Nacchio’s Puzzling (Innovative?) Defense

Thom Lambert —  24 January 2006

An article in today’s W$J reports on former Qwest CEO Joseph Nacchio’s planned defense in a criminal insider trading action brought by the SEC. The defense is perplexing.

The SEC has accused Nacchio of selling $101 million of Qwest stock while in possession of inside information that the firm wasn’t doing as well as its public statements would suggest. The Journal reports that

Mr. Nacchio’s attorneys have said in court that his defense will rest partly on a claim that he expected the company to do well despite its difficulties because he had secret information about classified, national security-related contracts he believed Qwest would win.

Come again? Is Nacchio claiming that it was OK for him to sell while in possession of material non-public bad news regarding company prospects because he also possessed material non-public good news? Is this a “two wrongs make a right” theory? Or is Nacchio saying that he shouldn’t be liable because he was really attempting to (irrationally?) hurt himself by selling while in possession of material non-public good news? The defense is odd.

In an attempt to figure out what Nacchio’s strategy is, I took a look at some recent filings in the case. In a document filed on January 18, Nacchio’s lawyers state:

The “material” information Mr. Nacchio is alleged to have possessed at the time of the stock sales in question (January 2 – May 29, 2001) related to the company’s ability to achieve its quarterly earnings targets. Thus, in order to prove the charged offense of insider trading, the government must prove not just that securities fraud was taking place at the company in the release of misleading financial information to the public, but that it was taking place with Mr. Nacchio’s knowledge prior to his sales of Qwest stock. This alleged inside information must be “material.”

Based on this statement (which is itself perplexing), I surmise that Nacchio’s defense (or this part of it, at least) is that two “wrongs” do make a right because the second piece of non-public information to which Nacchio was privy when he traded (i.e., the likelihood of the lucrative defense contracts) would make the first piece (i.e., various bits of bad news at the company) immaterial. In other words, the theory seems to be that the totality of non-public information of which Nacchio was aware would not be something a rational investor would consider important in deciding how to invest (and thus would not be material), for Nacchio’s private negative information was counterbalanced by private positive information.

Interesting. We’ll see where it goes. (I’m not optimistic for Nacchio.)

If anyone has other theories regarding Nacchio’s planned defense or knows of any decisions evaluating this “two wrongs” theory, please let us know.

Thom Lambert


I am a law professor at the University of Missouri Law School. I teach antitrust law, business organizations, and contracts. My scholarship focuses on regulatory theory, with a particular emphasis on antitrust.

7 responses to Nacchio’s Puzzling (Innovative?) Defense


    I’m not an expert in 10b-5 cases, including Qwest, but I know plenty about how corporate securities can be valued, and it alarms me how easily an insider trading charge can be alleged by an aggressive prosecutor (or plaintiff’s attorney). Any selective piece of company information may be deemed “material” by someone. Information that looks important may or may not move a stock; also, a stock may make a big move in the apparent absence of any big news. I know there are obvious cases, but the borderline seems very blurry. Was I in possession of illegal inside information if I bought shares when I knew my big division won a major contract, even if a couple of other big divisions losses offset my gains? Does it depend on what I knew? Or is it more complicated than that? (My concern about subjective or selective application of insider trading laws, and the loss of market information due to their enforcement, leaves me very skeptical about the value of such laws for our markets.)


    Excellent points by my co-blogger, Keith, and my colleague, Royce. It’ll be interesting to see how this defense gets fleshed out.


    Paragraph (a) of Rule 10b5-1 identifies the elements of an insider trading claim as violation of Rule 10b-5 that the trade was made “on the basis of material nonpublic information”.

    The rule was adopted after the decision in S.E.C. v. Adler, 137 F.3d 1325 (11th Cir. 1998), where the court opted for a “use” standard as opposed to a “possession” standard of liability.

    I suppose one might argue that the “use” standard is the appropriate one and that the SEC exceeded its authority in seeking to expand liability to impose liability on those possessing but not using the information. If the SEC did exceed its authority, then I would think possession of other material non-public information having a counterbalancing impact could provide a legitimate method for proving non-use.


    It would be an extraordinary coincidence for the two pieces of non-public information to be of exactly equal value and therefore precisely offsetting. But maybe all Nacchio is saying is that the positive inside info that he had more than offset the negative inside info, so his decision to sell cannot be attributed to his inside info but rather (perhaps) to the fact that he simply wished to diversify. Even if you have a positive view about a company’s direction, you might still want to diversify away from such a substantial position and so sell the text, positive expectations notwithstanding.


    I give them an “A” for creativity.

Trackbacks and Pingbacks:

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    […] trial of former Qwest CEO Joseph Naccio began yesterday. I’ve posted a couple of times (here and here) on Nacchio’s innovative defense, which the WSJ labeled a “black box” […]

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    […] I’m really starting to worry about lawyers for former Qwest CEO, Joseph Nacchio. (I first expressed concern here.) Mr. Nacchio has been charged with 42 counts of criminal insider trading. The charges are based on allegations that Mr. Nacchio learned, after Qwest had made some rosy public statements, that business wasn’t going as well as predicted, and he then sold $101 million worth of stock on the basis of that non-public information. […]