Securities Exchange Commission v. Butler

Full title: SECURITIES AND EXCHANGE COMMISSION, Plaintiff, v. DAVID W. BUTLER…

Court: United States District Court, W.D. Pennsylvania

Date published: Apr 18, 2005

Civil Action 00-1827 (W.D. Pa. Apr. 18, 2005)

Opinion

Civil Action 00-1827.

April 18, 2005

MEMORANDUM OPINION

DAVID CERCONE, District Judge

I. INTRODUCTION

The Securities and Exchange Commission (the "Commission") filed a complaint against defendant, David W. Butler ("Butler") alleging violations of Section 17(a) of the Securities Act of 1933 ("Securities Act"), 15 U.S.C. § 77q(a), and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), 15 U.S.C. § 78j(b) and Rule 10b-5 thereunder. The Commission contends that Butler knowingly or recklessly traded in the stock of his employer, FORE Systems, Inc. ("FORE"), on the basis of material, nonpublic information concerning FORE's quarterly earnings expectations. The Commission requests that the Court enter an Order enjoining Butler from future violations of the referenced laws, and requiring Butler to pay disgorgement, prejudgement interest and penalties.

A nonjury trial was commenced on September 20, 2004. At the close of the Commission's case on September, 23, 2004, Butler requested entry of judgment as a matter of law. Following arguments in open court, the Commission requested twenty-one (21) days to file a written brief in response to Butler's motion. The Court granted the Commission fourteen (14) days to file its brief in response, and gave Butler seven (7) days to file his reply. The parties have filed their briefs and the motion is now before the Court.

II. LEGAL STANDARD

At the close of the Commission's case, Butler made an oral motion for entry of judgment on partial findings pursuant to Rule 52(c) of the Federal Rules of Civil Procedure. Rule 52(c) provides:

(c) Judgment on Partial Findings. If during a trial without a jury a party has been fully heard on an issue and the court finds against the party on that issue, the court may enter judgment as a matter of law against that party with respect to a claim or defense that cannot under the controlling law be maintained or defeated without a favorable finding on that issue, or the court may decline to render any judgment until the close of all the evidence. Such a judgment shall be supported by findings of fact and conclusions of law as required by subdivision (a) of this rule.

FED. R. Civ. P. 52(c). Under Rule 52, the court is not required to consider the evidence in the light most favorable to the nonmoving party. See Madison v. Frank, 966 F.2d 344, 345 (9th Cir. 1992); Giant Eagle, Inc. v. Federal Insurance, Co., 884 F.Supp. 979, 982 (W.D. Pa. 1995); 9A WRIGHT MILLER, FEDERAL PRACTICE AND PROCEDURE, § 2573.1, at 497 (2d ed. 1995). Instead, the court weighs the evidence and assesses the credibility of witnesses to determine whether or not the plaintiff has demonstrated a factual and legal right to relief by a preponderance of the evidence. See Rego v. ARC Water Treatment Co. of Pa., 181 F.3d 396, 399 (3d Cir. 1998) (holding that the district court can resolve disputed factual questions under Rule 52(c)); Fechter v. Connecticut Gen. Life Ins. Co., 800 F. Supp. 182, 196 (E.D. Pa. 1992); 9A WRIGHT MILLER, FEDERAL PRACTICE AND PROCEDURE, § 2573.1.

Moreover, a judgment entered pursuant to Rule 52 shall not be overturned on appeal unless the findings of the district court are "clearly erroneous." Agathos v. Starlite Motel, 977 F.2d 1500, 1504 (3d Cir. 1992). "Factual findings are not clearly erroneous if the record contains sufficient evidence to support them." Id. In accordance with Rule 52, the following opinion shall constitute the Court's findings of fact and conclusions of law.

III. DISCUSSION

In order to establish an "insider trading" violation of section 10(b), section 17(a) and Rule 10b-5, the Commission must show that Butler is a corporate insider who purchased or sold securities while in possession of material non-public inside information, and acted with scienter. See United States v. O'Hagan, 521 U.S. 642, 651-52 (1997); Dirks v. S.E.C., 463 U.S. 646, 653-654 (1983); Chiarella v. United States, 445 U.S. 222, 227-228 (1980). The corporate insider's duty to "disclose or abstain" arises from the existence of a relationship affording access to inside information intended to be available only for a corporate purpose, and the unfairness of allowing a corporate insider to take advantage of that information by trading without disclosure. Chiarella v. United States, 445 U.S. at 228; Dirks v. S.E.C., 463 U.S. at 654. This means that "any insider `in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed.'" Castellano v. Young Rubicam, Inc., 257 F.3d 171, 179 (2d Cir. 2001) (quoting SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968) (en banc)); see also Chiarella v. United States, 445 U.S. at 226-30.

As the Supreme Court explained, this theory applies not only to officers, directors, and the other permanent insiders of a corporation, "but also to attorneys, accountants, consultants, and others who temporarily become fiduciaries of a corporation." United States v. O'Hagan, 521 U.S. at 652. Therefore, Rule 10b-5 prohibits an insider, who has a fiduciary duty to a corporate entity, from using material non-public information to the insider's advantage in order to gain profits. See Dirks v. S.E.C., 463 U.S. at 654.

In this instance, Butler argues that the nonpublic information he allegedly relied upon to make certain transactions in stock options was not material as that term has been defined in the antifraud provisions of the securities laws. The United States Supreme Court adopted the following standard for materiality in section 10(b) and Rule 10b-5 actions, including actions based upon insider trading:

[A] fact is material if there is a substantial likelihood that a reasonable investor would consider it important in deciding how to [act]. . . . there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available.

Basic v. Levinson, 485 U.S. 224, 231-232 (1988); TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).

The test as to the materiality of undisclosed or misrepresented facts is an objective one, turning on "whether a reasonable man would attach importance [to them] in determining his choice of action in the transaction." Cohen v. Uniroyal, 77 F.R.D. 685, 694 (E.D. Pa. 1977), quoting Rochez Bros. Inc v. Rhoades, 491 F.2d 402, 408 (3d Cir. 1974). "Material facts include those that `affect the probable future of the company and [that] may affect the desire of investors to buy, sell, or hold the company's securities.'" Castellano v. Young Rubicam, Inc., 257 F.3d 171, 180 (2d Cir. 2001) (quoting Texas Gulf Sulphur, 401 F.2d at 849.) If the allegedly undisclosed facts concern a contingent or speculative event, materiality is determined by "a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity." Id. (internal quotations omitted); see also Basic Inc. v. Levinson, 485 U.S. at 238. The Supreme Court has expressly stated that in such circumstances no single event or factor is necessarily determinative of the materiality inquiry. 485 U.S. at 239. Moreover, the Supreme Court has said that:

The issue of materiality may be characterized as a mixed question of law and fact. . . . The determination requires delicate assessments of the inferences a `reasonable shareholder' would draw from a given set of facts and the significance of those inferences to him, and these assessments are peculiarly ones for the trier of fact.

TSC Industries, Inc. v. Northway, Inc., 426 U.S. at 450.

The Commission contends that Butler, a Vice President of European, Middle Eastern and African Sales, had material non-public information that significantly heightened the probability that FORE would not meet analyst revenue predictions for the fourth quarter of 1997. Specifically, in December of 1996, Butler requested that he receive corporate wide bookings¹ information. (Tr. 9/20/04, p. 147). Beginning in February of 1997, Butler was sent FORE daily bookings reports that included what each region had booked for the day, week, month, quarter-to-date and also included the bookings goals² for each region. (Tr. 9/20/04, pp. 144-145, Plaintiff Exhibit 52). As a Vice President of Sales, Butler also began attending weekly forecast meetings in February of 1997 during which the regional vice presidents, the controller, and Thomas J. Gill, FORE's chief financial officer ("CFO") and chief operating officer³ ("COO"), discussed the bookings, competitive strategy, support issues, plans and forecasts. (Tr. 9/20/04, pp. 155-156). This information was considered confidential. (Tr. 9/20/04, p. 155).

1 Bookings are defined as orders that have no sales contingencies. (Tr. 9/20/04, pp. 141-142). If a booking, or order, that was received into backlog and shipped was a valid order, that order would become revenue when shipped. (Tr. 9/21/04, p. 55).

2 Thomas Gill, FORE's CFO/COO, described the "goal" set forth in these reports as the "stretch goal." It was an internal goal that was typically higher that the company goal and Wall Street's estimate for the company. (Tr. 9/21/04, pp. 46-47; Plaintiff Exhibit 36).

3 Mr. Gill became COO in January of 1997. (Tr. 9/21/04, p. 49).

Butler attended weekly forecast meetings on February 10, 1997, February 17, 1997, February 24, 1997, March 17, 1997, March 24, 1997 and March 31, 1997. (Tr. 9/20/04, p. 155; Stipulation ¶ 12). The March 17^th meeting began at 2:00 p.m. eastern standard time ("EST") and was attended by Butler for forty-three (43) minutes. (Tr. 9/20/04, pp. 156-157; Stipulation ¶ 13). At the meeting, there were discussions regarding what was needed in bookings to achieve $130 million in revenue and what was needed to achieve $120 million in revenue by the end of the March quarter. (Tr. 9/21/04, pp. 79-86; Plaintiff Exhibit 33). Mr. Gill testified that these were internal goals not related to Wall Street earnings per share estimates, but at $120 million in revenue FORE would meet its company earnings per share goal. (Tr. 9/21/04, pp. 85-89). Moreover, after the March 17, 1997, meeting, Mr. Gill expected that FORE's revenues for the quarter ending March 31, 1997, would be $120 million. (Tr. 9/21/04, p. 92). There were two (2) weeks left in the quarter, and FORE had historically experienced back-end loaded quarters, meaning that a disproportionate percentage of FORE's sales came late in any given quarter. (Stipulation ¶ 51).

The Commission places significance on what it refers to as "the $120 million reduced goal," however, there is no evidence in the record that establishes that the $120 million in revenue was a "reduced" goal. Moreover, Mr. Gill's testimony clearly indicated that he believed the $120 million in revenue was expected by the close of the quarter and would in fact allow FORE to meet its earnings per share goal for the quarter. (Tr. 9/21/04, pp. 85-89, 92).

Following the March 17, 1997, meeting, Butler placed an order with his broker, Prudential Securities, to sell one hundred fifty (150) April call option contracts on FORE stock with an exercise price of twenty ($20.00) dollars and a cost, premium, of $3.50 per share. (Stipulation ¶¶ 25, 28 and 29). A call option gives the owner of the call the right to receive stock on or before a specified future date at a specific, exercise price. (Tr. 9/20/04, p. 34). By selling a call option, Butler received a premium for selling someone else the right to call the FORE stock away from him for a specific price, in this case $20.00. (Tr. 9/20/04, p. 37). At the expiration of the contract, if the stock price was less than the $20.00 dollar exercise price, the owner of the contract would allow the option to expire. (Tr. 9/20/04, p. 38).

Also on March 17, 1997, Butler purchased six hundred (600) July put option contracts on FORE stock with an exercise price of twenty ($20.00) dollars and a cost of $2.8125 per share. (Stipulation ¶ 30). The put options gave Butler the right to sell sixty thousand (60,000) shares of FORE stock for twenty ($20.00) dollars. Id. Therefore, if the price of FORE stock falls below $20.00, Butler would benefit by selling the stock for the $20.00 exercise price. (Tr. 9/20/04, p. 38). On March 24, Butler placed an order to sell one hundred (100) April call option contracts on FORE stock with an exercise price of twenty ($20.00) dollars and a cost of $1.50 per share. (Stipulation ¶ 35). It is undisputed that Butler made a substantial amount of money as a result of these trades. Plaintiff Exhibit 102.

The Commission contends that at the time Butler made these option trades, he had inside information that significantly altered the probability as to whether FORE would, for the first time in FORE's history, report fiscal 1997 fourth quarter results below analyst expectations. Unfortunately for the Commission, this Court does not find support for such contention by the necessary preponderance in this record.

To show a likelihood that Butler traded on non-public material information, the Commission must establish that he had access to, and traded on, information that was specific and more private than general rumors. See SEC v. Gonzalez de Castilla, 184 F. Supp. 2d 365, 378 (S.D.N.Y. 2002) (quoting United States v. Mylett, 97 F.3d 663, 666 (2d Cir. 1996)). In In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410 (3d Cir. 1997), the Third Circuit held that information, an omissions in this case, is immaterial as a matter of law if the facts omitted "would have had no more than a negligible impact on a reasonable investor's prediction of the firm's future earnings." Id. at 1427. In determining the effect of an omission, a court must examine whether the information omitted is speculative or unreliable, see In re Craftmatic Sec. Litig., 890 F.2d 628, 644 (3d Cir. 1989), or if it is contingent. See Lewis v. Chrysler Corp., 949 F.2d 644, 652-53 (3d Cir. 1991). Moreover, the court found that such considerations were especially relevant when the information omitted was "soft" information, a term which includes statements such as estimates and appraisals. See Craftmatic, 890 F.2d at 642-43; see also In re Rockefeller Ctr. Props. Sec. Litig., 184 F.3d 280, 289-290 (3d Cir. 1999).

Internal projections of profits and revenues are the type of confidential information that a corporate officer obtains by reason of his position. Such projections give rise to a duty to abstain or disclose if they are material. See, e.g., SEC v. Fox, 855 F.2d 247, 252-53 (5th Cir. 1988). However, this Court finds ample evidence in the record that, at the time Butler made the trades at issue, FORE expected to meet both its internal revenue goals and its external earnings per share goal for the March 1997 quarter. Any information to the contrary, especially based upon FORE's history of back-end loaded quarters, was speculative at best. In addition, the information available to Butler did not "significantly [alter] the `total mix' of information made available" to the public. See TSC Industries, Inc. v. Northway, Inc., 426 U.S. at 450. Finally, once the non-public information relied upon by the Commission herein was available to the investing public, such information had little, if any, effect on FORE's market price.

A. Information Known to Butler

The Commission adamantly contends that prior to the March 17, 1997, forecast meeting, Butler had material non-public information that significantly heightened the probability that FORE would not meet analyst revenue predictions for the fourth quarter of 1997. It is certainly true that Butler was privy to: (a) bookings information for all of FORE's sales regions; (b) internal revenue goals for each region; and, (c) the plans, forecasts and competitive strategies regarding meeting the regional goals. (Tr. 9/20/04, p. 147-148, 155-156). It is also true that the bookings information had a direct correlation to FORE's revenue, and Butler was admittedly aware of the relationship.⁴ (Tr. 9/21/04, p. 148; Tr. 9/20/04, p. 143). The Commission then concludes that a reasonable investor, with access to the bookings information available to Butler, could have drawn inferences about whether FORE was likely to meet, exceed, or fall below Wall Street revenue expectations. Therefore, Butler was in possession of material, non-public information when he made trades on the option contracts. Based on a preponderance of the evidence in the record, this Court finds such conclusion unavailing.

4 "[I]n general, bookings turn into revenue." (Tr. 9/20/04, p. 143).

The information available to Butler at the March 17^th and March 24^th forecast meetings was simply not a reliable indicator of FORE's probable quarterly revenue, nor was it a valid indicator of its earnings. Moreover, the interim bookings information is only significant in determining FORE's revenue during a particular period if one also knows the backlog at both the beginning and end of that particular period.⁵ (Tr. 9/21/04, pp. 148-149). There is no evidence, however, that Butler had information which defined any of those variables for the March 1997 quarter. Specifically, Butler knew bookings to date, but because of the disproportionate amount of sales at the end of a given quarter, he could hardly predict the bookings for the remainder of March, and Butler had no access to either the beginning or ending backlog for the period. (Tr. 9/20/04, pp. 148-151; Tr. 9/22/04, pp. 6-7, 32-34), see also (Tr. Maniglia⁶ Deposition, pp. 190-192).

5 For any given period, the revenue attributable to that period is equal to the beginning backlog plus bookings, minus the ending backlog. (Tr. 9/21/04, p. 148).

6 Michael J. Maniglia was a Vice President employed by FORE in March of 1997, who was deposed in this matter in August of 2001.

FORE's COO, Mr. Gill, testified that the interim bookings information possessed by Butler would not allow one to predict the end of quarter revenues. (Tr. 9/22/04, pp. 6-7, 32-34). Moreover, Mr. Gill specifically stated that sales volume for a quarter "was highly unpredictable all the way up to the last day, sometime last half day, sometimes the last two or three hours of the day." (Tr. 9/22/04, p. 7). In explaining the unpredictable nature of FORE's business and the number of orders that typically come on the last day of the quarter, Mr. Gill testified that in one past quarter "we had $20 million [in orders come] in on one day."⁷ (Tr. 9/22/04, p. 26). Mr. Gill further stated that "[i]t was so unpredictable, it was scary . . ." (Tr. 9/22/04, p. 30). Mr. Maniglia also testified that based upon the bookings information available two weeks before the end of the quarter it would be "difficult to reach an accurate estimate" of revenues. (Tr. Maniglia Depo., pp. 238-239). Clearly, the information available to Butler at the time he made the trades at issue was very speculative regarding, and certainly not a reliable indicator of, FORE's revenue and earnings for the quarter ending March of 1997.

7 Mr. Gill gave another example of a quarter when on the last day of the quarter FORE "received $21 million worth of orders . . . at ten o'clock at night . . ." Because the orders were needed by 6:00 p.m. to get the orders shipped to their customers, FORE missed the revenue goal for that quarter. Gill stated that "[w]e got all our orders. We just couldn't get them shipped out." (Tr. 9/22/04, p. 27).

The Commission strongly disagrees with the argument that the interim bookings data known by Butler fourteen (14) days before the close of the quarter was not material because the information might not predict the ultimate results. In support, the Commission cites to Shaw v. Digital Equip. Corp., 82 F.3d 1194 (1^st Cir. 1996) wherein the Court of Appeals for the First Circuit, in determining a duty to disclose⁸ intra-quarter performance results, stated:

Defendants posit, in essence, that there can never be a duty to disclose internally known, pre-end-of-quarter financial information, because any inferences about the quarter that might be drawn from such information could be rendered unreliable by later developments in the same quarter, such as a sudden surge of profitable sales. This position does not withstand scrutiny. Present, known information that strongly implies an important future outcome is not immune from mandatory disclosure merely because it does not foreordain any particular outcome.

Shaw v. Digital Equip. Corp., 82 F.3d at 1210. The court found that, where there is a duty to disclose, materiality of the information should be determined by assessing whether there is "sufficient probability that unexpectedly disastrous quarter-to-date performance will carry forward to the end of the quarter, such that a reasonable investor would likely consider the interim performance important to the overall mix of information available[.]" Id.

8 The same standard for materiality is used in insider trading cases as in cases alleging a fraudulent failure to disclose on the part of a company. See, e.g., Isquith v. Middle South Utilities, Inc., 847 F.2d 186, 208 (5th Cir. 1988) (applying the TSC v. Northway standard in a failure to disclose case); Alfus v. Pyramid Technology Corp., 745 F. Supp. 1511, 1518 (N.D. Cal. 1990) (holding that "since plaintiff has failed to allege any material non-public information or omissions which should have been disclosed, it cannot be found at this juncture that the insiders had a duty to disclose [before trading]").

The Commission further cites to SEC v. Truong, 98 F. Supp. 2d 1086 (N.D. Cal. 2000), wherein the court rejected the argument that the SEC had to prove the financial information in the defendant's possession specifically indicated the ultimate outcome of the quarter. In rejecting defendant's argument, the court stated:

the SEC need not show that [the defendant] knew that [the company] would "miss its sales targets by 20 percent," but it must show that [the defendant] possessed information making it likely that [the company] would fall behind expectations. As Judge Walker stated in [ SEC v. Soroosh]: "Even without knowing exactly how great an effect the news [of a delay of a significant product] would have on earnings or when it would affect the share price, the reasonable trader would know that the existence of a significant delay shaded the odds in favor of a short position."

SEC v. Truong, 98 F. Supp. 2d at 1098 (quoting SEC v. Soroosh, 1997 WL 487434, *12-13 (N.D. Cal. 1997), aff'd 166 F.3d 343 (9^th Cir. 1998). In denying the defendant's motion for summary judgment, the court found that "a reasonable jury could deem this information material because a reasonable investor could consider it significant that [the company] was behind plan so late in the quarter." SEC v. Truong, 98 F. Supp. 2d at 1100.

The Court is not persuaded by the findings in either Shaw or Truong. Unlike the interim results in Shaw, the forecast meetings attended by Butler did not indicate a "disastrous quarter-to-date" performance by FORE that strongly implied such results would carry forward to the end of the quarter. See Shaw v. Digital Equip. Corp., 82 F.3d at 1210. Nor did Butler have information, as the defendant had in Truong, that FORE would "likely . . . fall behind expectations." See SEC v. Truong, 98 F. Supp. 2d at 1098.⁹ To the contrary, the information available to Butler at the time of his trades did not make it any more likely than not that FORE would fail to meet either internal or external revenue expectations. Not even the COO could predict how the interim bookings information would affect the end-of-quarter results.

9 Moreover, the court in Truong was ruling on a motion for summary judgment, therefore drawing all reasonable inferences in favor of the SEC. Here the Court is also sitting as the fact finder, and must weigh the evidence and assesses the credibility of witnesses to determine whether or not the Commission has demonstrated a factual and legal right to relief by a preponderance of the evidence.

In addition to the unpredictability of FORE's quarterly sales, this Court also finds it very telling that, to the extent the interim bookings data indicated any trend for the quarter, FORE management believed the indications were that FORE would meet or exceed Wall Street estimates. (Tr. 9/21/04, pp. 200-202; Tr. 9/22/04, pp. 34-35, 220-221). As of the March 17 forecast meeting, FORE had booked $64.3 million through March 14 and needed to book an additional $51.7 million to reach a total of $116 million, which combined with the $4 million in backlog, would generate revenue of at least $120 million.¹⁰ See Butler Exhibits 9 and 164. Mr. Maniglia also believed that FORE would record revenues in the area of $120 million based upon the bookings data available during the March 17, 1997, forecast meeting. (Tr. Maniglia Depo. pp. 191-192). Moreover, Mr. Gill testified that information available at the March 17, 1997, meeting indicated that FORE was in a better position to meet its goals for the quarter ending March 1997, than it was at the same point in the prior quarter, the quarter ending December 1996, a quarter in which FORE exceeded Wall Street expectations.¹¹ (Tr. 9/21/04, pp. 181-182). At the time of his trades, Butler certainly had no information that would cause a reasonable investor to believe that the March 1997 quarter results would be any different than the December quarter.

10 Mr. Gill indicated that $120 million in revenue was sufficient to exceed earnings expectations. (Tr. 9/21/04, p. 195).

11 Despite the clear and uncontroverted testimony of Mr. Gill and Mr. Maniglia, the Commission insists that the information available to Butler "on or just before March 17, 1997 . . . would have dispelled the apparent predominant analyst belief . . . that FORE would meet analyst published revenue and earnings expectations." See SEC Response, p. 25 n. 63. Not only is such contention speculative, it is contrary to the clear weight of the evidence.

The Commission, however, argues that after the March 17, 1997, meeting Butler became aware of the $120 million "reduced" internal goal, and clearly had inside information that "significantly altered the probability" of whether FORE would report fourth quarter results below analyst expectations for the first time in history. This Court agrees that bookings data that would increase the probability that FORE systems would fall below its quarterly earnings expectations would be material to a reasonable investor. The overwhelming trial testimony, however, clearly shows that booking and revenue information available to FORE management at or about the time of Butler's option trading indicated to everyone, except the Commission, that FORE was on track to meet Wall Street expectations. Even if the $120 million in expected revenue was a "reduced" internal goal as the Commission contends, there is no evidence that this created a greater probability that FORE's fourth quarter earnings results would disappoint investors.

In Glassman v. Computervision Corp., 90 F.3d 617 (1^st Cir. 1996), the court considered whether a company's failure to disclose that "domestic bookings . . . were significantly below bookings at comparable points in the past 5 quarters" constituted a failure to "state a material fact required to be stated [in the registration statement] or necessary to make the statements therein not misleading." Glassman v. Computervision Corp., 90 F.3d at 624, 630. In finding that Computervision had no duty to disclose the interim bookings data, the court noted that mid-quarter results are material only when they indicate a "substantial likelihood that the quarter would turn out to be an extreme departure from publicly known trends and uncertainties." Glassman v. Computervision Corp., 90 F.3d at 630 (quoting Shaw v. Digital Equip. Corp., 82 F.3d at 1194.). In the instant case, there is no evidence that FORE's interim results indicated an "extreme departure" from past trends known to the investing public. To the contrary, at the time Butler made the trades at issue, all indications were that FORE would meet or exceed Wall Street expectations, just as it had in the December 1996 quarter.

Moreover, it is axiomatic that Butler's liability for insider trading can be based only on material, nonpublic information known at the time of the trade, not on information learned later. See, e.g., TSC Indus., Inc. v. Northway, Inc., 426 U.S. at 449 n. 10; United States v. Teicher, 987 F.2d 112, 120 (2d Cir.), cert. denied, 510 U.S. 976 (1993). The preponderance of the evidence shows that at the time Butler made the trades on the option contracts, though there was a modicum of external concern over FORE's sales for the quarter, the clear indication was that FORE would meet estimates.

The Commission also mentions that the fact that Butler traded after learning of the information is probative of materiality. The Court disagrees. The uncontroverted evidence is that Butler consistently traded in options over a period from January of 1996 through the date of the trades at issue. (Tr. 9/20/04, pp. 54-55). In fact, prior to his trades in March of 1997, Butler made twenty-six (26) trades in FORE stock options. (Tr. 9/20/04, p. 55); Plaintiff Exhibit 103. It was certainly obvious that in March of 1997, FORE's stock was trending downward. Defendant Exhibit 15. When the trend of a particular stock is downward, and a large part of one's net worth is invested in that stock, one does not have to be a member of Mensa¹² to determine that some type of action is in order. It was certainly logical, sensible and consistent with past practice for Butler to hedge¹³ against the risks presented. Therefore, the fact that Butler traded in his account after the forecast meetings in March carries little weight in the Court's determination of materiality.

12 Mensa is a society for bright people that welcomes people from every walk of life whose IQ is in the top 2% of the population. See www.mensa.org.

13 See Dr. McCann's testimony at Tr. 9/20/04, p. 46.

B. Information Available to the Public

The Commission must also prove that the information available to Butler at the time he made his option trades "would have been viewed by the reasonable investor as having significantly altered the `total mix' of information made available" to a reasonable investor. See Basic v. Levinson, 485 U.S. at 231-232; TSC Industries, Inc. v. Northway, Inc., 426 U.S. at 449. Again, the Court finds that the Commission has failed in its burden.

The Commission contends that the reported consensus analyst estimate of FORE's revenue for the March quarter was $122 million.¹⁴ See Plaintiff's Exhibits 33 and 54.¹⁵ This however, was very much in line with Mr. Gill's estimate in mid-March that the revenue would be around $120 million. Gill's "reduced" $120 million estimate was only 1.6% off the consensus expectation of $122 million; hardly an extreme departure from public expectations. Moreover, Butler argues that this de minimus variance is immaterial as a matter of law. See In re Westinghouse Sec. Litig., 90 F.3d 696, 715 (3d Cir. 1996) (finding that representations affecting 0.54% of net income were "not sufficiently material to be actionable, i.e., there is not a substantial likelihood that this information would have assumed actual significance in the deliberations of a reasonable investor."); see also Glassman v. Computervision Corp., 90 F.3d at 633 (where allegedly undisclosed information as to quarter-to-quarter changes in backlog merely indicated "a minor drop of a few percent," a claim of nondisclosure could be ruled immaterial as a matter of law."). The Court does not find that this mere 1.6% variance in the revenue estimates leads to the conclusion that the information known to Butler at the time of his trades was immaterial as a matter of law, however it is certainly highly relevant evidence to be weighed on the issue.

14 Butler argues that the $122 million revenue estimate set forth in an analyst's report (SEC Exhibit 54) was admitted for the limited purpose of showing the statements therein were made, and not for the purpose of proving the matter asserted. The $122 million, however, is a revenue estimate, not a statement of fact. The fact that the $122 million revenue estimate was in the public domain is relevant.

15 The Commission admits, however, that there was no official revenue consensus estimate during the March quarter. See SEC Response, p. 18 n. 46.

More significantly, the investing public was aware in early March that there was a risk that FORE's March quarter results would fall short of Wall Street expectations. An analyst from Hambrecht Quist, reduced his estimate of FORE's quarterly revenue from $122.8 million to $110.5 million, and reduced his rating on the stock to a "hold." See Defendant's Exhibit 19. In addition, the Hambrecht Quist analyst lowered the earnings estimate for FORE's fourth quarter from $0.15 per share to $0.14 per share.¹⁶ Other relevant and significant information entering the market concerning FORE in March of 1997 included:

16 Earlier in the quarter, this same analyst had increased the forecast for FORE's earnings from $0.14 to $0.15 per share. Defendant exhibit 19.

• A New York Times article dated March 8, 1997 stating that FORE "would report lower-than-expected earnings because of declining sales overseas." Plaintiff Exhibit 48, at Tab 15; Defendant Exhibit 22.

• Wessels, Arnold Henderson reporting that after a meeting with FORE management that weaker business from Japan was putting pressure on the March quarter. Defendant Exhibit 16.

• Furman Selz and Goldman Sacks reports on or about March 7, 1997, indicating that pressure from a back-loaded quarter and risk of not meeting "street estimates" caused a sell-off of FORE stock.¹⁷ Plaintiff Exhibit 48, at Tab 16; Defendant Exhibit 17.

• A Paine Webber Industry Report dated March 13, 1997 stated "Fore's stock tumbled as concerns about (1) the degree of back-end loading in the March quarter and (2) fears on slowing Japanese business gripped investors." Further, in discussing these trends the report mentioned the increased "risk that FORE could come in short on the revenue line since deal sizes are now larger, more strategic and more difficult to close." Defendant Exhibit 20.

17 It should be noted that Furman Selz stood by their estimate of "$121 million [in] revenue" for FORE's fourth quarter. This was only one million more than Mr. Gill's estimate after the March 17, 1997 forecast meeting.

It is also significant that FORE's stock price fell from 33-1/2 on March 3, 1997 to 22-1/8 on March 17, 1997, but during period Butler was making his trades, March 17 and March 24, the stock price fluctuated by less than four (4) points.¹⁸ Defendant Exhibit 15.

18 Considering the fluctuation of the stock price and the many concerns noted by analysts, only one analyst lowered FORE's earnings estimate for the quarter, reducing its earnings forecast from $0.15 to $0.14. See Defendant's Exhibit 19.

The movement of FORE's stock price over the first half of March indicates that the above disclosures were clearly understood by the investing market and the market reacted accordingly. At the time Butler made the trades at issue, the market had absorbed the perceived risks to FORE's revenues, and in fact, appeared to stabilize between March 21, 1997, and March 27, 1997, fluctuating between 18-3/8 and 17-5/8. Defendant Exhibit 15; Plaintiff Exhibit 66. Clearly, the evidence supports a finding that the information available to Butler at the time he made the relevant trades did not significantly alter the "total mix" of information made available to the public.

C. Effect on FORE's Market Price

The Commission also argues that the market's reaction to FORE's disclosures on April 1, 1997, that it would report quarterly revenue of only $101 million, a figure much lower than anticipated both within and outside of FORE, is evidence that the information at Butler's disposal on March 17^th and 24^th of 1997 was in fact material. In SEC v. Texas Gulf Sulphur Co., the Court of Appeals for the Second Circuit used what it termed the "market effect" test as a means of determining materiality. See SEC v. Texas Gulf Sulphur Co., 401 F.2d at 849. There the court made its materiality determination based on whether the information was "reasonably certain to have a substantial effect on the market price of the security." Id. at 848. Though not endorsed by the United States Supreme Court, the "market effect" has been used as a component of a court's analysis of the materiality issue. See, e.g., Oran v. Stafford, 226 F.3d 275, 282 (3d Cir. 2000) (describing and emphasizing the role of the market effect on the stock price by the company's disclosure in materiality analysis); In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1425 (3d Cir. 1987) (declaring that "because the market for BCF stock was `efficient' and because the July 29 disclosure had no effect on BCF's price, it follows that the information disclosed on September 20 was immaterial as a matter of law."); Geiger v. Solomon-Page Group, Ltd., 933 F. Supp. 1180, 1188 (S.D.N.Y. 1996) ("Evidence of stock price movement may be relevant to the issue of materiality but it is not determinative."); see also Joan MacLeod Heminway, Materiality Guidance in the Context of Insider Trading: A Call for Action, 52 AM. U. L.REV. 1131, 1158-1159 (2003).

In Burlington Coat Factory, the Court of Appeals for the Third Circuit reasoned that because efficient markets are those in which information important to reasonable investors is immediately incorporated into stock prices, then to the extent that information is not important to reasonable investors, release of such information will have a negligible effect on the stock price. In re Burlington Coat Factory Sec. Litig., 114 F.3d at 1425; see also Shaw v. Digital Equip. Corp., 82 F.3d at 1218; Roots Partnership v. Lands' End, Inc., 965 F.2d 1411, 1419 (7th Cir. 1992); Wielgos v. Commonwealth Edison Co., 892 F.2d 509, 510 (7th Cir. 1989) ("The Securities and Exchange Commission believes that markets correctly value the securities of well-followed firms, so that new sales may rely on information that has been digested and expressed in the security's price."). Therefore, in an efficient market "the concept of materiality translates into information that alters the price of the firm's stock," if a company's disclosure of information has no effect on stock prices, "it follows that the information disclosed . . . was immaterial as a matter of law." Oran v. Stafford, 226 F.3d at 282 quoting In re Burlington Coat Factory Sec. Litig, 114 F.3d at 1425.

As indicated above, on April 1, 1997, FORE reported quarterly revenue of $101 million, sixteen (16%) below the $120 million estimate given by COO Gill on or about March 17, 1997. FORE's stock had closed on March 31, 1997, at $15.00 per share. Defendant Exhibit 15. With an announcement of fourth quarter revenue much lower than the information possessed by Butler at the time of his alleged insider trading, FORE's stock opened on April 1^st at $10.625 per share.¹⁹ Defendant Exhibit 320. The stock hit a low of $10.00 at about 9:19 a.m., traded at or about $10:00 for approximately twelve (12) minutes, then steadily rose to $12.00 by approximately 10:28 a.m., and thereafter steadily rose to a close on April 1, 1997, of $13-1/16. FORE's stock price fully recovered by April 4, 1997, when it closed at $15-3/16. See Defendant Exhibit 320; Defendant Exhibit 15.

19 That price occurred at 9:00:25 a.m.

The Commission argues that the opening price of FORE stock on April 1, 1997 at $10.125, "down 33% from its close the day before" was a significant market reaction to the announcement that it had missed Wall Street estimates. See SEC Response, p. 25. The Commission further argues that "[t]his point is even more compelling when you consider the magnitude in the decline of [FORE's] stock price from March 17, 1997 . . . to the April 1, 1997 announcement." Id. These contentions are not only inconsistent with the facts of this case, they are contrary to law.

The Commission ignores the fact that FORE's stock price regained more than fifty-five (55%) percent of its initial loss by the end of the day. Moreover, FORE stock was trading for more than $15.00 per share by April 4, 1997, recovering all of its initial loss within three (3) days of the announcement. This hardly qualifies as a significant market reaction. Indeed, while a precipitous drop in share price can be evidence of materiality, see, e.g., Manavazian v. Atec Group, Inc., 160 F. Supp. 2d 468, 483-84 (E.D.N.Y. 2001), the recovery of a substantial part of the decrease during the first day following FORE's announcement and regaining the entire initial loss within three (3) days, "negates any inference of materiality, because it indicates that investors quickly determined that the `new' information was not material to their investment decisions." See In re Allied Capital Corp. Sec. Litig., 2003 U.S. Dist. LEXIS 6962 at *18 (S.D.N.Y. Apr. 25, 2003) (finding no material misstatements or fraudulently concealed material information after stock price recovered within a week.). In a similar decision by the United States District Court for the Southern District of New York, the court stated:

That the price of Westinghouse common stock recovered to its pre-announcement level within five trading days of February 27, 1991 and traded without dramatic fluctuation for a substantial period thereafter shows that the market did not change its valuation of Westinghouse common stock because of the February 27, 1991 announcement.

See Westinghouse Elec. Corp. V. `21' Int'l. Holdings, Inc., 821 F. Supp. 212, 220 (S.D.N.Y. 1993).

In Oran v. Stafford, supra., the Third Circuit reviewed two (2) incidents of a company's failure to disclose information and its effect on the market after such information was released. The court first reviewed the market effect of certain information announced on July 8, 1997, on American Home Products' ("AHP") stock and found no appreciable negative effect on the stock price; in fact, AHP's share price rose by $3.00 during the four days after the disclosure. Oran v. Stafford, 226 F.3d at 283. Applying Burlington, the court stated: "this price stability is dispositive of the question of materiality." Id. The court also reviewed a second release of alleged material information on September 17, 1997, which resulted in a four (4%) percent drop in AHP's share price. Id. at 285. Though the court found that "this share price activity does suggest that investors viewed this final category of undisclosed information as material," it found no need to analyze subsequent activity because AHP had no duty to disclose the information. Applying Burlington in Butler's case, the Court is unable to find an appreciable negative effect on FORE's stock price. The evidence strongly supports Butler's argument that he possessed no material information that altered the total mix available to investors in March of 1997.

The Commission also argues that an analysis of FORE's stock price from March 17, 1997, to April 1, 1997,²⁰ is compelling evidence of the materiality of the nonpublic information upon which Butler allegedly made his trades. The Commission argues:

20 FORE's stock fell from $22-1/8 on March 17, 1997, to $13-1/16 on April 1, 1997.

the defendant's advantage over the market, by virtue of his advance knowledge concerning the information later revealed to the market on April 1, 1997, is glaringly manifest by the decline in the stock price from the date he learned of the information to the date on which the company's quarterly results were publicly disclosed.

SEC Response, p. 26. If the information upon which Butler made his trades was nonpublic, such information could not have affected the market. The market can not possibly react to information that has not been disclosed. The Court finds the Commission's argument illogical, and such evidence of little value in determining the market effect of FORE's earnings shortfall.

Moreover, a review of FORE's stock price during March of 1997 is a further indication that Butler did not trade on material nonpublic information. On February 28, 1997, FORE's stock closed at $33-1/2. Defendant Exhibit 15. By market close on March 17, 1997, the stock had fallen to $22-1/8, and, in fact, hit a low of $21-5/8 earlier in the day. Id. Therefore, the trading public obviously had concerns regarding some particular risks to FORE, as well as some general risks regarding the "Networking Sector" itself. See Defendant Exhibits 16-22. Thereafter, the stock continued to fall reaching $15.00 per share on March 31, 1997. This downward trend FORE stock price is evidence that the public had information regarding material risks that was no less accurate than the information available to Butler. Accordingly, the Commission's argument that the "market effect" of FORE's April 1^st announcement is compelling evidence that Butler traded on nonpublic material information fails. The clear indication to this Court is that FORE's announced $101 million in revenue for the quarter ending March 31, 1997, had little effect on investors. Therefore, the fact that FORE "reduced" an internal revenue goal to $120 million on March 17, 1997, was not material at the time Butler made the option trades shortly thereafter.

IV. CONCLUSION

For the foregoing reasons, the Court finds by a preponderance of the evidence that Butler did not possess material nonpublic information when he made his trades in March of 1997. To summarize, at the time Butler made the trades at issue, FORE expected to meet both its internal revenue goals and its external earnings per share goal for the March 1997 quarter. Any information to the contrary, especially based upon FORE's history of back-end loaded quarters, was speculative at best. In addition, the information available to Butler did not "significantly [alter] the `total mix' of information made available" to the public. Finally, once the non-public information relied upon by the Commission herein was available to the investing public, such information had little, if any, effect on FORE's market price. Accordingly, Butler's Motion for Judgment under Rule 52(c) of the Federal Rules of Civil Procedure shall be granted.

An appropriate order will follow.

ORDER OF COURT

AND NOW, this 18th day of April, 2005, upon consideration of Defendant's Motion for Judgment under Rule 52(c) of the Federal Rules of Civil Procedure, Plaintiff's Response thereto, together with the briefs filed therewith, as well as the parties' oral argument on September 23, 2004, and the testimony and exhibits entered into the record during three (3) days of trial before this Court,

IT IS HEREBY ORDERED, that the Motion for Judgment under Rule 52(c) of the Federal Rules of Civil Procedure on behalf of Defendant, David W. Butler, is GRANTED. Judgment is hereby entered for Defendant, David W. Butler, and against Plaintiff, Securities and Exchange Commission.