The Extreme Importance of the Gain on Nacchio’s Insider Trades

Nacchio’s legal counsel has made similar legal arguments to attack the government’s perspective on the appropriate prison term range and on the appropriate amount that Nacchio should forfeit due to the illegal insider trades. These legal arguments can be found for the appropriate sentence by the government in its “United States’ Sentencing Statement” filed on July 6^th, 2007 and by Nacchio’s response to the Presentence Report by the U.S. Department of Probation. Similarly, these legal arguments can be found for the appropriate forfeiture by the government in its Motion for Entry of Money Judgment filed on April 26^th, 2007 and by Nacchio’s Response to Motion of the United States for Entry of Money Judgment.

The stakes are high since if Nacchio wins on both these issues--Nacchio can substantially mitigate the effect of the guilty verdicts on 19 counts as shown by the following table:

                             Government’s Position      Nacchio’s Position

Sentence Range       70 to 87 months               41 to 51 months

Forfeiture                  $52,007,545.47                $1,800,000.00

The central issue in dispute between the government and Nacchio’s attorneys is the proper measurement of: (1) “gain” on the total increase in value realized for sentencing purposes, and (2) “proceeds” from the illegal insider trades for forfeiture purposes. I discuss each measurement in detail next.

Gain and the Federal Sentencing Guidelines:

Gain according to the government for Nacchio’s sentencing range was computed as follows:

Total Sales Price $ 52,007,550

Nacchio’s Cost        7,315,000

Net Gain              $44,692,550

The government’s method results in 17 base levels as opposed to 12 levels using Nacchio’s approach and thus accounts for the material difference in the “Sentence Range” in the above table.

This method is prescribed by the Federal Sentencing Guidelines as interpreted by the Eight Circuit in United States v. Mooney, 425 F.3d 1093, 1100 (8^th Cir. 2005). In Mooney, the Eight Circuit repudiated the “market absorption approach” to calculate a much lower gain directly attributable to the material nonpublic information as measured by the affect disclosure of the information had on the stock price. The Eight Circuit ended its analysis by stating:

The focus in § 2B1.4 [Federal Sentencing Guidelines] on the increase in value realized by the defendant’s trades provides a simple, accurate, and predictable rule for judges to apply and follows the congressional mandate that sentences reflect the seriousness of the offense.

In contrast, Nacchio’s counsel argues that a civil damages model should apply and since Nacchio’s insider trading sales were only inflated by approximately $1.8 million due to the inside information according to his expert, this amount is the limit of his “net gain.” In Naccho’s Response to Motion of the United States for Entry of Money Judgment, the following is offered to describe how Nacchio’s expert determined the $1.8 million:

Professor Fischel has identified four dates following the insider trading period on which disclosures of the material inside information were made, and a fifth date on which an analyst report was published referencing information disclosed on one of the four disclosure dates. An analysis of the effect of these subsequent disclosures on the price of Qwest stock using well known and established techniques in financial economics shows that the portion of Mr. Nacchio’s sales proceeds that can be attributed to inside information and therefore, identified as “ill-gotten” gains, is no more than $1,832,561.

This market absorption approach is not completely without legal merit. In Mooney, there was well reasoned vigorous dissent based on the lack of uniformity that could result in applying the total gain, some of which might not be attributable to the material nonpublic information. Moreover, in the law journal article entitled “Reexamining 'loss' and 'gain' in the wake of Dura Pharmaceuticals v. Broudo -- New Ammunition for Securities Fraud Defendants” (30 Champion 10), the authors provide the following recommendation to legal counsel in Nacchio’s position:

The goal of uniformity in sentencing is clearly undermined by applying the Guidelines in a way that leads to such disparate sentences for defendants who engaged in identical conduct. "Such an application would create a through-the-looking-glass inversion of the Guidelines -- advising unequal sentences for identical crimes -- defeating the chief purpose of the Guidelines." While the "realistic economic approach" adopted in Olis advances the guidelines' goals of uniformity and fairness, the "brightline" rule applied in Mooney sacrifices those goals in favor of expediency.

For all of these reasons, it is difficult to reconcile Mooney with the Fifth Circuit's subsequent holding in Olis, or with the pragmatic approach adopted by the Supreme Court in Dura. Consequently, Mooney should not deter counsel from encouraging sentencing courts, when calculating the gain attributable to insider trading, to apply "thorough analyses grounded in economic reality," aimed at determining the economic impact that the "'defendant truly caused or intended to cause,'" "exclusive of other sources" of impact on the price of the security. (Emphasis added).

Proceeds and the Statutory Forfeiture Provisions

The battle over “proceeds” under the forfeiture provisions is whether direct costs related to the proceeds should be allowed. The government cites United States v. Keeling, 235 F.3d 533 (10 Cir. 2000) for the precedent that the amount subject to forfeiture is the gross amount of the proceeds, not some smaller amount based upon direct costs or net profits. The Tenth Circuit explained that requiring forfeiture of the gross amount was in accord not only with the legislative history and policies undergirding the forfeiture statute, but also with the “purpose of forfeiture,” which “is to remove property facilitating crime or property produced by the crime—all of which is tainted by the illegal activity.” Consequently, Nacchio’s $5.50 per share option cost could not be used to offset the “proceeds” as allowed to determine “gain” for sentencing purposes.

In contrast, Nacchio argues that the defendant in Keeling involved a drug dealer who wanted to offset the “proceeds” by his direct costs in paying his drug supplier for the drugs. The ruling in the Tenth Circuit made public policy sense because the effect of the ruling would be to shut down an illegal business as opposed to Nacchio’s insider trades.

Nacchio cites many cases that appear to allow “net profits” as the measure for the forfeiture provisions. Consequently, not only would Nacchio’s cost of the shares sold of $7,315,000 be allowed as an offset, but his $16,000,000 in withheld income taxes would also be allowed since he never received the total proceeds, only the net of the tax withholdings. Under this approach, Nacchio would have to forfeit $28.6 million after deducting his Qwest stock costs, commissions, and income taxes from his total proceeds of $ 52,007,550.

Finally, similar to numerous civil cases that have held that the amount of illicit gain in an insider trading case is generally the difference between the value of the shares when the insider sold them while in possession of the material, nonpublic information, and their market value a reasonable time after public dissemination of the inside information, Nacchio argues that the best measure is again the market absorption approach determined by his expert of approximately $1,800,000.

As is readily apparent, Judge Nottingham’s decisions on these issues will dramatically affect Nacchio’s level of punishment meted out on July 27^th, 2007. While I believe Nacchio will not prevail on these issues at the trial level, Nacchio’s counsel will have preserved legal issues that can be appealed to the Tenth Circuit.