Insider Trading

Tuesday, June 26, 2018 6:22 PM

General
• Trading on material non-public information in breach of a fiduciary duty.
• Basic rule under 10b-5, insiders must either disclose material non-public information prior to trade or abstain from
trading based on that information.
○ Disclosure usually means to the public market, HOWEVER, it may mean that you can disclose an intent to
trade to the source of the information.
• Has everything to do with if there was a fiduciary trust breach at any point AND NOT about the quality of
information.

Inquiry Roadmap
• Was there a trade?
○ Does the trade involve a tender offer?
• What is the information?
○ Is it material?
○ Is it non-public?
• Who is the person trading on the information?
○ Are they an insider, an agent, an outsider, or a tippee?
• Was a fiduciary duty breached?
• To whom was the duty owed?
○ Is a duty owed to the source of the information?
○ Is a duty owed to the corporation in which the securities are traded?

Types of Insider Trading:

• Classical Insider Trading ("Fiduciary Nexus Theory")
○ A person who has access to material, non-public information and has a relationship of trust and confidence
with the corporation in which the securities are traded must either disclose to public or abstain from
trading.
▪ Key question: is the person an employee of the company?
○ A "fiduciary nexus" is required for liability.
○ Who is a classical insider?
▪ Officers, directors, controlling shareholders and any employee.
• Constructive Insider Trading
○ A version of classical insider trading that involves a person who becomes a temporary fiduciary of the
corporation (e.g. lawyers, bankers, accountants).
▪ In an agency relationship, you are not allowed to use the assets of the principal for personal gain
without the principal's permission.
▪ Result: abstain or disclose to public.
• Outside Trading ("Misappropriation Theory")
○ A person who appropriates material, non-public information in violation of a duty of trust and confidence
with the source of the information must either disclose or abstain from trading.
▪ Key question: does the person owe the source of information a fiduciary duty?
▪ Result: disclose to source of information protects from insider trading, but not a civil breach of loyalty
to the source based on agency theories.
○ Rule 10b5-2(b): A relationship of trust and confidences exists when:
▪ The recipient agreed to keep the information confidential;
▪ The persons involved in the communication have a history or pattern of sharing confidences (recipient
should have known); OR

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 should have known); OR
▪ The person who provided the information was a spouse, parent, child or sibling of the recipient, unless
the recipient could show that there was no reasonable expectation of confidentiality.
○ Theoretically, classical insider trading is a form of misappropriation.
○ [EXAM] Examine every single communication and the relationship to the source. Is there a breach of trust?z
• Tipper/Tippee Insider Trading
○ A tipper or tippee faces liability for trading based on material, non-public information upon satisfaction of
the "personal benefits" and "breach of fiduciary duty" tests.
▪ Key question: was it done for an improper motive, pecuniary or non-pecuniary?
▪ Personal benefits defined under Dirks.
□ [EXAM] Any personal benefit suffices, even feeling "warm and fuzzy."
▪ Breach of fiduciary duty can be to:
□ The company of which the securities are being traded; OR
□ The source of the information.
○ Applies to both classical and misappropriation theories.
▪ The Tipper must improperly "tip" in violation to a fiduciary duty to the principal or the source of
information.
○ Tipper is liable for the entire chain of tippees.
▪ Where connections might seem too tenuous to satisfy requirement of Tippees "knew or should have
known," liability may still be shown where there is a conscious indifference to the source of
information.
○ For Tippees to be liable:
▪ Tippee knows or should have known tipper breached a fiduciary duty (or duty of trust and
confidence).
▪ Tippee knows or should have known tipper provided information for personal benefit.
▪ There must be a culpable Tipper.
○ Eavesdropping Exception for Liability
▪ You are not required to abstain from trading based on material, non-public information if you hear
that information from someone with whom you have no relationship of trust or confidence.
▪ Tipper is also excepted because a personal benefit cannot be shown.
• Tender Offers (Rule 14e-3)
○ Prohibits trading based on material, non-public information about unannounced tender offers.
○ Applies to everyone.
• Regulation FD ("Fair Disclosure")
○ Prevents selective disclosure of material information (e.g., financial analysts and investors).
○ For intentional disclosures, at the same time information is provided to financial analysts and investors, the
corporation must disclose the same information the entire investing public.
○ For unintentional disclosures, the corporation must promptly

United States v. O'Hagan

• Issues: Is a person who trades in securities for personal profit, using confidential information misappropriated in
breach of a fiduciary duty to the source of the information, guilty of violating § 10(b) and Rule 10b-5?
○ Case also addresses SEC's rulemaking.
○ Patched a loophole where an attorney representing a company seeking to buy another company could trade
in the other company.
• Facts: Attorney was charged with defrauding his law firm and client, Grand Met, by profiting off Pillsbury stock
options using material, non-public information regarding Grand Met's planned tender offer. Attorney used the
proceeds to repay embezzled funds from his trust accounts.
• Holding: § 10(b) allows for security fraud by insider trading under two theories:
○ Classical Theory - Where a corporate insider trades in securities of his/her corporation on the basis of
material, nonpublic information.
○ Misappropriation Theory - Fraud is committed "in connection with" a securities transaction when
confidential information is misappropriated for securities purposes, in breach of a duty owed to the source

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confidential information is misappropriated for securities purposes, in breach of a duty owed to the source
of the information.
▪ The principal is defrauded by the fiduciary's undisclosed, self-serving use of information to purchase
or sell securities.

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