise its inherent authority to change the judge.  The decision has given rise to speculation about the reasons, particularly given the bad publicity suffered over recent months by the trial judge. Steve Bainbridge has noted these concerns and has invited comment from those who followed the case more closely.

While the judges no doubt knew about these issues (as do probably all judges in the circuit if not the country), the issue that did come up constantly at the trial was a sort of test of wills that arose from having two federal judges in the court room, Judge Nottingham and Herbert Stern, a former federal judge in New Jersey.  I wrote an editorial for the Denver Post on the subject early in the proceeding (In courtroom with three judges, only one with gavel matters).  Most likely it was this dynamic that caused the court to conclude that the case should go to another judge.  

I will say this, however.  The defendant's brief was an epitome of understatement on this issue, merely asking for a new judge.  The subtle stroke was, however, sufficient to alert the panel (probably already to some degree aware of the issue from press reports) and carry the day.  It was the right strategy from someone who knows how courts operate.

US v. Nacchio: Government Options

The following is a list of my initial reactions to the Tenth Circuit’s split decision to grant Joe Nacchio a new trial based upon the improper exclusion of his expert witness.

1.  While a victory for Nacchio, he would have preferred a finding by the 10th Circuit that the evidence at trial was insufficient to convict him. If the 10th Circuit court had so found, Nacchio would have won a complete victory since to try him again would violate the Double Jeopardy Clause. Moreover, the government’s positions on the balance of the appealable issues were validated by the 10th Circuit. Consequently, with this roadmap from the 10th Circuit, the government’s prosecuting team might be more efficient and effective the second time around resulting in another Nacchio conviction.

2.  While the government is weighing all its options at this time, one option that has to be considered is to petition the 10th Circuit for a review of the 2-1 decision by the full court under Fed. R. App. P. Rule 35(a)(2) on the basis that “the proceeding involves a question of exceptional importance.” Justice Holmes vigorous dissent on the expert witness exclusion issue invites the government to strongly consider this option. The question of “exceptional importance” is whether Nacchio’s disclosures related to his expert witness were sufficient under Rule 16 of the Federal Rules of Criminal Procedure or did Nacchio fail in his Daubert obligation to establish the admissibility of his expert’s testimony. Resolution of this question by the full court would go a long way in providing the needed guidance to district court judges within the circuit.

3.  It is worthwhile to note the contrast between the trial judge and one of the 10^th Circuit judges on the expert witness exclusion issue. In reaction to Nacchio’s attorney expressing surprise at the judge’s ruling to exclude the expert witness, Judge Nottingham stated in open court that if anyone would have told him that Nacchio’s attorneys would be surprised by his ruling, “you could have blown me over with a feather.” In contrast, Judge Kelley during oral arguments before the 10^th Circuit, expressed surprise and some indignation that Nottingham disallowed Nacchio’s expert witness.

4.  While it is another option that probably is remote but has to be considered, the government and Nacchio could avoid a trial by negotiating a lesser prison term (for example, a two to three year prison terms instead of the six years meted out by Judge Nottingham.) Ostensibly, strategic arguments can be made from both the perspective of Nacchio and the government. Both Nacchio and the government can avoid the “hazards of litigation” with a plea agreement because the government might lose in a retrial or Nacchio might face a similarly long six year prison term if he is again convicted. Moreover, both sides can avoid the cost of a new trial running into the millions. However, Nacchio may want to seek complete exoneration to avoid a guilty plea that could be used against him in the civil suits by shareholders and the SEC. Similarly, the government may want to seek another conviction to avoid public cynicism that might be triggered if it appeared that the wealthy can violate the rule of law and avoid the full retribution inherent in the law violated.

US v. Nacchio: The 10th Circuit Reverses

Thoughts on Tenth Circuit Reversal in Nacchio Case

John Holcomb

Department of Business Ethics & Legal Studies

Daniels College of Business

University of Denver

Having read the Tenth Circuit’s opinions, I have the following thoughts:

1. I think Judge Holmes has it right on the expert witness and Daubert issues, even though Judge McConnell is a real intellectual force on the bench. It is interesting how two judges can read the same facts and record, cite some of the same case authority, and come to such conflicting conclusions. However, Judge Holmes is persuasive that the case is more about Daubert than it is about rule 16 and that Judge Nottingham gave the defense ample opportunity to qualify the expert witness and his methodology and to request a Daubert hearing.

2. The Appeals Court opinion is firm in upholding Judge Nottingham on the issues of materiality and sufficiency of evidence. In fact, it points out Judge Nottingham was more generous toward the defense than he needed to be in some key instructions and that the defense was just wrong in much of its analysis. This makes it highly unlikely that another jury and court will come to a different conclusion on guilt when the case is argued on remand.

3. The national security defense is also likely now disposed of for good. The Court’s succinct analysis puts that issue to rest and even demonstrates that if Nacchio could prove his point on the confidential positive information at his disposal, this makes him all the more guilty if he is claiming that he acted on such information in his trading behavior.

4. On the Daubert issue, the only one on which the Court reverses the Nacchio verdict, it ironically relies on a case (Goebel v. Denver & Rio Grande) in which Nottingham had improperly allowed expert testimony, in the eyes of the Tenth Circuit. Nottingham must feel that he is in a Catch-22 situation – whether he allows or disallows the expert witness, he gets hammered.

5. What is the likely impact of this ruling on remand? We will get the same result, with the added expense of a new trial. Fischel and possibly other “experts” will be allowed to testify. He or they will then be vigorously cross-examined, and the government will call its own experts to refute Fischel and his interpretation of the facts. It may be a wash for the jury, or Nacchio will appear even guiltier. This may simply delay the day of reckoning for Nacchio.

6. The Appeals Court has thrown a momentary lifeline to the defense and bailed it out from its own mistakes. First, it should have answered the Court’s challenges and provided more qualifications for its expert’s methodology, and it should have also requested a Daubert hearing at an earlier stage. Further, as the opinion states on page 27, the facts were allowed in Court as summary testimony, and they evidently didn’t have any real impact on the jury. The defense also didn’t even see fit to use any of the facts or testimony in its closing argument, so how pivotal could they be on retrial?

7. What are other possible outcomes that might occur? Given the relatively minor issue on which the case is reversed, and the strength of the Appeals Court’s opinion in upholding the insider trading verdict, leading Denver attorney Ray Friedlob suggests that there may be a possible plea before the second trial. Given the likelihood of a guilty verdict the second time around, and the risk of an even longer sentence, Nacchio may opt to cut a deal for a 2-3 year sentence in advance of the second trial.

8. If the case does go to a second trial, the time and expense become unfortunate, given the narrowness of the Court’s opinion and the persuasive dissent from Judge Holmes.

9. Since the Court overturned the verdict solely on the basis of the expert witness issue, it raises once again the question posed by Jay Brown of the Sturm School of Law at the University of Denver. Did the University of Chicago connection between Judge McConnell, Professor Fischel, and defense counsel Maureen Mahoney play at all into the opinion? For appearances sake, should Judge McConnell have recused himself, leading to the participation of another judge from the Tenth Circuit panel instead? Jay Brown may now have further thoughts on those issues.

Nacchio Conviction Reversed, As Predicted

The appeal of Joe Nacchio came out today.  The opinion is posted on the 10th Circuit web site, the panel reversing only on procedural grounds, the trial judge's exclusion of an expert witness without a hearing having been reversible error.  How much of a surprise was it?  We predicted on this Blog the precise outcome, although we indicated that it would be a 3-0 decision.  In fact, as we also noted, Judge Holmes was unsympathetic to the appeal and, in fact, dissented.  We will write more on this opinion tomorrow but one of the most interesting things was the decision to order a new trial judge.  Given Judge Kelly's expression of strong dislike for the way the judge handled the case, it is not a surprise either. 

A Hint of What's Coming in the Nacchio Appeal

Kevin O'Bien has written a three part series on the reversal by theTenth Circuit of the trial court's approval of a civil settlement in one of the suits against Qwest (New England Health Care Employees Pension Fund v. Woodruff). 

While this has already been raised to some degree, we take a moment and emphasize the implications for the merit review of Joe Nacchio.  This reversal was written by Judge Kelly, who also sat on the panel hearing Nacchio's merit review.  Judge Kelly's opinion is not particularly deferential to the district court, contains a lecturing tone (explicitly telling the trial judge what to do on remand), and comes out in favor of Nacchio and Robert Woodruff.  

Sound familiar?  At the oral argument in the merit appeal, Judge Kelly was deferential to counsel for Nacchio, openly annoyed at the trial judge, and sometimes lecturing in tone.  Whatever the outcome of the merit panel, Judge Kelly's vote can be counted on for reversal. 

Having already predicted the 5-3 vote in Stoneridge and the affirmance by the 7th Circuit in Tellabs, we are of course predicting a reversal of the conviction of Joe Nacchio, with Judge Kelly siding with the former CEO.  It will be a prognostication trifecta.

Nacchio Civil Class Action Appeal: Part 3 (Prejudice)

Part 3 of this three-part series addresses one of the two principal legal issues present in New England Health Care Employees Pension Fund v. Woodruff, No. 06-1482. In a 2 to 1 split decision, the 10th Circuit remanded the case to U.S. District Judge Robert Blackburn to determine whether the $400 million settlement by the plaintiffs and Qwest of the class-action case was “fair, reasonable, and adequate” when Nacchio and his CFO were excluded from the settlement. Id. at *15 (Majority Opinion). Consequently, the $400 million by Qwest is now frozen until the validity of the private agreement is ultimately determined--namely,werer Nacchio's indemnification rights prejudiced by the agreement.  Ultimately, this case could significantly impair settlements in class action lawsuits where plaintiff shareholders and a company desire settlement without including culpable executives who hide behind employment indemnification clauses.

In the majority opinion, Judge Kelly and Judge Baldock held that the court need not address the legal merits of the PFJ [Partial Final Judgment], but only two procedural issues which it decided in Nacchio’s favor: (1) whether Nacchio and Woodruff had standing to contest the private contractual provisions between the plaintiffs and Qwest; and (2) whether the District Court provided sufficient findings in the case which was the subject of Part 2 of the series.

This last post in the series tackles the very obtuse, but critical, “standing” issue to contest the fairness of the settlement agreement between Qwest and the Plaintiffs. The analysis of this post supports the dissenting judge’s legal analysis that Nacchio and Woodruff did not have standing to contest the private settlement agreement between Qwest and the plaintiffs because their indemification rights were not prejudiced by the terms of the agreement.

The standing/prejudice issue requires an analysis of what truly is motivating Qwest, the plaintiffs, and Nacchio as further complicated by indemnification agreements with Qwest. The following are four key facts listed in the majority opinion that aid in understanding motivations of the parties involved in the lawsuit:

Mr. Nacchio and Mr. Woodruff were not included in the settlement negotiations but were informed that they would be included if they would pay personally into any settlement fund.

Plaintiffs believed that Mr. Nacchio and Mr. Woodruff were especially culpable and should not be allowed to join a settlement in which only Qwest would pay. Id.

Mr. Nacchio and Mr. Woodruff were not so inclined and therefore were not included in the final settlement.

Both Mr. Nacchio and Mr. Woodruff have agreements with Qwest that require Qwest to indemnify them for any reasonable amounts they might pay in settlement of a lawsuit against them as former directors or officers. Id. at * 4.

From these facts it becomes clear that while the plaintiffs were satisfied with the $400 million settlement from Qwest, the plaintiffs wanted Nacchio and Woodruff to pay personally due to, in their minds, Nacchio’s and Woodruff’s increased culpability as the top two financial officers of the company.

However, if Nacchio were to have settled the case or to lose at a trial, he would have the right to pursue indemnification from Qwest under his employment contract. (As an aside, Nacchio recently settled with Qwest on ongoing payments of legal costs—Qwest does not have to pay for Nacchio’s criminal appeal, but will continue to pay for legal costs related to all his civil litigation under the employment agreement indemnification.) Consequently, Qwest’s $400 million liability would be increased substantially if Nacchio and Woodruff were liable personally and Qwest had to indemnify them. However under itsbylaws as referenced by Nacchio’s employment agreement in the indemnification clause, Qwest would not have to indemnify Nacchio under the following situations:

…to the extent that any such indemnification against a particular liability is expressly prohibited by applicable law or where a judgment or other final adjudication adverse to the indemnified representative establishes, or where it is determined in accordance with applicable law, that his or her acts or omissions (i) were in breach of such person’s duty of loyalty to the Corporation or its stockholders, (ii) were not in good faith or involved intentional misconduct or a knowing violation of law, or (iii) resulted in receipt by such person of an improper personal benefit.

Since the claims in the case involve “knowing violation of law” (federal securities laws), it is possible and even probable that with the SEC civil case and civil cases against Nacchio including the present case, Nacchio would eventually be judged as intentionally violating securities laws and thus be prevented contractually from seeking indemnification from Qwest.

However, Qwest wanted a guarantee to settle for $400 million and Plaintiffs wanted the cash. Thus, Plaintiffs and Qwest entered into a private agreement excluding Nacchio and Woodruff with two contractual provisions that would ensure that Qwest's ultimate liability would not exceed $400 million. The two clauses in question are: (1) the “Class” (plaintiffs) will not settle any claim or judgment against Nacchio/Woodruff without obtaining from them the release of any and all claims they may have against Qwest based upon the subject matter of the lawsuit; and (2) the “Class” members agree that they will reduce or credit any settlement or judgment (up to the amount of such settlement or judgment) they may obtain against Nacchio/Woodruff by an amount equal to the amount of any settlement of final, non-appealable judgment that Nacchio/Woodruff may obtain against Qwest.

In his majority opinion overruling the district court, Judge Kelly held that Nacchio and Woodruff did have standing to contest the terms of Qwest’s private settlement due to the prejudicial nature of the terms. Quoting from the opinion:

In order to have standing to challenge a settlement, non-settling parties must demonstrate that they have been prejudiced by the settlement. In re Integra Realty Res., Inc. (In re Integra I), 262 F.3d 1089, 1102 (10th Cir. 2001). “Plain legal prejudice sufficient to confer standing upon a non-settling litigant in a class action has been found to include any interference with a party’s contract rights or a party’s ability to seek contribution or indemnification.” Id. at *8. (Emphasis added).

The majority opinion then focused on the word “any” to make the following perfunctory argument:

In In re Integra I, the opt-out parties lacked standing on a claim that immediate payment of settlement amounts would make it more difficult for the opt-out parties to defend their cases. In contrast, the Contractual Provisions here interfere with Mr. Nacchio and Mr. Woodruff’s ability to seek indemnification and therefore come within the terms of our precedent. Id. at *10.

In contrast, the dissenting opinion looked at the substance of the provisions to show that no prejudice is created by the settlement:

Contrary to the majority’s misreading of the Contractual Provisions, they do not “essentially strip” or “palpably interfere with” Non-Settling Defendants [Nacchio/Woodruff] "preexisting rights and potential legal claims.” (Majority Op. at 10.) Rather, the Contractual Provisions simply provide for a private contractual agreement between Plaintiffs and the Released Persons [Qwest], whereby Plaintiffs agree not to negotiate a settlement with Non-Settling Defendants that prejudices the Released Persons—and to indemnify the Released Persons if they do. Even if the practical effect of the Contractual Provisions is to decrease Plaintiffs’ incentive to settle with the Non-Settling Defendants, this “show[s] merely the loss of some practical or strategic advantage in litigating their case,” rather than any “plain legal prejudice.” In re Integra I, 262 F.3d at 1102. Id. Dissenting Op. *3 (Emphasis added.)

Rather than a loss of a strategic advantage to Nacchio, ironically, if Nacchio and Woodruff ultimately prevail on this issue, it will give them a tremendous “strategic advantage” in the form of leverage over the Plaintiffs who desire the cash now and over Qwest which wants certitude over its liability. Consequently, Qwest and the Plaintiffs might even negotiate a revised upward settlement with the Plaintiff’s release of all claims against Nacchio and Woodruff to remove the impediment to settlement.

The dissenting opinion further counters logically the majority opinion on two points central to the “prejudice” issue.  Regarding the first point regarding the requirement of a release, the dissenting opinion reads as follows:

By paraphrasing the terms of the second Contractual Provision as “mandat[ing] that Plaintiffs must obtain a release,” (Majority Op. at 12 n.3), the majority omits the simple fact that Non-Settling Defendants remain in control of whether they will, or will not, enter into a settlement with Plaintiffs in the first place. Non-Settling Defendants have choices. Unless and until Non-Settling Defendants agree to a settlement with Plaintiffs, the question of a release does not arise.

Moreover, if Nacchio did decide to settle with the Plaintiffs and sought a release from Qwest, then Nacchio and Qwest could engage in good faith bargaining on the relative merits of Nacchio's indemnification claim.  For example, if Nacchio settled for $50 million with the Plaintiffs, Nacchio could negotiate the release from Qwest.  If Nacchio and Qwest believed, based upon the hazards of litigation that 50% should be the percentage of indemnification, Qwest would indemnify Nacchio $25 million.  The plaintiffs under the agreement would then credit Qwest for the $25 million so that the $400 million Qwest liability does not change.  Nacchio would have to pay $50 million but his net liability is $25 million after the Qwest indemnification.  Consequently, the Plaintiffs will be satisfied that Nacchio pays damages personally.  This negotiation for a release might never occur if the majority opinion stands and such clauses in a settlement with a company is deemed prejudicial.

The dissenting opinion discusses the lack of prejudice related to the "reduction" clause of the settlement as follows:

As for the first Contractual Provision, which the majority describes as “mandat[ing] that Plaintiffs . . . must reduce the settlement amount by any amount [Non-Settling Defendants] might still receive as an indemnity from Qwest,” (Majority Op. at 12 n.3), this provision merely guarantees that Plaintiffs will not indirectly recover additional amounts from the Released Persons, over and above the $400 million that the Released Persons have already agreed to pay under the Settlement. This provision ensures that, if Plaintiffs recover $X from Non- Settling Defendants, and Non-Settling Defendants later recover that amount ($X) from the Released Persons (via, for instance, an action for indemnification), then Plaintiffs will reduce their recovery against Non-Settling Defendants to nothing. This agreement is solely between Plaintiffs and the Released Persons. It guarantees the Released Persons that their total liability will be $400 million—no more, no less—and provides them with the peace of mind that settling parties both expect and require. Non-Settling Defendants are not prejudiced by either Contractual Provision.

As can be seen by this vigorous dissenting opinion on both the standing issue and the sufficiency of the district court’s findings, this is clearly a divided court. The standing issue is also an extremely important one since most CEOs and CFOs are protected by strong indemnification clauses in their employment agreements. However, these clauses do not customarily protect them for intentional unlawful conduct under federal security laws. From a public policy standpoint, if the Judge Kelly’s majority opinion ultimately results in granting executives strong bargaining leverage over their company and plaintiffs to settle resulting in full but inappropriate indemnification, “culpable” executives will not face financial retribution for their unlawful acts that in many cases resulted in large windfalls through equity flavored compensation.