222 F. 3d 633 - United States of America v. Steven J Henke

Chan Desaigoudar and Steven Henke, former executives of California Micro Devices, Inc. ("Cal Micro"), appeal their convictions for conspiracy to make false statements to the Securities Exchange Commission (18 U.S.C. S 371), making false statements (18 U.S.C. S 1001), securities fraud (15 U.S.C. SS 78m(a), 78ff(a)), and insider trading (15 U.S.C. SS 78j(b), 78ff(a)). The government cross-appeals the defendants' sentences.

The defendants claim that their convictions must be set aside because a conflict of interest prevented their counsel from cross-examining a key government witness and because there was insufficient evidence to support their insider trading convictions. They also argue that the district court erred in admitting lay opinion testimony and an out-of-court statement into evidence, and in failing to conduct an in camera review of government notes from an interview with a key government witness to ensure that the notes did not contain information that the government was required to disclose to the defense. Finally, they claim that the prosecutor committed misconduct in forcing Desaigoudar to testify that various government witnesses were lying. We agree with the defendants that a new trial is necessary because their lawyers' ability to conduct their defense was impaired by a conflict of interest. We also agree that the district court erred in admitting lay opinion testimony on the key issue of knowledge. We disagree, however, that the evidence was insufficient to support their insider trading convictions. We therefore remand the case to the district court for a new trial. While we address the defendants' remaining claims because they present issues that may recur on re-trial, because we vacate the convictionsand sentences, we do not address the government's sentencing appeal.

This case arises from a false revenue reporting conspiracy carried out by Cal Micro executives in order to preserve the appearance that the company was a good investment option when in fact it was struggling financially. Cal Micro designs, manufactures, and markets electronic components and semiconductor products for the defense and electronics industries. The company was purchased in 1980 by Desaigoudar, who turned it into a multi-million dollar company during the 1980s. In addition to being Cal Micro's largest shareholder, Desaigoudar served as its Chief Executive Officer and Chairman of the Board until he was removed in 1994.

In 1993, Cal Micro had two objectives. It hoped both to attract a strategic outside partner to invest in the company and to raise about $40 million in outside capital through a second public offering. Making the company an attractive investment option for outside companies and private investors was crucial to achieving these objectives and Desaigoudar instituted an incentive-based stock option plan to motivate officers and managers to meet revenue goals. These goals became increasingly difficult to meet, however, because Apple Computers, one of the company's largest customers, substantially reduced its orders.

Unable to close the widening gap between revenue targets and actual sales, some Cal Micro executives devised a plan to make it appear on paper that the company was meeting its financial goals. Under Cal Micro's stated revenue recognition policy, revenue was recognized when an order was shipped. These Cal Micro executives began to deviate from this practice in several ways. They started: (1) recognizing revenue when some orders were received, rather than when shipped; (2) shipping orders earlier than requested in order to recognize the revenue during a certain fiscal period; (3) sending unwanted shipments; (4) creating false orders; and (5) executing "title transfers" falsely reflecting that products stored at Cal Micro had been purchased by a client.

While this was occurring, Cal Micro successfully negotiated an agreement with Hitachi under which Hitachi would purchase two million shares of Cal Micro stock at $23 a share. Cal Micro and its investment bankers also put in motion plans for a second public offering.

Things then took a turn for the worse. Those involved began to worry about the implications of the revenue scheme. Moreover, the company's plan to write off several million dollars in "bad debts" caused Cal Micro's investment bankers to balk at a second public offering. The Board eventually instituted an investigation and ultimately ousted Desaigoudar.

Desaigoudar and Henke, a former Chief Financial Officer, Vice President, and Treasurer of Cal Micro, were indicted on charges of conspiracy, making false statements, securities fraud, and insider trading. Surendra Gupta, Cal Micro's President during the revenue reporting scheme, was also indicted, but reached a plea agreement with the government shortly before trial was to begin. The central issue at trial was whether the defendants had early knowledge of the false revenue reporting scheme and whether they traded their stock because of this inside information. Several of Cal Micro's executive officers, including former co-defendant Gupta, testified that the defendants did have such early knowledge. The jury believed the government's witnesses and convicted the defendants.

The defendants' principle claim is that they are entitled to a new trial because their attorneys worked under an actual conflict of interest that prohibited them from cross-examining one of the government's key witnesses, Gupta.

Before trial, Desaigoudar, Henke, and Gupta participated in joint defense meetings during which confidential information was discussed. Communications made during these pre-trial meetings were protected by the lawyers' duty of confidentiality imposed by a joint defense privilege agreement. Before trial was to begin, Gupta accepted a plea agreement and promised to testify for the government.

Desaigoudar's attorney then moved for a mistrial and to withdraw because his duty of confidentiality to Gupta under the joint defense agreement prevented him from crossexamining Gupta on matters involving information he learned as a result of the privileged pre-trial meetings. Henke's lawyer was also present at the joint defense meetings and felt that his duty to Gupta impaired his ability to adequately represent Henke.

The district court denied the motion to withdraw. It reasoned that any privileged impeaching information counsel learned about Gupta would not be known to new counsel and the defendants were therefore no worse off for being represented by their original attorneys. The court granted the motion for a mistrial to allow defense counsel to regroup after Gupta's plea.

Once the new trial began, Gupta testified for the government. Defense counsel conducted no cross-examination for fear that the examination would lead to inquiries into material covered by the joint defense privilege.

The issue for our decision is whether the government's use of a former defendant, with whom both Henke's and Desaigoudar's attorneys had an attorney-client relationship arising from a joint defense agreement, as a key witness at trial created a conflict of interest that impaired defense counsel's ability to defend their clients.

The joint defense privilege is an extension of the attorney-client privilege. It has been recognized by this Circuit since at least 1964. Waller v. Financial Corp. of America, 828 F.2d 579, 583 n.7 (9th Cir. 1987). A joint defense agreement establishes an implied attorney-client relationship with the co-defendant, here between Henke's and Desaigoudar's attorneys and Gupta. See United States v. McPartlin, 595 F.2d 1321, 1337 (7th Cir. 1979); Wilson P. Abraham Constr. Corp. v. Armco Steel Corp., 559 F.2d 250, 253 (5th Cir. 1977). The government concedes in its brief the existence of this privilege in this case.

This privilege can also create a disqualifying conflict where information gained in confidence by an attorney becomes an issue, as it did in this case. As the court said in Abraham Construction,

Just as an attorney would not be allowed to proceed against his former client in a cause of action substantially related to the matters in which he previously represented that client, an attorney should also not be allowed to proceed against a co-defendant of a former client wherein the subject matter of the present controversy is substantially related to the matters in which the attorney was previously involved, and wherein confidential exchanges of information took place between the various codefendants in preparation of a joint defense.

559 F.2d at 253; see also Westinghouse Elec. Corp. v. KerrMcGee Corp., 580 F.2d 1311, 1319 (7th Cir. 1978) (defense attorney breaches fiduciary duty if he uses information obtained in a joint defense meeting). Here, what Gupta allegedly said in confidence during pre-trial joint defense meetings about the defendants' presence at a critical meeting of Cal Micro executives was claimed to be at odds with his trial testimony for the government. This evidence put the two defense attorneys in a difficult position. Had they pursued the material discrepancy in some other way, a discrepancy they learned about in confidence, they could have been charged with using it against their one-time client Gupta. In fact, Gupta's lawyers had threatenedHenke's and Desaigoudar's attorneys with legal action if they failed to protect Gupta's confidences. Here is the text of the letter received by defense counsel:

Dear [attorneys for defendants Desaigoudar and Henke]:

It has come to our attention you may be contemplating filing an ex parte in camera submission to Judge Walker outlining what you contend are the contradictory statements made by Mr. Gupta in what you have conceded was a joint defense privileged meeting.

Please be advised that we do not, waive, and at no point ever have waived the joint defense privilege. Please be further advised that we are aware of no legal basis upon which you have any right to breach the privilege and that we reserve Mr. Gupta's right to pursue any and all appropriate legal remedies for any unauthorized breach of the privilege.

Please consider this letter as a formal objection to any ex parte in camera submissions to Judge Walker of any joint defense privileged information.

Yours very truly,

[Signed] Attorneys for Suren Gupta

Under these circumstances, the district court erred in not fully acknowledging the conflict and then acting on its implications.

Nothing in our holding today is intended to suggest, however, that joint defense meetings are in and of themselves disqualifying. We stress that it was defense counsel in this case that timely moved for disqualification. As the Supreme Court said in Holloway v. Arkansas, the attorney "is in the best position professionally and ethically to determine when a conflict of interest exists or will probably develop in the course of a trial." 435 U.S. 475, 485 (1978). There may be cases in which defense counsel's possession of information about a former co-defendant/government witness learned through joint defense meetings will not impair defense counsel's ability to represent the defendant or breach the duty of confidentiality to the former co-defendant. Here, however, counsel told the district court that this was not a situation where they could avoid reliance on the privileged information and still fully uphold their ethical duty to represent their clients. There is nothing in this record to suggest that the attorneys were doing anything other than attempting to adhere to their ethical duties as lawyers.

Few aspects of our criminal justice system are more vital to the assurance of fairness than the right to be defended by counsel, and this means counsel not burdened by a conflict of interest. Here, because of that conflict, the appellants' lawyers were constrained to impair yet another primary right of their clients: the right to cross-examine a witness who testified against them. By choosing to convert Gupta into a prospective witness shortly before the trial was scheduled to start, the government -which may not have anticipated this complication when it made a deal with Gupta -caused this problem, and should not now be heard to complain.

The defendants also challenge the sufficiency of the evidence supporting their convictions for insider trading under Section 10 of the Securities Exchange Act of 1934, 15 U.S.C. S 78j(b) (West 2000). Each contends that the evidence established that he sold his Cal Micro stock for innocent reasons and not because of information about the company's false revenue reporting.

We may reverse a jury conviction for insufficient evidence only if, viewing the evidence in the light most favorable to the government, no rational jury could have found the essential elements of the crime beyond a reasonable doubt. SeeJackson v. Virginia, 443 U.S. 307, 319 (1979). In this case, we look to whether the evidence supports a finding that the defendants traded stock on the basis of material nonpublic information with an intent to deceive, manipulate, or defraud. See United States v. Smith, 155 F.3d 1051, 1068-69 (9th Cir. 1998), cert. denied 525 U.S. 1071 (1999).

With respect to Desaigoudar, the jury heard evidence that he sold a portion of his stock after learning of Cal Micro's false revenue reporting scheme and that his sudden decision to "diversify" his portfolio came after receiving this information. Moreover, Desaigoudar's financial adviser had been advising Desaigoudar to diversify since 1986, but Desaigoudar only sold his stock in 1994 after the revenue reporting scheme surfaced. This evidence permits the inference that Desaigoudar traded on the basis of inside information and acted with the requisite scienter. Although Desaigoudar sold only a small portion of his Cal Micro stock, cf. In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1427 (9th Cir. 1994), his overall pattern of trading Cal Micro stock, when viewed in the light most favorable to the government, supports the jury's verdict.

Henke relies on our law that when there is evidence that an investor had a preexisting pattern or plan of trading and continued to execute that plan even after coming into possession of material nonpublic information, such evidence negates an inference that the investor acted with the scienter required for an insider trading conviction. See Smith, 155 F.3d at 1068; In re Worlds of Wonder, 35 F.3d at 1427-28. In Henke's case, however, the "preexisting pattern" of trading consisted of only two stock sales. Moreover, these sales netted him a relatively small return. The sale made after knowledge of the revenue scheme enabled him to avoid hundreds of thousands of dollars of loss in the stock's value. In addition, Desaigoudar's executive assistant testified that Henke told her that she would be stupid not to sell her own stock. When viewed in the light most favorable to the government, these circumstances permitted the jury to infer that the sales were the result of Henke's insider knowledge and not an earlier plan. We therefore conclude that sufficient evidence supports both Henke's and Desaigoudar's insider trading convictions.

Desaigoudar also contends that some of the evidence the government presented as to when he obtained inside information varied from one of the dates alleged in the indictment. There is no material variance or even inconsistency. See United States v. Tsinhnahijinnie, 112 F.3d 988, 991 (9th Cir. 1997) (noting that a variance is immaterial where it is not of a character which could have misled the defendant at trial and there is no danger of double jeopardy). The government proved that Desaigoudar had inside information on the date alleged in the indictment.

The defendants argue that the district court erred in admitting lay opinion testimony on the issue of the defendants' knowledge. Proving that Desaigoudar and Henke had knowledge of the false revenue reporting scheme was critical to the government's case. Without establishing this knowledge, it could not carry its burden of proving beyond a reasonable doubt that the defendants knew that financial statements they made were false, or that they possessed material nonpublic information before trading their stock.

One of the witnesses the government used to prove knowledge was Wade Meyercord, Desaigoudar's replacement as Chairman of Cal Micro's Board of Directors. Over the defendants' objections, the prosecutor systematically and repeatedly asked Meyercord about the reasons for terminating the defendants and other officers of Cal Micro. This questioning was done in order to elicit Meyercord's conclusion that the defendants "must haveknown" about the revenue reporting scheme.1 The defendants claim that it waserror to admit this testimony. We agree.

Under Federal Rule of Evidence 701, a lay witness's testimony in the form of an opinion is permissible only when it is helpful to understanding the witness's testimony or to the determination of a fact in issue. If the jury already has all the information upon which the witness's opinion is based, the opinion is not admissible. See United States v. Skeet, 665 F.2d 983,985 (9th Cir. 1982) ("If the jury can be put into a position of equal vantage with the witness for drawing the opinion, then the witness may not give an opinion."); Jack B. Weinstein & Margaret A. Berger, Weinstein's Federal Evidence S 701.05 (2d ed. 2000) ("[L]ay testimony generally is not helpful on matters that are essentially a jury question, such as credibility issues."); see also United States v. Anderskow, 88 F.3d 245, 251 (3d Cir. 1996) (holding that a witness's testimony that a defendant "must have known" fails to meet the helpfulness requirement); United States v. Rea, 958 F.2d 1206, 1219 (2d Cir. 1992) (same).

Here the jury was in the best position to determine whether the defendants knew about the revenue scheme. Unlike Meyercord and the Board of Directors, the jury had the benefit of several years of discovery, investigation, and litigation to flesh out the facts. Moreover, it heard testimony from all of the key actors in the scheme. While Meyercord testified that the Board formed a special committee of independent directors to investigate the false revenue reporting scheme, he was not questioned about the facts that the investigation turned up or how those facts were discovered. Meyercord was simply asked about the Board's conclusion that the defendants "must have known" about the scheme--a conclusion that went to the primary question for the jury. Because the jury was in a superior vantage point to decide this issue, Meyercord's testimony that the defendants must have known about the revenue scheme was not helpful. Its admission was therefore error.

In the event of retrial, there are three remaining issues that may recur. The defendants claim that the district court erred in admitting an out-of-court statement and refusing to review interview notes with a key government witness in camera to ensure that the notes did not contain information the government would be constitutionally or statutorily obligated to disclose. They also contend that prosecutorial misconduct occurred when the prosecutor required Desaigoudar to testify that government witnesses were lying. We address each in turn.

The first issue is whether the court properly admitted Desaigoudar's out-of-court response--"next question please" --to an accusation in a press conference that the defendants were "cooking the books." The district court found that the response was not unduly prejudicial and that, under the circumstances, the natural response to such an accusation would be to address or deny it. It therefore admitted the statement as an adoptive admission. See Fed. R. Evid. 801(d)(2)(B). It was within its discretion to do so. See United States v. Schaff, 948 F.2d 501, 505 (9th Cir. 1991).

[8] The defendants also contend that the district court erred in failing to conduct an in camera review of the government's notes from interviews with Ron Romito, a key witness, to ensure that the notes did not contain information that should be produced as exculpatory material under Brady v. Maryland, 373 U.S. 83 (1963), as impeachment material under Giglio v. United States, 405 U.S. 150 (1972), or as witness statements under the Jencks Act, 18 U.S.C. S 3500 (West 2000). The government provided the defendants with a substantial amount of information about Romito, including FBI reports, declarations, and a copy of his plea agreement, but invoked the work-product privilege as to its pretrial interview notes. The defendants made no showing that they might discover something exculpatory or impeaching. Nor did they show that the notes were used or adopted by the witness. Accordingly, the defendants did not trigger thedistrict court's obligation to review the privileged notes in camera. See United States v. Boshell, 952 F.2d 1101, 1104-05 (9th Cir. 1991) (finding that the defendants failed to make a showing that notes were read or adopted by the witness and that the notes were therefore not subject to the Jencks Act production requirements).

Finally, the defendants claim that the government acted improperly in forcing Desaigoudar to testify on crossexamination that the government's witnesses were lying. During Desaigoudar's cross-examination, the prosecutor repeatedly forced him to say that several of the government's witnesses lied on the stand. After the judgments were entered in this case, we made clear that forcing a defendant to comment on the veracity of another witness's testimony is inappropriate. See United States v. Sanchez, 176 F.3d 1214, 121920 (9th Cir. 1999). In light of Sanchez, this line of questioning by the prosecutor was improper and must be avoided on retrial.

The judgments of conviction are reversed, the sentences vacated, and the matters remanded for new trial or other proceedings consistent with this opinion.

REVERSED and REMANDED.

I join the court's opinion only with respect to the sections entitled BACKGROUND and LAY OPINION TESTIMONY. Because the district court's error prejudiced both defendants and was not harmless, I would reverse the defendants' convictions and remand for a new trial. Because this ground is sufficient to order such relief, I would not address the other issues raised on appeal.