Securities Fraud

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Chapter 5
SECURITIES FRAUD
[A]
INTRODUCTORY NOTES
[1]
The Quintessential White Collar Crime?
Securities fraud encompasses a wide range of crimes. For example, if a company makes
material misstatements or omissions about the company in public documents, then the company
and its agents may be liable for defrauding investors in that company. Such fraud has been
alleged in a number of high-profile corporate scandals in recent decades. a In addition, securities
fraud encompasses fraud committed by individual investors. The latter type of securities fraud
includes what is perhaps the quintessential white collar crime — insider trading. The government
has pursued a number of high profile insider trading investigations and prosecutions of public
figures.b Consequently, as a former director of enforcement at the Securities and Exchange
Commission noted, “insider trading has a unique hold on the American popular imagination,” and
is worthy of special attention. Linda Chatman Thomsen, Remarks Before the Australian
Securities and Investments Commission 2008 Summer School: U.S. Experience of Insider Trading
Enforcement (February 19, 2008), https://www.sec.gov/news/speech/2008/spch021908lct.htm.
This chapter provides an overview of the principal securities fraud statutes, while
focusing primarily upon insider trading. Securities fraud is just one specific type of fraud covered
in the federal criminal code.c It will be important during the course of this chapter to observe the
a
For example, securities fraud was the principal allegation in the criminal cases arising out of the
massive collapses of both Enron and WorldCom. See John R. Emshwiller, Executives on Trial; Enron Ex-
Official Pleads Not Guilty to Fraud, Agrees to Aid Probe, Wall St. J., Aug. 2, 2004, at C3; Ken Belson, Ex-
Chief of WorldCom Is Found Guilty in $11 Billion Fraud, Wall St. J., Mar. 16, 2005, at A1. More recently,
Theranos founder, Elizabeth Holmes, was charged with massive securities fraud for making false and
misleading statements to investors concerning her company’s technology and financial performance. See
Joel Rosenblatt, The Spectacular Rise and Fall of Elizabeth Holmes and Theranos, BLOOMBERG
(December 3, 2020), https://www.bloomberg.com/news/storythreads/2020-12-03/the-spectacular-rise-and-
fall-of-elizabeth-holmes-and-theranos.
b
As commentators have noted, “insider trading prosecutions have drawn more public attention to
the securities markets than virtually any other event since the passage of the federal securities laws.”
Charles A. Stillman et al., Securities Fraud, in WHITE COLLAR CRIME: BUSINESS AND REGULATORY
OFFENSES § 12.03 (Law Journal Press, Otto G. Obermaier et al., eds., 2015).
c
See, e.g., 18 U.S.C. §§ 1341 and 1343 (Chapter 4, Mail and Wire Fraud, supra), and 18 U.S.C.
1
Electronic copy available at: https://ssrn.com/abstract=3760792

interplay between specific securities fraud statutes on the one hand, and the more generally
applicable crimes covered in the previous two chapters (conspiracy and mail and wire fraud) on
the other. In addition, charges may also arise in specific fraud cases under the “cover-up” statutes
involving false statements, perjury, and obstruction of justice covered later in this text. Readers
may ask themselves, as they review the securities fraud materials below, why the defendants in
these cases are so often charged with attempting to cover up their acts. d
The interplay among these various criminal laws also raises important questions that
appear throughout this book concerning enforcement obstacles, prosecutorial discretion, and
statutory vagueness. In particular, the relationships among these crimes provide some sense of the
choices prosecutors must make in deciding whether and how to charge a criminal case. This is
particularly true in the securities fraud context because, as noted below, the government in many
cases will be able to choose among pursuing administrative and/or civil remedies in addition to,
or instead of, criminal sanctions.
[2]
Civil and Criminal Enforcement
Securities fraud may be alleged in a number of different contexts. First, the government,
through the Securities and Exchange Commission (the “SEC” or the “Commission”), may initiate
an administrative proceeding or civil lawsuit alleging a violation of the federal securities laws.
Second, private parties may bring causes of action and seek damages for alleged violations of
those laws. Third, the United States Department of Justice may bring a criminal case in addition
to, or instead of, any civil action brought by the SEC and/or a private party. Note that the legal
issues decided in civil cases may also apply to criminal cases; many of the cases discussed in this
chapter were civil cases brought by the SEC or by private parties. Because securities fraud is
subject to parallel civil and criminal actions, the wise counsel will be mindful of the particulars
and consequences of liability in each context. While this chapter focuses on criminal liability for
securities fraud, §[E] below highlights some important aspects of civil enforcement and issues
that may arise in parallel proceedings. (See also Chapter 18, infra, for issues that arise in parallel
criminal and civil enforcement generally.)
[3]
The Federal Securities Regulation Scheme e
Congress enacted the two principal securities laws in the aftermath of the stock market
§ 1347 (Chapter 6, Health Care Fraud and Abuse, infra).

d
See, e.g., United States v. Stewart, 323 F. Supp. 2d 606 (S.D.N.Y. 2004); United States v. Arthur
Andersen, 374 F.3d 281 (5th Cir. 2004), rev’d, 544 U.S. 696 (2005).
e
The states have their own securities laws and regulations, which are referred to as “blue sky laws.”
Most of the important securities cases are brought at the federal level, although states have been
increasingly active in enforcing their own securities statutes.
2

crash of 1929. The Securities Act of 1933 (the “Securities Act” or the “1933 Act”), 15 U.S.C.
§§ 77a–77aa, generally regulates a company’s original registration and issuance of securities,
known as the “primary” or “new-issue” securities market. This statute, and the regulations
adopted pursuant to the statute, govern the disclosure of information to potential purchasers of
those securities. The Securities Exchange Act of 1934 (the “Exchange Act” or the “1934 Act”),
15 U.S.C. §§ 78a–78ll, on the other hand, generally governs what is known as the “secondary” or
“trading” market. Thus, this statute and the regulations adopted under the statute apply to trading
in the securities markets.
The civil and criminal fraud provisions of these statutes only apply when there has been a
purchase or sale of a “security.” The definition of the term “security” is a technical one that is a
mixed question of law and fact. See United States v. McKye, 734 F.3d 1104 (10th Cir. 2013). For
present purposes, the most important securities include stocks (equity interests that give a
stockholder an ownership interest in the issuing company) and bonds (debt instruments that
essentially are loans that the bond holder makes to the company).
Section 24 of the 1933 Act, 15 U.S.C. § 77x, and Section 32(a) of the 1934 Act, 15
U.S.C. § 78ff, make it a crime to commit a “willful” violation of the statutes or of the rules and
regulations adopted under the statutes. Most criminal securities fraud cases are brought for willful
violations of the statutes’ “catch-all” anti-fraud provisions, set forth at Section 17(a) of the 1933
Act, 15 U.S.C. § 77q(a), Section 10b of the 1934 Act, 15 U.S.C. § 78j, and Rule 10(b)(5)
thereunder, 17 C.F.R. § 240.10b-5.f Although sentences vary widely under the discretionary
federal sentencing guidelines, the statutory maximum for securities fraud under Section 10b is 20
years for each count and fines of up to $5 million for individuals and $25 million for
organizations. 15 U.S.C. §§ 77x, 78j(b), 77ff. In white collar cases, the sentences recommended
by the guidelines are often driven up dramatically by the amount of loss. See U.S.S.G. § 2B1.1;
Chapter 19, Sentencing, infra.
In addition, the corporate accounting scandals of the early 21st century led to the passage
of the Sarbanes-Oxley Act of 2002.g This broad-ranging legislation imposed new corporate
compliance and corporate audit procedures on publicly traded companies and created new crimes
relating to securities fraud. The latter is codified at 18 U.S.C. § 1348.h Some commentators have
questioned whether the new crimes truly differ from the existing securities fraud statutes, or
whether they will make prosecutions for securities fraud any easier.i To date, case law involving
f
The 1933 and 1934 Acts grant the SEC the power to issue regulations under the securities statutes.
Rule 10b-5 is one such regulation and renders it unlawful “[t]o make any untrue statement of a material fact
or to omit to state a material fact necessary in order to make the statements made … not misleading … in
connection with the purchase or sale of a security.”
g
Pub. L. No. 107-204, 116 Stat. 745 (2002). The Act touches on many areas of securities
regulation, and has been aptly termed “a securities regulation smorgasbord.” Harold S. Bloomenthal,
Sarbanes-Oxley Act in Perspective, SEC-SOAP § 1:10 (2007).
h
This new securities fraud statute (set forth in the statutory supplement) was intended to
“supplement the patchwork of existing technical securities law violations with a more general and less
technical provision, with elements and intent requirements comparable to current bank fraud and health
care fraud statutes.” 148 Cong. Rec. S7418-01, S7418 (2002) (statement of Sen. Leahy).
i
See, e.g., Phillip Lambert, Worlds are Colliding: A Critique of the Need for the Additional
Criminal Securities Fraud Section in Sarbanes-Oxley, 53 CASE W. RES. L. REV. 839, 851 (Spring 2003)
3

prosecutions under § 1348 is limited, but some courts have indeed found it to be broader in
scope.j
[4]
Elements of Securities Fraud
Most of the cases discussed in this chapter were brought under Section 10b of the 1934
Act and Rule 10b-5 thereunder. To obtain a conviction under these provisions, the government
must prove that:
(1) the defendant
(a) engaged in a fraudulent scheme, or
(b) made a material misstatement, or
(c) omitted material information to one to whom the
defendant owed a duty;
(2) the scheme, misstatement, or omission occurred in
connection with the purchase or sale of a security; and
(3) the defendant acted willfully.
With this general introduction to securities fraud in place, we turn now to the principal focus of
this chapter—insider trading.
[B]
INSIDER TRADING
The “insider” trader provides a classic image of the white collar criminal — the wealthy
corporate officer who steals a company’s secret information and profits at the expense of the
average investor. But the reality, of course, is more complex. Initially, it is important to note that
the term “insider” trading is a misnomer. The crime actually applies to a broad range of people
who trade on nonpublic information, including, but not limited to, corporate “insiders.”
There are two different, albeit overlapping, definitions of insider trading. First, under the
“traditional” or “classical” theory, a corporate employee or agent — the “insider” — takes
information from the corporation and uses the information to trade in the corporation’s stock in
(“[T]he language contained in section 807 of Sarbanes-Oxley … covers virtually identical transactions and
conduct as the language in the Securities Act and Exchange Act.”).
j
For example, the Second Circuit recently held in United States v. Blaszczak, 947 F.3d 19, 26 (2d
Cir. 2019), that the personal-benefit test (which is so crucial to tipper-tippee insider trading liability under
the Title 15 securities fraud statutes, see infra § [B][4]), does not apply to insider trading charges brought
under §1348. As noted below, the future of the Blaszczak court’s holding was uncertain at the time this text
went to press.
4

violation of a duty to its shareholders. This theory applies to two distinct categories of defendants:
(a) officers and employees of that corporation (“insiders”); and (b) outside lawyers, accountants,
and others who work for that corporation on a temporary basis (“quasi-” or “temporary-”
insiders). Second, the broader “misappropriation” theory applies to anyone who steals
confidential information in violation of a fiduciary duty to the information’s source and then uses
the information to buy or sell securities. This theory would apply, for example, to a reporter who
stole confidential, pre-publication information from the financial magazine that employs him and
then traded on that information.
This section highlights the historical development of insider trading law. Though Section
10b of the Exchange Act (see §[A], supra) provides the principal statutory authority for our
current federal insider trading enforcement regime, you may have noticed that the statute neither
defines nor even references insider trading. The insider trading laws have therefore effectively
developed through administrative decisions and federal common law. k The Supreme Court did
not rule on the validity of insider trading as a form of Section 10b securities fraud until United
States v. Chiarella, the first case in this section. Chiarella was brought under the classical theory.
While the Chiarella Court recognized the validity of the classical theory, it reversed the
defendant’s conviction because an essential element of that theory was not met. Almost twenty
years later, in the second case in this section, United States v. O’Hagan, the Supreme Court
approved of the misappropriation theory of insider trading. This theory dramatically expands the
potential scope of insider trading liability, far beyond corporate insiders, and has been the subject
of substantial criticism because of its broad and somewhat uncertain scope. The third case is
Dirks v. Securities and Exchange Commission, which examines the liability of “tippers” and
“tippees,” that is, people who give and receive confidential information used in connection with
securities trading. The Dirks rule sets forth the specific requirements for tipper-tippee liability.
Finally, while insider trading is one of the more headline-grabbing of white-collar crimes,
it is also one of the more controversial. Its lack of statutory definition, and the ambiguity in its
common-law elements, have led to persistent due-process and notice challenges from defendants
charged with insider trading. Moreover, some jurists and economists have argued that insider
trading should not be illegal at all, claiming that it harms no one and is actually good for
securities markets. This section will address these and other controversies alongside its treatment
of the law’s development.
[1]
The Elements of Insider Trading
Violations of laws prohibiting insider trading essentially constitute a subset of the general
category of securities fraud. For this reason, it is helpful to identify the specific elements of a
criminal insider trading case. Based upon the applicable statutes, regulations, and Supreme Court
decisions, in a case brought against the principal l under Section 10b and Rule 10b-5, the
k
The SEC brought its first insider trading enforcement action pursuant to Rule 10b-5 in Cady,
Roberts & Co., 40 S.E.C. 907 (1961).
l
Accessory liability is discussed in connection with the Dirks decision, infra.
5

government must prove that:
1. The defendant knowingly possessed material, nonpublic information;
2. The defendant bought or sold securities on the basis of that information;
3. The defendant—
(a) Was an insider of the company the securities of which were traded;
(b) Was a temporary insider of the company the securities of which were
traded; and/or
(c) Was a misappropriator of the material, nonpublic information from a

person or entity to whom the defendant owed a fiduciary duty; and
4. The defendant acted willfully.
As we shall see, the law of insider trading is notoriously complex, largely because of the
overlap between the classical and misappropriation theories and vagueness in many of the
elements just identified. To successfully navigate these complexities in each case in this section,
you will find it helpful to track the answers to the following questions: (a) To whom does the
defendant owe a duty? (b) What theory — “classical” and/or “misappropriation” theory —
provides the basis for that duty? And (c) what company’s stock was traded?
[2]
The Classical Theory
In the case that follows, a printing company employee uncovered secret information
during his employment and traded on that information. A majority of the Supreme Court
determined that the classical insider trading theory did not apply to the defendant. Why did the
Court reach this conclusion?
CHIARELLA v. UNITED STATES

445 U.S. 222 (1980)
Mr. JUSTICE POWELL delivered the opinion of the Court.
Petitioner is a printer by trade. In 1975 and 1976, he worked as a “markup man” in the New
York composing room of Pandick Press, a financial printer. Among documents that petitioner
handled were five announcements of corporate takeover bids. When these documents were
delivered to the printer, the identities of the acquiring and target corporations were concealed by
blank spaces or false names. The true names were sent to the printer on the night of the final
printing.
The petitioner, however, was able to deduce the names of the target companies before the final
printing from other information contained in the documents. Without disclosing his knowledge,
6

petitioner purchased stock in the target companies and sold the shares immediately after the
takeover attempts were made public. By this method, petitioner realized a gain of slightly more
than $30,000 in the course of 14 months. Subsequently, the Securities and Exchange Commission
(Commission or SEC) began an investigation of his trading activities. In May 1977, petitioner
entered into a consent decree with the Commission in which he agreed to return his profits to the
sellers of the shares. On the same day, he was discharged by Pandick Press.
In January 1978, petitioner was indicted on 17 counts of violating Section 10(b) of the
Securities Exchange Act of 1934 (1934 Act) and SEC Rule 10b-5. After petitioner unsuccessfully
moved to dismiss the indictment, he was brought to trial and convicted on all counts.
The Court of Appeals for the Second Circuit affirmed petitioner’s conviction. 588 F.2d 1358
(1978). We granted certiorari, and we now reverse.
Section 10(b) of the 1934 Act, 15 U.S.C. § 78j, prohibits the use “in connection with the
purchase or sale of any security … [of] any manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the Commission may prescribe.” Pursuant to this
section, the SEC promulgated Rule 10b-5 which provides in pertinent part:
It shall be unlawful for any person, directly or indirectly, by the use of
any means or instrumentality of interstate commerce, or of the mails or
of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud, [or] …
(c) To engage in any act, practice, or course of business which operates
or would operate as a fraud or deceit upon any person, in connection with
the purchase or sale of any security.
17 CFR § 240.10b-5 (1979).
This case concerns the legal effect of the petitioner’s silence. The District Court’s charge
permitted the jury to convict the petitioner if it found that he willfully failed to inform sellers of
target company securities that he knew of a forthcoming takeover bid that would make their
shares more valuable. In order to decide whether silence in such circumstances violates Section
10(b), it is necessary to review the language and legislative history of that statute as well as its
interpretation by the Commission and the federal courts.
Although the starting point of our inquiry is the language of the statute, Section 10(b) does not
state whether silence may constitute a manipulative or deceptive device. Section 10(b) was
designed as a catch-all clause to prevent fraudulent practices. But neither the legislative history
nor the statute itself affords specific guidance for the resolution of this case. When Rule 10b-5
was promulgated in 1942, the SEC did not discuss the possibility that failure to provide
information might run afoul of Section 10(b).
The SEC took an important step in the development of Section 10(b) when it held that a
broker-dealer and his firm violated that section by selling securities on the basis of undisclosed
information obtained from a director of the issuer corporation who was also a registered
representative of the brokerage firm. In Cady, Roberts & Co., 40 S.E.C. 907 (1961), the
Commission decided that a corporate insider must abstain from trading in the shares of his
corporation unless he has first disclosed all material inside information known to him. The
obligation to disclose or abstain derives from
[a]n affirmative duty to disclose material information[, which] has been
traditionally imposed on corporate “insiders,” particular officers,
directors, or controlling stockholders. We, and the courts have
consistently held that insiders must disclose material facts which are
known to them by virtue of their position but which are not known to
7

persons with whom they deal and which, if known, would affect their
investment judgment.
Id. at 911.
The Commission emphasized that the duty arose from (i) the existence of a relationship
affording access to inside information intended to be available only for a corporate purpose, and
(ii) the unfairness of allowing a corporate insider to take advantage of that information by trading
without disclosure. Id. at 912, and n.15.8
That the relationship between a corporate insider and the stockholders of his corporation gives
rise to a disclosure obligation is not a novel twist of the law. At common law, misrepresentation
made for the purpose of inducing reliance upon the false statement is fraudulent. But one who
fails to disclose material information prior to the consummation of a transaction commits fraud
only when he is under a duty to do so. And the duty to disclose arises when one party has
information “that the other [party] is entitled to know because of a fiduciary or other similar
relation of trust and confidence between them.” In its Cady, Roberts decision, the Commission
recognized a relationship of trust and confidence between the shareholders of a corporation and
those insiders who have obtained confidential information by reason of their position with that
corporation. This relationship gives rise to a duty to disclose because of the “necessity of
preventing a corporate insider from … [taking] unfair advantage of the uninformed minority
stockholders.” Speed v. Transamerica Corp., 99 F. Supp. 808, 829.
The federal courts have found violations of Section 10(b) where corporate insiders used
undisclosed information for their own benefit. The cases also have emphasized, in accordance
with the common-law rule, that “[t]he party charged with failing to disclose market information
must be under a duty to disclose it.” Frigitemp Corp. v. Financial Dynamics Fund, Inc., 524 F.2d
275, 282 (2d Cir. 1975). Accordingly, a purchaser of stock who has no duty to a prospective
seller because he is neither an insider nor a fiduciary has been held to have no obligation to reveal
material facts. …
Thus, administrative and judicial interpretations have established that silence in connection
with the purchase or sale of securities may operate as a fraud actionable under Section 10(b)
despite the absence of statutory language or legislative history specifically addressing the legality
of nondisclosure. But such liability is premised upon a duty to disclose arising from a relationship
of trust and confidence between parties to a transaction. Application of a duty to disclose prior to
trading guarantees that corporate insiders, who have an obligation to place the shareholder’s
welfare before their own, will not benefit personally through fraudulent use of material,
nonpublic information.
In this case, the petitioner was convicted of violating Section 10(b) although he was not a
corporate insider and he received no confidential information from the target company.
Moreover, the “market information” upon which he relied did not concern the earning power or
operations of the target company, but only the plans of the acquiring company. Petitioner’s use of
that information was not a fraud under Section 10(b) unless he was subject to an affirmative duty
to disclose it before trading. In this case, the jury instructions failed to specify any such duty. In
effect, the trial court instructed the jury that petitioner owed a duty to everyone; to all sellers,
8
The transaction in Cady, Roberts involved sale of stock to persons who previously may not have
been shareholders in the corporation. 40 S.E.C., at 913 and n.21. The Commission embraced the reasoning
of Judge Learned Hand that “the director or officer assumed a fiduciary relation to the buyer by the very
sale; for it would be a sorry distinction to allow him to use the advantage of his position to induce the buyer
into the position of a beneficiary although he was forbidden to do so once the buyer had become one.” Id.
at 914, n.23.
8

indeed, to the market as a whole. The jury simply was told to decide whether petitioner used
material, nonpublic information at a time when “he knew other people trading in the securities
market did not have access to the same information.”
The Court of Appeals affirmed the conviction by holding that “[a]nyone — corporate insider or
not — who regularly receives material nonpublic information may not use that information to
trade in securities without incurring an affirmative duty to disclose.” 588 F.2d at 1365 (emphasis
in original). Although the court said that its test would include only persons who regularly receive
material, nonpublic information, its rationale for that limitation is unrelated to the existence of a
duty to disclose. The Court of Appeals, like the trial court, failed to identify a relationship
between petitioner and the sellers that could give rise to a duty. Its decision thus rested solely
upon its belief that the federal securities laws have “created a system providing equal access to
information necessary for reasoned and intelligent investment decisions.” Id. at 1362. The use by
anyone of material information not generally available is fraudulent, this theory suggests, because
such information gives certain buyers or sellers an unfair advantage over less informed buyers
and sellers.
This reasoning suffers from two defects. First, not every instance of financial unfairness
constitutes fraudulent activity under Section 10(b). Second, the element required to make silence
fraudulent — a duty to disclose — is absent in this case. No duty could arise from petitioner’s
relationship with the sellers of the target company’s securities, for petitioner had no prior dealings
with them. He was not their agent, he was not a fiduciary, he was not a person in whom the
sellers had placed their trust and confidence. He was, in fact, a complete stranger who dealt with
the sellers only through impersonal market transactions.
We cannot affirm petitioner’s conviction without recognizing a general duty between all
participants in market transactions to forgo actions based on material, nonpublic information.
Formulation of such a broad duty, which departs radically from the established doctrine that duty
arises from a specific relationship between two parties, should not be undertaken absent some
explicit evidence of congressional intent.
As we have seen, no such evidence emerges from the language or legislative history of Section
10(b). Moreover, neither the Congress nor the Commission ever has adopted a parity-of-
information rule. …
We see no basis for applying such a new and different theory of liability in this
case. … Section 10(b) is aptly described as a catchall provision, but what it catches must be fraud.
When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to
speak. We hold that a duty to disclose under Section 10(b) does not arise from the mere
possession of nonpublic market information. The contrary result is without support in the
legislative history of Section 10(b) and would be inconsistent with the careful plan that Congress
has enacted for regulation of the securities markets. 20
[T]he United States offers an alternative theory to support petitioner’s conviction. It argues that
petitioner breached a duty to the acquiring corporation when he acted upon information that he
obtained by virtue of his position as an employee of a printer employed by the corporation. The
breach of this duty is said to support a conviction under Section 10(b) for fraud perpetrated upon
both the acquiring corporation and the sellers.
We need not decide whether this theory has merit for it was not submitted to the jury. …
The jury instructions demonstrate that petitioner was convicted merely because of his failure to
20
It is worth noting that this is apparently the first case in which criminal liability has been imposed
upon a purchaser for Section 10(b) nondisclosure. Petitioner was sentenced to a year in prison, suspended
except for one month, and a 5-year term of probation.
9

disclose material, nonpublic information to sellers from whom he bought the stock of target
corporations. The jury was not instructed on the nature or elements of a duty owed by petitioner
to anyone other than the sellers. Because we cannot affirm a criminal conviction on the basis of a
theory not presented to the jury, we will not speculate upon whether such a duty exists, whether it
has been breached, or whether such a breach constitutes a violation of Section 10(b).
The judgment of the Court of Appeals is reversed.
Mr. CHIEF JUSTICE BURGER, dissenting.
I believe that the jury instructions in this case properly charged a violation of Section 10(b) and
Rule 10b-5, and I would affirm the conviction.
As a general rule, neither party to an arm’s-length business transaction has an obligation to
disclose information to the other unless the parties stand in some confidential or fiduciary
relation. This rule permits a businessman to capitalize on his experience and skill in securing and
evaluating relevant information; it provides incentive for hard work, careful analysis, and astute
forecasting. But the policies that underlie the rule also should limit its scope. In particular, the
rule should give way when an informational advantage is obtained, not by superior experience,
foresight, or industry, but by some unlawful means. … I would read Section 10(b) and Rule 10b-
5 to encompass and build on this principle: to mean that a person who has misappropriated
nonpublic information has an absolute duty to disclose that information or to refrain from trading.
The language of Section 10(b) and of Rule 10b-5 plainly supports such a reading. By their
terms, these provisions reach any person engaged in any fraudulent scheme. This broad language
negates the suggestion that congressional concern was limited to trading by “corporate insiders”
or to deceptive practices related to “corporate information.” Just as surely Congress cannot have
intended one standard of fair dealing for “white collar” insiders and another for the “blue collar”
level. …
The history of the statute and of the Rule also supports this reading. The antifraud provisions
were designed in large measure “to assure that dealing in securities is fair and without undue
preferences or advantages among investors.” H.R. Conf. Rep. No. 94-229, p. 91 (1975), U.S.
Code Cong. & Admin. News 1975, p. 323. An investor who purchases securities on the basis of
misappropriated nonpublic information possesses just such an “undue” trading advantage; his
conduct quite clearly serves no useful function except his own enrichment at the expense of
others.
This interpretation of Section 10(b) and Rule 10b-5 is in no sense novel. It follows naturally
from legal principles enunciated by the Securities and Exchange Commission in its seminal Cady,
Roberts decision. 40 S.E.C. 907 (1961). There, the Commission relied upon two factors to impose
a duty to disclose on corporate insiders: (1) “ … access … to information intended to be available
only for a corporate purpose and not for the personal benefit of anyone” (emphasis added); and
(2) the unfairness inherent in trading on such information when it is inaccessible to those with
whom one is dealing. Both of these factors are present whenever a party gains an informational
advantage by unlawful means. …
***
In sum, the evidence shows beyond all doubt that Chiarella, working literally in the shadows of
the warning signs in the printshop misappropriated — stole to put it bluntly — valuable
nonpublic information entrusted to him in the utmost confidence. He then exploited his ill-gotten
informational advantage by purchasing securities in the market. In my view, such conduct plainly
violates Section 10(b) and Rule 10b-5. Accordingly, I would affirm the judgment of the Court of
10

Appeals.
Mr. JUSTICE BLACKMUN, with whom Mr. JUSTICE MARSHALL joins, dissenting.
Although I agree with much of what is said in Part I of the dissenting opinion of THE CHIEF
JUSTICE, ante, I write separately because, in my view, it is unnecessary to rest petitioner’s
conviction on a “misappropriation” theory. … I also would find petitioner’s conduct fraudulent
within the meaning of Section § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.
§ 78j(b), and the Securities and Exchange Commission’s Rule 10b-5, 17 CFR § 240.10b-5, even
if he had obtained the blessing of his employer’s principals before embarking on his profiteering
scheme. Indeed, I think petitioner’s brand of manipulative trading, with or without such approval,
lies close to the heart of what the securities laws are intended to prohibit.
The Court continues to pursue a course, charted in certain recent decisions, designed to
transform Section 10(b) from an intentionally elastic “catchall” provision to one that catches
relatively little of the misbehavior that all too often makes investment in securities a needlessly
risky business for the uninitiated investor. Such confinement in this case is now achieved by
imposition of a requirement of a “special relationship” akin to fiduciary duty before the statute
gives rise to a duty to disclose or to abstain from trading upon material, nonpublic information.
The Court admits that this conclusion finds no mandate in the language of the statute or its
legislative history. Yet the Court fails even to attempt a justification of its ruling in terms of the
purposes of the securities laws, or to square that ruling with the long-standing but now much
abused principle that the federal securities laws are to be construed flexibly rather than with
narrow technicality.
I, of course, agree with the Court that a relationship of trust can establish a duty to disclose
under § 10(b) and Rule 10b-5. But I do not agree that a failure to disclose violates the Rule only
when the responsibilities of a relationship of that kind have been breached. As applied to this
case, the Court’s approach unduly minimizes the importance of petitioner’s access to confidential
information that the honest investor no matter how diligently he tried, could not legally obtain. In
doing so, it further advances an interpretation of Section 10(b) and Rule 10b-5 that stops short of
their full implications. Although the Court draws support for its position from certain precedent, I
find its decision neither fully consistent with developments in the common law of fraud, nor fully
in step with administrative and judicial application of Rule 10b-5 to “insider” trading.
***
Whatever the outer limits of the Rule, petitioner Chiarella’s case fits neatly near the center of
its analytical framework. He occupied a relationship to the takeover companies giving him
intimate access to concededly material information that was sedulously guarded from public
access. Petitioner, moreover, knew that the information was unavailable to those with whom he
dealt. And he took full, virtually riskless advantage of this artificial information gap by selling the
stocks shortly after each takeover bid was announced. This misuse of confidential information
was clearly placed before the jury. Petitioner’s conviction, therefore, should be upheld, and I
dissent from the Court’s upsetting that conviction.
NOTES AND QUESTIONS
1.
11

Theories of “insider trading.” Why, precisely, did the majority reverse the conviction? Is
it not clear that Chiarella did something wrong? In their dissents, what theories did Chief Justice
Burger and Justice Blackmun cite in support of their arguments that the conviction should have
been affirmed? In each case, how did the majority respond?
2.
“Inside” information. There are many different types of “inside” information. Most
insider trading cases, including Chiarella, arise in the context of “extraordinary corporate
transactions.” Such transactions include mergers, tender offers, and proxy contests. m In these
situations, rapid fluctuations in stock prices make it possible to make (or lose) a lot of money very
quickly. In other cases, such as the case relating to Sam Waksal, Martha Stewart, and ImClone
stock — where the stock was sold shortly before an unfavorable United States Food and Drug
Administration ruling was announcedn— the defendants allegedly traded based upon secret, un-
released information that would likely affect the stock price. Other kinds of nonpublic
information include financial projections, earnings statements, and similar information that reflect
the company’s strengths and weaknesses. Some insider trading schemes involve large-scale
arrangements to trade on various forms of information, such as the cases arising out of the
investigations of hedge fund giant SAC Capital Investors LP and Raj Rajaratnam, the head of the
Galleon Group hedge fund. See Patricia Hurtado et al., SAC Record $1.8 Billion Plea Caps
Seven-Year Insider Trading Probe, 9 WHITE COLLAR CRIME REP. (BNA) No. 242 (April 14,
2014); United States v. Rajaratnam, 719 F.3d 139 (2d Cir. 2013).
3.
Materiality. As the Court noted in Chiarella, for insider trading to be illegal, the
information traded upon must be “material.” See, e.g., Chiarella, 445 U.S. at 230. In Basic Inc. v.
Levinson, 485 U.S. 224 (1988), the Supreme Court held that information is “material” for
purposes of §10(b) securities fraud liability if “there is a substantial likelihood that a reasonable
shareholder would consider it important” in making an investment decision. Id. at 231 (quoting
TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)). In addition, “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.”
Id. at 232. This definition of materiality leaves a number of questions unanswered. For example,
who is a “reasonable shareholder”? See, e.g., Joan MacLeod Heminway, Materiality Guidance in
the Context of Insider Trading: A Call for Action, 52 AM. U.L. REV. 1131, 1152 (2003); see also,
Donald C. Langevoort, Commentary: Stakeholder Values, Disclosure, and Materiality, 48 CATH.
m
In a tender offer, the offering company offers to buy all of a “target” company’s stock at a
specified price over the then-current market price for the stock. In a proxy contest, the shareholders vote,
by giving their votes to “proxies,” on corporate decisions such as the election of a board of directors or a
merger.
n
Waksal pleaded guilty to insider trading and was sentenced to more than seven years in prison.
Kara Scannell, Waksal’s Sentence in Trading Case Tops Seven Years, WALL ST. J., June 11, 2003, at A2.
Stewart was not criminally charged with insider trading, but was named in a SEC civil suit based on that
theory. Kara Scannell & Laurie P. Cohen, Homemaking Maven Pleads Not Guilty to Criminal Counts; SEC
Files Civil Insider Charges, WALL ST. J., June 5, 2003, at C1.
12

U.L. REV. 93, 98 (1988) (noting that “investors are not homogeneous”).
Another difficulty in determining whether information is material for purposes of insider

trading liability arises in the context of “soft information.” Information is “soft” if it “inherently
involves some subjective analysis or extrapolation, such as projections, estimates, opinions,
motives, or intentions.” Bruce A. Hiler, The SEC and the Courts’ Approach to Disclosure of
Earnings Projections, Asset Appraisals, and other Soft Information: Old Problems, Changing
Views, 46 Md. L. Rev. 1114, 1116 (1987). The Basic Court held that the materiality of soft
information should be determined by the application of a probability-magnitude test: If, by
multiplying the magnitude of the substance of the soft information (e.g., a merger negotiation
with an uncertain outcome) by the probability of its becoming hard (e.g., the likelihood the
merger will be finalized), the factfinder determines the reasonable investor would deem the
information important and as significantly altering the total mix of information, then it is material.
See Basic, 485 U.S. at 238. Unfortunately, as Professor Stephen Bainbridge has noted, the
Supreme Court has not offered guidance on “how high a probability or how large a magnitude is
necessary for information to be deemed material.” STEPHEN BAINBRIDGE, INSIDER TRADING:
LAW AND POLICY 67 (2014).
4.
What is the harm? In Cady, Roberts & Co., 40 S.E.C. 907 (1961), the SEC stated that it is
unfair for an insider to profit from secret information belonging to the company and its
shareholders. And as the United States Supreme Court stated in United States v. O’Hagan, 521
U.S. 642, 658 (1997), “an animating purpose of the Exchange Act [is] to insure honest securities
markets and thereby promote investor confidence.” Is this the correct view? Consider the
following:
Insider trading is a relatively “new” crime, and is emblematic of the
broadening scope of white collar criminalization. A debate has raged
over whether insider trading is harmful or, in fact, beneficial. The courts
and the SEC adhere to the view that insider trading harms both individual
traders and the market in general. Under this view, the person who trades
with someone who possesses the inside information is damaged because
that person is operating at an informational disadvantage. Further, the
market itself is harmed by the perception of an uneven playing field;
average investors will shy away if they believe they are handicapped vis-
a-vis insiders.
Many commentators argue, however, that insider trading is neither unfair
nor harmful to the market. As to harm to individual investors, as one
commentator has noted, “it is difficult to conceptualize how public
investors are any worse off simply because the person with whom they
trade did not disclose her intent to trade to the source of her
information.” As to harm to the market, many argue that trading based
upon nonpublic information causes stock prices to change based upon
that information. The market price will adjust to the new (nonpublic)
information. Those who trade after the market has absorbed the effect of
the insider trading will thus benefit from the insider trading because the
stock price will more accurately reflect the stock’s value. One recent
survey of the literature thus found that “most commentators conclude
13

that insider trading prohibitions are probably not worth the heavy
regulatory cost and that the underlying efficiencies, rather than more
amorphous ‘fairness’ concepts, should rule the day.”
J. Kelly Strader, White Collar Crime and Punishment — Reflections on Michael, Martha, and
Milberg Weiss, 15 GEO. MASON L. REV. 45, 69–70 (2007). In addition to the arguments just
referenced, economists and other scholars have offered a number of other reasons for and against
the criminalization of insider trading.
Additional arguments in favor of the criminalization of insider trading:
a. Adverse selection. Economists have argued that insider trading results in the problem of
adverse selection. That is, if insider trading is prevalent, “because of order imbalances and the
difficulty of sustaining a liquid market only with matching [orders], a liquidity provider [or
market maker]o has to transact with his own inventory and thus bears the risk of consistently
buying ‘high’ from and selling ‘low’ to insiders.” Stanislov Dolgopolov, Insider Trading and
the Bid-Ask Spread: A Critical Evaluation of Adverse Selection in Market Making, 33 CAP.
U.L. REV. 104–05 (2004). Persistent losses to insiders forces market makers to increase their
bid-ask spreads to offset these persistent losses. In short, the concern is that insider trading
forces market makers to impose a tax on all traders to offset losses imposed by insiders.
b. Moral hazard. Some also argue that insider trading creates a moral hazard for firm
employees. For example, because insiders can profit from trading when their firm’s stock goes
down in price (e.g., by shorting their firm’s shares), they may have a perverse incentive to
create bad news for the firm. See, e.g., Saul Levmore, Securities and Secrets: Insider Trading
and the Law of Contracts, 68 VA. L. REV. 117, 149 (1982). Insiders may also have an incentive
to delay public disclosures that would otherwise be made in order to gain time to free up capital
for trading, or to tip others. See Roy A. Schotland, Unsafe at Any Price: A Reply to Manne,
Insider Trading and the Stock Market, 53 VA. L. REV. 1425, 1448–49 (1967).
c. Harms firm by denying right of exclusive use. Finally, whenever insiders or others trade on
a firm’s material nonpublic information against the express wishes of the firm, there will almost
always be some loss to the firm—otherwise the firm’s instructions not to trade would never
have be issued in the first place. See, e.g., John P. Anderson, What’s the Harm in Issuer-
Licensed Insider Trading?, 69 U. MIAMI L. REV. 795, 799 (2015).
Additional arguments against the criminalization of insider trading:
d. Market smoothing. Insider trading can function as a “market smoother” and reduce volatility. If
insiders trade prior to disclosure, prices will move more gradually—avoiding the rapid price
fluctuations (and windfall gains and losses) that result from the immediate digestion of
o
Market makers are securities dealers that provide market liquidity by standing ready to step in and
transact where buy and sell orders for a security fail to achieve equilibrium.
14

information upon the release of information to the general public. See, e.g., Stephen Bainbridge,
Insider Trading, ENCYC. OF L. & ECON. § 5650 (2000).
e. Real-time information to management. Some economists have suggested that price movements
resulting from insider trading can raise “red flags” of a fraud or some other issuer to upper
management in real time without having to wait “for the bureaucratic pipeline to deliver a
memorandum.” See JONATHAN R. MACEY, INSIDER TRADING: ECONOMICS, POLITICS, AND
POLICY 10 (1991).
f. Efficient form of executive compensation. Insider trading may also serve as an efficient means
of executive compensation. Allowing employees to trade on good news they generate for the
company may offer savings to shareholders in terms of reduced executive salaries, while
incentivizing and rewarding entrepreneurship within the firm. See, e.g., Ian Ayers & Steven Choi,
Internalizing Outsider Trading, 101 MICH. L. REV. 313, 338 (2002); Henry G. Manne, Insider
Trading and the Law Professors, 23 VAND. L. REV. 533 (1970). Indeed, there is evidence that
firms adjust salary based on the stringency of their insider-trading policies. See, e.g., M. Todd
Henderson, Insider Trading and CEO Pay, 64 VAND. L. REV. 505, 509–10 (2011).
Which view do you believe is correct? Why? Can you think of other considerations (ethical or
economic) for or against the criminalization of insider trading?
5.
Should issuer-licensed insider trading be permissible? Some scholars have argued that
insider trading should be (and perhaps already is) legally permitted when the firm that owns the
information expressly licenses such trading. For example, Professor John P. Anderson has argued
that issuer-licensed insider trading should be permitted if the following conditions are satisfied:
 The insider submits a written plan to the issuer of the shares that details
the proposed trade(s).
 The issuing firm authorizes the trading plan.
 The firm has previously disclosed to the investing public that it will
permit its employees (or others) to trade on the firm’s material nonpublic
information through these plans when it is in the interest of the firm to do
so.
 The firm discloses ex post all trading profits resulting from the execution
of these plans.
15

See JOHN P. ANDERSON, INSIDER TRADING: LAW, ETHICS, AND REFORM 243-244 (2018).
Professor Anderson argues that issuer-licensed insider trading is not deceptive and would have
few, if any, of the drawbacks outlined in the preceding note (see Note 3.a., b., and c. above),
while allowing firms and markets to enjoy all the potential benefits of insider trading in the
preceding note (see Note 3.d., e., and f. above). Based on your understanding of Chiarella, do you
think issuer-licensed insider trading is legal under the current regime? Do you think issuer-
licensed insider trading should be legal? Can you foresee any moral or economic problems that
might arise from issuer-licensed insider trading? If legal, do you think firms would take
advantage of issuer-licensed insider trading? Why or why not?
[3]
The Misappropriation Theory
In Chiarella, the Supreme Court declined to consider whether an insider trading

conviction could be based upon the “misappropriation” theory. Seven years later, in Carpenter v.
United States, 484 U.S. 19 (1987), the Court divided four-to-four on this issue. Finally, in the
case that follows, a split court resolved the question. As you read the decision, consider whether
the majority made a persuasive case for the rule it adopted.
UNITED STATES v. O’HAGAN

521 U.S. 642 (1997)
JUSTICE GINSBURG delivered the opinion of the Court.
***
Respondent James Herman O’Hagan was a partner in the law firm of Dorsey & Whitney in
Minneapolis, Minnesota. In July 1988, Grand Metropolitan PLC (Grand Met), a company based
in London, England, retained Dorsey & Whitney as local counsel to represent Grand Met
regarding a potential tender offer for the common stock of the Pillsbury Company, headquartered
in Minneapolis. Both Grand Met and Dorsey & Whitney took precautions to protect the
confidentiality of Grand Met’s tender offer plans. O’Hagan did no work on the Grand Met
representation. Dorsey & Whitney withdrew from representing Grand Met on September 9, 1988.
Less than a month later, on October 4, 1988, Grand Met publicly announced its tender offer for
Pillsbury stock.
On August 18, 1988, while Dorsey & Whitney was still representing Grand Met, O’Hagan
began purchasing call options for Pillsbury stock. Each option gave him the right to purchase 100
shares of Pillsbury stock by a specified date in September 1988. Later in August and in
September, O’Hagan made additional purchases of Pillsbury call options. By the end of
September, he owned 2,500 unexpired Pillsbury options, apparently more than any other
individual investor. O’Hagan also purchased, in September 1988, some 5,000 shares of Pillsbury
common stock, at a price just under $39 per share. When Grand Met announced its tender offer in
October, the price of Pillsbury stock rose to nearly $60 per share. O’Hagan then sold his Pillsbury
call options and common stock, making a profit of more than $4.3 million.
16

The Securities and Exchange Commission (SEC or Commission) initiated an investigation into
O’Hagan’s transactions, culminating in a 57-count indictment. The indictment alleged that
O’Hagan defrauded his law firm and its client, Grand Met, by using for his own trading purposes
material, nonpublic information regarding Grand Met’s planned tender offer. According to the
indictment, O’Hagan used the profits he gained through this trading to conceal his previous
embezzlement and conversion of unrelated client trust funds. O’Hagan was charged with 20
counts of mail fraud, in violation of 18 U.S.C. § 1341; 17 counts of securities fraud, in violation
of Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act), 15 U.S.C. § 78j(b), and
SEC Rule 10b-5, 17 CFR § 240.10b-5 (1996); 17 counts of fraudulent trading in connection with
a tender offer, in violation of § 14(e) of the Exchange Act, 15 U.S.C. § 78n(e), and SEC Rule
14e-3(a), 17 CFR § 240.14e-3(a) (1996); and 3 counts of violating federal money laundering
statutes, 18 U.S.C. §§ 1956(a)(1)(B)(I), 1957. A jury convicted O’Hagan on all 57 counts, and he
was sentenced to a 41-month term of imprisonment.
A divided panel of the Court of Appeals for the Eighth Circuit reversed all of O’Hagan’s
convictions. Liability under Section 10(b) and Rule 10b-5, the Eighth Circuit held, may not be
grounded on the “misappropriation theory” of securities fraud on which the prosecution
relied. … The Eighth Circuit further concluded that O’Hagan’s mail fraud and money laundering
convictions rested on violations of the securities laws, and therefore could not stand once the
securities fraud convictions were reversed. …
We address first the Court of Appeals’ reversal of O’Hagan’s convictions under Section 10(b)
and Rule 10b-5. Following the Fourth Circuit’s lead, the Eighth Circuit rejected the
misappropriation theory as a basis for Section 10(b) liability. We hold, in accord with several
other Courts of Appeals, that criminal liability under Section 10(b) may be predicated on the
misappropriation theory.
The statute proscribes (1) using any deceptive device (2) in connection with the purchase or
sale of securities, in contravention of rules prescribed by the Commission. The provision, as
written, does not confine its coverage to deception of a purchaser or seller of securities; rather, the
statute reaches any deceptive device used “in connection with the purchase or sale of any
security.” …
Under the “traditional” or “classical theory” of insider trading liability, Section 10(b) and Rule
10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis
of material, nonpublic information. Trading on such information qualifies as a “deceptive device”
under Section 10(b), we have affirmed, because “a relationship of trust and confidence [exists]
between the shareholders of a corporation and those insiders who have obtained confidential
information by reason of their position with that corporation.” Chiarella v. United States, 445
U.S. 222, 228 (1980). That relationship, we recognized, “gives rise to a duty to disclose [or to
abstain from trading] because of the ‘necessity of preventing a corporate insider from … tak[ing]
unfair advantage of … uninformed … stockholders.’” Id. at 228–229 (citation omitted). The
classical theory applies not only to officers, directors, and other permanent insiders of a
corporation, but also to attorneys, accountants, consultants, and others who temporarily become
fiduciaries of a corporation.
The “misappropriation theory” holds that a person commits fraud “in connection with” a
securities transaction, and thereby violates Section 10(b) and Rule 10b-5, when he
misappropriates confidential information for securities trading purposes, in breach of a duty owed
to the source of the information. Under this theory, a fiduciary’s undisclosed, self-serving use of a
principal’s information to purchase or sell securities, in breach of a duty of loyalty and
confidentiality, defrauds the principal of the exclusive use of that information. In lieu of
premising liability on a fiduciary relationship between company insider and purchaser or seller of
the company’s stock, the misappropriation theory premises liability on a fiduciary-turned-trader’s
17

deception of those who entrusted him with access to confidential information.

The two theories are complementary, each addressing efforts to capitalize on nonpublic
information through the purchase or sale of securities. The classical theory targets a corporate
insider’s breach of duty to shareholders with whom the insider transacts; the misappropriation
theory outlaws trading on the basis of nonpublic information by a corporate “outsider” in breach
of a duty owed not to a trading party, but to the source of the information. The misappropriation
theory is thus designed to “protec[t] the integrity of the securities markets against abuses by
‘outsiders’ to a corporation who have access to confidential information that will affect th[e]
corporation’s security price when revealed, but who owe no fiduciary or other duty to that
corporation’s shareholders.” Id.
In this case, the indictment alleged that O’Hagan, in breach of a duty of trust and confidence he
owed to his law firm, Dorsey & Whitney, and to its client, Grand Met, traded on the basis of
nonpublic information regarding Grand Met’s planned tender offer for Pillsbury common stock.
This conduct, the government charged, constituted a fraudulent device in connection with the
purchase and sale of securities.5
We agree with the government that misappropriation, as just defined, satisfies Section 10(b)’s
requirement that chargeable conduct involve a “deceptive device or contrivance” used “in
connection with” the purchase or sale of securities. We observe, first, that misappropriators, as
the government describes them, deal in deception. A fiduciary who “[pretends] loyalty to the
principal while secretly converting the principal’s information for personal gain,” Brief for
United States 17, “dupes” or defrauds the principal.
We addressed fraud of the same species in Carpenter v. United States, 484 U.S. 19 (1987),
which involved the mail fraud statute’s proscription of “any scheme or artifice to defraud,” 18
U.S.C. § 1341. Affirming convictions under that statute, we said in Carpenter that an employee’s
undertaking not to reveal his employer’s confidential information “became a sham” when the
employee provided the information to his co-conspirators in a scheme to obtain trading profits.
484 U.S. at 27. A company’s confidential information, we recognized in Carpenter, qualifies as
property to which the company has a right of exclusive use. The undisclosed misappropriation of
such information, in violation of a fiduciary duty, the Court said in Carpenter, constitutes fraud
akin to embezzlement — “‘the fraudulent appropriation to one’s own use of the money or goods
entrusted to one’s care by another.’” Id. at 27. Carpenter’s discussion of the fraudulent misuse of
confidential information, the government notes, “is a particularly apt source of guidance here,
because [the mail fraud statute] (like Section 10(b)) has long been held to require deception, not
merely the breach of a fiduciary duty.” Brief for United States 18 n.9.
Deception through nondisclosure is central to the theory of liability for which the government
seeks recognition. As counsel for the government stated in explanation of the theory at oral
argument: “To satisfy the common law rule that a trustee may not use the property that [has] been
entrusted [to] him, there would have to be consent. To satisfy the requirement of the Securities
Act that there be no deception, there would only have to be disclosure.” Tr. of Oral Arg. 12.6
5
The government could not have prosecuted O’Hagan under the classical theory, for O’Hagan was
not an “insider” of Pillsbury, the corporation in whose stock he traded. Although an “outsider” with respect
to Pillsbury, O’Hagan had an intimate association with, and was found to have traded on confidential
information from, Dorsey & Whitney, counsel to tender offeror Grand Met. Under the misappropriation
theory, O’Hagan’s securities trading does not escape Exchange Act sanction, as it would under Justice
THOMAS’ dissenting view, simply because he was associated with, and gained nonpublic information
from, the bidder, rather than the target.
6
Under the misappropriation theory urged in this case, the disclosure obligation runs to the source
18

The misappropriation theory advanced by the government is consistent with Santa Fe

Industries, Inc. v. Green, 430 U.S. 462 (1977), a decision underscoring that Section 10(b) is not
an all-purpose breach of fiduciary duty ban; rather, it trains on conduct involving manipulation or
deception. In contrast to the government’s allegations in this case, in Santa Fe Industries, all
pertinent facts were disclosed by the persons charged with violating Section 10(b) and Rule 10b-
5, therefore, there was no deception through nondisclosure to which liability under those
provisions could attach. Similarly, full disclosure forecloses liability under the misappropriation
theory: Because the deception essential to the misappropriation theory involves feigning fidelity
to the source of information, if the fiduciary discloses to the source that he plans to trade on the
nonpublic information, there is no “deceptive device” and thus no Section 10(b) violation —
although the fiduciary-turned-trader may remain liable under state law for breach of a duty of
loyalty.7
We turn next to the Section 10(b) requirement that the misappropriator’s deceptive use of
information be “in connection with the purchase or sale of [a] security.” This element is satisfied
because the fiduciary’s fraud is consummated, not when the fiduciary gains the confidential
information, but when, without disclosure to his principal, he uses the information to purchase or
sell securities. The securities transaction and the breach of duty thus coincide. This is so even
though the person or entity defrauded is not the other party to the trade, but is, instead, the source
of the nonpublic information. A misappropriator who trades on the basis of material, nonpublic
information, in short, gains his advantageous market position through deception; he deceives the
source of the information and simultaneously harms members of the investing public.
The misappropriation theory targets information of a sort that misappropriators ordinarily
capitalize upon to gain no-risk profits through the purchase or sale of securities. Should a
misappropriator put such information to other use, the statute’s prohibition would not be
implicated. The theory does not catch all conceivable forms of fraud involving confidential
information; rather, it catches fraudulent means of capitalizing on such information through
securities transactions.
The Government notes another limitation on the forms of fraud § 10(b) reaches: “The
misappropriation theory would not … apply to a case in which a person defrauded a bank into
giving him a loan or embezzled cash from another, and then used the proceeds of the misdeed to
purchase securities.” In such a case, the Government states, “the proceeds would have value to
the malefactor apart from their use in a securities transaction, and the fraud would be complete as
soon as the money was obtained.” In other words, money can buy, if not anything, then at least
many things; its misappropriation may thus be viewed as sufficiently detached from a subsequent
securities transaction that § 10(b)’s “in connection with” requirement would not be met.
JUSTICE THOMAS’ charge that the misappropriation theory is incoherent because information,
like funds, can be put to multiple uses misses the point. The Exchange Act was enacted in part “to
insure the maintenance of fair and honest markets,”15 U.S.C. § 78b, and there is no question that
fraudulent uses of confidential information fall within § 10(b)’s prohibition if the fraud is “in
connection with” a securities transaction. It is hardly remarkable that a rule suitably applied to the
of the information, here, Dorsey & Whitney and Grand Met. Chief Justice Burger, dissenting in Chiarella,
advanced a broader reading of § 10(b) and Rule 10b-5; the disclosure obligation, as he envisioned it, ran to
those with whom the misappropriator trades. The government does not propose that we adopt a
misappropriation theory of that breadth.
7
Where, however, a person trading on the basis of material, nonpublic information owes a duty of
loyalty and confidentiality to two entities or persons — for example, a law firm and its client — but makes
disclosure to only one, the trader may still be liable under the misappropriation theory.
19

fraudulent uses of certain kinds of information would be stretched beyond reason were it applied
to the fraudulent use of money. …
The misappropriation theory comports with Section 10(b)’s language, which requires deception
“in connection with the purchase or sale of any security,” not deception of an identifiable
purchaser or seller. The theory is also well tuned to an animating purpose of the Exchange Act: to
insure honest securities markets and thereby promote investor confidence. Although
informational disparity is inevitable in the securities markets, investors likely would hesitate to
venture their capital in a market where trading based on misappropriated nonpublic information is
unchecked by law. An investor’s informational disadvantage vis-à-vis a misappropriator with
material, nonpublic information stems from contrivance, not luck; it is a disadvantage that cannot
be overcome with research or skill.
[C]onsidering the inhibiting impact on market participation of trading on misappropriated
information, and the congressional purposes underlying Section 10(b), it makes scant sense to
hold a lawyer like O’Hagan a Section 10(b) violator if he works for a law firm representing the
target of a tender offer, but not if he works for a law firm representing the bidder. The text of the
statute requires no such result. The misappropriation at issue here was properly made the subject
of a Section 10(b) charge because it meets the statutory requirement that there be “deceptive”
conduct “in connection with” securities transactions.
In sum, the misappropriation theory, as we have examined and explained it in this opinion, is
both consistent with the statute and with our precedent. Vital to our decision that criminal liability
may be sustained under the misappropriation theory, we emphasize, are two sturdy safeguards
Congress has provided regarding scienter. To establish a criminal violation of Rule 10b-5, the
government must prove that a person “willfully” violated the provision. 12 Furthermore, a
defendant may not be imprisoned for violating Rule 10b-5 if he proves that he had no knowledge
of the Rule. O’Hagan’s charge that the misappropriation theory is too indefinite to permit the
imposition of criminal liability, thus fails not only because the theory is limited to those who
breach a recognized duty. In addition, the statute’s “requirement of the presence of culpable intent
as a necessary element of the offense does much to destroy any force in the argument that
application of the [statute]” in circumstances such as O’Hagan’s is unjust. Boyce Motor Lines,
Inc. v. United States, 342 U.S. 337, 342 (1952).
The Eighth Circuit erred in holding that the misappropriation theory is inconsistent with
Section 10(b). The Court of Appeals may address on remand O’Hagan’s other challenges to his
convictions under § 10(b) and Rule 10b-5. …
JUSTICE SCALIA, concurring in part and dissenting in part. (Omitted.)
JUSTICE THOMAS, with whom THE CHIEF JUSTICE joins, concurring in the
judgment in part and dissenting in part.
Today the majority upholds respondent’s convictions for violating Section 10(b) of the
Securities Exchange Act of 1934, and Rule 10b-5 promulgated thereunder, based upon the
Securities and Exchange Commission’s “misappropriation theory.” Central to the majority’s
12
In relevant part, Section 32 of the Exchange Act, as set forth in 15 U.S.C. § 78ff(a), provides:
“Any person who willfully violates any provision of this chapter … shall upon conviction be fined not
more than $1,000,000 [now $5,000,000], or imprisoned not more than 10 years [now 20 years], or both … ;
but no person shall be subject to imprisonment under this section for the violation of any rule or regulation
if he proves that he had no knowledge of such rule or regulation.”
20

holding is the need to interpret Section 10(b)’s requirement that a deceptive device be “use[d] or
employ[ed], in connection with the purchase or sale of any security.” 15 U.S.C. § 78j(b). Because
the Commission’s misappropriation theory fails to provide a coherent and consistent
interpretation of this essential requirement for liability under Section 10(b), I dissent.
I do not take issue with the majority’s determination that the undisclosed misappropriation of
confidential information by a fiduciary can constitute a “deceptive device” within the meaning of
Section 10(b). Nondisclosure where there is a pre-existing duty to disclose satisfies our
definitions of fraud and deceit for purposes of the securities laws.
Unlike the majority, however, I cannot accept the Commission’s interpretation of when a
deceptive device is “use[d] … in connection with” a securities transaction. …
[The misappropriation theory should not] cover cases, such as this one, involving fraud on the
source of information where the source has no connection with the other participant in a securities
transaction. It seems obvious that the undisclosed misappropriation of confidential information is
not necessarily consummated by a securities transaction. In this case, for example, upon learning
of Grand Met’s confidential takeover plans, O’Hagan could have done any number of things with
the information: He could have sold it to a newspaper for publication; he could have given or sold
the information to Pillsbury itself; or he could even have kept the information and used it solely
for his personal amusement, perhaps in a fantasy stock trading game.
Any of these activities would have deprived Grand Met of its right to “exclusive use” of the
information and, if undisclosed, would constitute “embezzlement” of Grand Met’s informational
property. Under any theory of liability, however, these activities would not violate § 10(b) and,
according to the Commission’s monetary embezzlement analogy, these possibilities are sufficient
to preclude a violation under the misappropriation theory even where the informational property
was used for securities trading. That O’Hagan actually did use the information to purchase
securities is thus no more significant here than it is in the case of embezzling money used to
purchase securities. In both cases the embezzler could have done something else with the
property, and hence the Commission’s necessary “connection” under the securities laws would
not be met. If the relevant test under the “in connection with” language is whether the fraudulent
act is necessarily tied to a securities transaction, then the misappropriation of confidential
information used to trade no more violates § 10(b) than does the misappropriation of funds used
to trade. As the Commission concedes that the latter is not covered under its theory, I am at a loss
to see how the same theory can coherently be applied to the former.
In upholding respondent’s convictions under the new and improved misappropriation theory,
the majority also points to various policy considerations underlying the securities laws, such as
maintaining fair and honest markets, promoting investor confidence, and protecting the integrity
of the securities markets. But the repeated reliance on such broad-sweeping legislative purposes
reaches too far and is misleading in the context of the misappropriation theory. It reaches too far
in that, regardless of the overarching purpose of the securities laws, it is not illegal to run afoul of
the “purpose” of a statute, only its letter. …
[A]s we have repeatedly held, use of nonpublic information to trade is not itself a violation of
Section 10(b). Rather, it is the use of fraud “in connection with” a securities transaction that is
forbidden. Where the relevant element of fraud has no impact on the integrity of the subsequent
transactions as distinct from the nonfraudulent element of using nonpublic information, one can
reasonably question whether the fraud was used in connection with a securities transaction. And
one can likewise question whether removing that aspect of fraud, though perhaps laudable, has
anything to do with the confidence or integrity of the market.
The absence of a coherent and consistent misappropriation theory and, by necessary
implication, a coherent and consistent application of the statutory “use or employ, in connection
with” language, is particularly problematic in the context of this case. The government claims a
21

remarkable breadth to the delegation of authority in Section 10(b), arguing that “the very aim of
this section was to pick up unforeseen, cunning, deceptive devices that people might cleverly use
in the securities markets.” Tr. of Oral Arg. 7. As the Court aptly queried, “[t]hat’s rather unusual,
for a criminal statute to be that open-ended, isn’t it?” Id. Unusual indeed. Putting aside the
dubious validity of an open-ended delegation to an independent agency to go forth and create
regulations criminalizing “fraud,” in this case we do not even have a formal regulation
embodying the agency’s misappropriation theory. …p
NOTES AND QUESTIONS
1.
The misappropriation theory. Neither Section 10b nor Rule 10b-5 sets forth a
“misappropriation” theory. Why did the majority affirm the use of that theory? Is the decision
consistent with Chiarella? What is the dissent’s complaint? Is the dissent correct?
What sorts of duties will support a misappropriation case? For example, assume that a
patient discusses material nonpublic information during a session with a psychiatrist and that the
psychiatrist and the psychiatrist’s broker then trade on the information. Does that suffice? See,
e.g., United States v. Willis, 737 F. Supp. 269 (S.D.N.Y. 1990); SEC v. Willis, 825 F. Supp. 617
(S.D.N.Y. 1993) (upholding misappropriation theory based upon the psychiatrist’s breach of duty
to his patient).
2.
The “in connection with” requirement. What is the dissent’s argument concerning
whether O’Hagan’s deception was “in connection with” his securities trading? The majority
concludes that one who embezzles an employer’s money to use in trading securities has not
committed insider trading, while one who steals an employer’s confidential information for such
use has committed insider trading. Does this distinction make sense? Why or why not?
3.
The Carpenter case. In Carpenter (presented in Chapter 4, Mail and Wire Fraud, supra), a
Wall Street Journal reporter traded on information from a column he wrote for the journal. Under
newspaper policy, the information was confidential and was not to be disclosed prior to
publication. The column often affected stock prices, and the reporter and his cohorts traded in
advance of publication and made handsome profits. Note that the Wall Street Journal reporter had
no duty to any of the participants in the transactions involved in the trading in Carpenter. In
contrast, O’Hagan did have a duty to his firm’s former client, which was the offering party in the
Pillsbury transaction. What was the potential harm from O’Hagan’s actions? From the Wall Street
Journal reporter’s actions? Was the former more serious than the latter? Why or why not?
p
The SEC subsequently adopted Rule 10b5-2, which attempts to define the fiduciary duties that may give
rise to liability under the misappropriation theory. This Rule is discussed after the notes and questions
following O’Hagan.
22

4.
The market confidence theory of harm. The O’Hagan Court claimed that “investors likely
would hesitate to venture their capital in a market where [insider trading] is unchecked by law.”
521 U.S. at 658. The suggestion that a general awareness of rampant insider trading would
undermine confidence in our markets and make it more difficult for firms to raise capital is one of
the more frequently-cited justifications for the regulation of insider trading. There appear to be
three claims implicit in the market confidence justification for the criminalization of insider
trading: (1) A significant portion of the investing public believes that insider trading is unfair and
widespread; (2) this perception leads those who share it to reduce or end their market
participation; and (3) aggressive enforcement of insider trading restrictions is therefore necessary
to prevent the harm to capital markets that would result from (2). A recent empirical study sought
to test the market confidence theory against actual public attitudes. See John P. Anderson, Jeremy
Kidd, & George Mocsary, Public Perceptions of Insider Trading, 51 SETON HALL L. REV. __
(2021). For example, the survey participants were asked, “If you knew insider trading was
common in the stock market, would you be more likely to invest, less likely, or would it make no
difference?” Overall, 43.3% said they would be less likely to trade, 40.6% said such knowledge
would make no difference to their trading, and 14.9% said knowledge of insider trading would
make them more likely to trade. Id. at ______. How would you respond to this question? Do you
think the survey results confirm the market confidence theory? Why or why not?
5.
Tender offer rules.
a.
Rule 14e-3(a). Insider trading can be prosecuted under laws other than Section 10b and
Rule 10b-5. Section 14 of the Exchange Act and Rule 14e-3(a) thereunder, for example, prohibit
trading while in possession of material nonpublic information relating to a tender offer. A tender
offer is a takeover bid that involves a public offer to current shareholders of the target company to
purchase some or all of their shares within a specified time period. Because the tender offer price
typically involves a significant premium over the current trading price of the target shares, trading
on the basis of advance knowledge of the offer can generate massive profits. Rule 14e-3(a), 17
C.F.R. 240.14e-3(a), provides:
If any person has taken a substantial step or steps to commence, or has
commenced, a tender offer (the “offering person”), it shall constitute a
fraudulent, deceptive or manipulative act or practice within the meaning
of section 14(e) of the [Exchange] Act for any other person who is in
possession of material information relating to such tender offer which
information he knows or has reason to know is nonpublic and which he
knows or has reason to know has been acquired directly or indirectly
from:
(1) The offering person,
(2) The issuer of the securities sought or to be sought by

such tender offer, or
23

(3) Any officer, director, partner or employee or any other

person acting on behalf of the offering person or such issuer, to
purchase or sell or cause to be purchased or sold any of such
securities … , unless within a reasonable time prior to any
purchase or sale such information and its source are publicly
disclosed by press release or otherwise.
O’Hagan was also convicted under this provision. On appeal, he argued that the SEC
exceeded its rulemaking authority when it adopted Rule 14e-3(a). Because that Rule imposes
liability even where the defendant has not obtained the information in breach of a fiduciary duty,
O’Hagan argued, the Rule violates the Chiarella holding. The Court rejected O’Hagan’s
argument. The Court noted that O’Hagan had indeed breached a fiduciary duty and stated that the
SEC, “to the extent relevant to this case, did not exceed its authority.”
b.
Warehousing. By the language quoted above, the Court implied that Rule 14e-3(a) might
not be valid where there has been no breach of duty. What if, for example, the owner of the
information specifically approved of the trading? In O’Hagan, the Court stated that “[w]e leave
for another day, when the issue requires decision, the legitimacy of Rule 14e-3(a) as applied to
‘warehousing,’ which the government describes as ‘the practice by which bidders leak advance
information of a tender offer to allies and encourage them to purchase the target company’s stock
before the bid is announced.’” Should such trading be forbidden? Why or why not?
c.
Mens rea for Rule 14e-3. There is also some uncertainty as to the mens rea requirement
under Section 14 and Rule 14e-3(a). What if a defendant obtained material, nonpublic
information relating to a tender offer, but (a) did not breach a duty in obtaining the information
and (b) did not know the information involved a tender offer? Could that defendant be liable
under those provisions? Courts have not resolved this question. In one case, the court did hold
that a defendant who traded on material, nonpublic information, but who did not breach a duty in
obtaining the information and did not know that the information involved a tender offer, was not
guilty under Section 14. United States v. Cassese, 290 F. Supp. 2d 443 (S.D.N.Y. 2003), aff’d,
428 F.3d 92 (2d Cir. 2005).
NOTE ON UNITED STATES v. CHESTMAN AND RULE 10B5-2
The Court in O’Hagan did not define the sorts of fiduciary duties that may give rise to a
misappropriation case. In a pre-O’Hagan case, United States v. Chestman, 947 F.2d 551 (2d Cir.
1991) (en banc), the Second Circuit attempted to draw the boundaries of fiduciary duties among
family members. In that case, Ira Waldbaum gave inside information concerning the sale of his
company to his sister so that she could make the financial arrangements attendant to the sale. In
turn, the sister gave the information to her daughter, who gave it to her husband. The husband,
Keith Loeb, and Chestman, the husband’s stockbroker, then traded on the information. Each of
these persons knew that the information was material and nonpublic information relating to a
tender offer.
24

Loeb pleaded guilty and testified against Chestman, who was convicted under Section
10b. The Second Circuit reversed. As will be seen below in the discussion of tippee liability, for
Chestman to be guilty under Section 10b, the government was required to show that Loeb
breached a fiduciary duty when giving Chestman the information. The Second Circuit found that
there was no such breach because the husband owed no duty to the company, to his wife, or to his
wife’s family to keep the information secret. The husband was not employed by the company,
and had no history of maintaining the business confidences of his wife or his wife’s family.
(Because no such breach of duty is required under Section 14, however, the court affirmed the
husband’s conviction for illegal trading in connection with a tender offer.)
In the wake of Chestman and O’Hagan, the SEC, in 2000, adopted Rule 10b5-2. Entitled
“Duties of trust or confidence in misappropriation insider trading cases,” the rule attempts to
define the fiduciary duties that may give rise to misappropriation liability:
For purposes of this section, a “duty of trust or confidence” exists in the
following circumstances, among others:
(1) Whenever a person agrees to maintain information in confidence;
(2) Whenever the person communicating the material nonpublic
information and the person to whom it is communicated have a history,
pattern, or practice of sharing confidences, such that the recipient of the
information knows or reasonably should know that the person
communicating the material nonpublic information expects that the
recipient will maintain its confidentiality; or
(3) Whenever a person receives or obtains material nonpublic
information from his or her spouse, parent, child, or sibling; provided,
however, that the person receiving or obtaining the information may
demonstrate that no duty of trust or confidence existed with respect to the
information, by establishing that he or she neither knew nor reasonably
should have known that the person who was the source of the information
expected that the person would keep the information confidential,
because of the parties’ history, pattern, or practice of sharing and
maintaining confidences, and because there was no agreement or
understanding to maintain the confidentiality of the information.
17 C.F.R. § 240.10b5-2(b) (emphasis added).
Does this section provide clarity to the misappropriation theory? Does it overturn the
result in Chestman?
1.
Trust and/or confidence? Recall that in Chiarella and O’Hagan, the Court held that
Section 10b insider trading liability presupposes a breach of a fiduciary or similar duty of “trust
and confidence.” See, e.g., O’Hagan, 521 U.S. at 652-53. SEC Rule 10b5-2, however, defines
misappropriation liability in terms of a duty of “trust or confidence.” Is the shift from the
conjunctive to the disjunctive significant for the scope of liability? If so, is the expanded scope
under the administrative rule authorized by the statute?
25

2.
The Cuban case and question of confidentiality agreements. In June of 2004 the CEO of
Mamma.com called Mark Cuban (owner of the Dallas Mavericks and regular on the hit-show,
“Shark Tank”) and left a message for Cuban to call him back. When Cuban called back, the CEO
said “I’ve got confidential information;” Cuban responded, “Okay, uh huh, go ahead.” At this
point the CEO told Cuban (who was a major shareholder at Mamma.com—but not an insider at
the company) that the company would likely issue new shares to raise capital. This was bad news
for Cuban because his existing shares would be diluted in value with the issuance of the new
shares. Shortly after this call (but before the public announcement of this material information),
Cuban sold all his 600,000 shares in the company. By selling when he did, Cuban avoided losses
of approximately $750,000. See SEC v. Cuban, 620 F.3d 551, 556 (5th Cir. 2010). The SEC
brought an insider trading enforcement action against Cuban. The case raised the important
question of whether a mere contractual or other commitment to confidence (without more) is
enough to trigger insider trading liability. We have seen that the Supreme Court has consistently
held that insider trading liability under Section 10b presupposes the breach of a fiduciary or
similar duty of loyalty to either the shareholders (which Cuban, who was not an insider at the
company, did not have) or the source of the information (which Cuban also did not appear to
have, since he was only a shareholder of Mamma.com—and therefore owed no duty of loyalty to
the CEO or the company). But we have also seen that SEC Rule 10b5-2(b)(1) defines the relevant
duty of “trust or confidence” to include “whenever a person agrees to maintain information in
confidence.” At a minimum, Cuban was aware that the CEO wished him to keep the information
in confidence.
The district court held that, without an express or implied commitment not to trade (duty
of trust or loyalty), a mere commitment to keep information in confidence does not give rise to
insider trading liability. SEC v. Cuban, 643 F.Supp.2d 713, 725 (2009). On appeal, however, the
Fifth Circuit refused to affirm the district court’s ruling on the question of whether an express or
implied commitment not to trade was required, explaining its decision to punt on the issue as
follows:
Given the paucity of jurisprudence on the question of what constitutes a

relationship of “trust and confidence” and the inherently fact-bound
nature of determining whether such a duty exists, we decline to first
determine or place our thumb on the scale in the district court’s
determination of its presence or to now draw the contours of any liability
that it might bring, including the force of Rule 10b5-2(b)(1).
Cuban, 643 F.3d at 558. The case was remanded and Cuban ultimately won the case on the merits
before a jury. See Jana Pruet, Billionaire Mark Cuban Cleared of Insider Trading; Blasts U.S.
Government, REUTERS (Oct. 16, 2013, 3:34 PM), https://www.reuters.com/article/us-usasec-
cuban-verdict-idUSBRE99F0ZM20131016). The issue of whether a mere agreement to keep
information in confidence (without an express or implicit agreement not to trade) is enough to
incur insider-trading liability under the misappropriation theory, however, remains unresolved.
How do you think this issue should be resolved? Do you think Cuban did something wrong here?
Do you think the CEO may have had some improper motive in sharing the information with
Cuban?
PROBLEMS
26

5-1.
Keith Joon was Chief Executive Officer (“CEO”) of Goose Foods, Inc. He had also been
a member, for 10 years, of the National Leaders Organization (“NLO”), a national organization of
company executives under 50 years old. The NLO is organized into regional chapters, and further
divided into small forums. Joon was a member of the Northern California Forum.
The “Forum Principles” of the Northern California Forum stated that: “We operate in an
atmosphere of absolute confidentiality. Nothing discussed in forum will be discussed with
outsiders. Confidentiality, in all ways and for always.” Members were also required to comply
with a written “Confidentiality Commitment” as a condition of membership. That agreement
provided: “I understand that to achieve the level of trust necessary to ensure the interchange we
all seek in the Forum, all information shared by the membership must be held in absolute
confidence.” Joon knew of the Confidentiality Commitment, but did not sign an agreement to that
effect or otherwise promise to adhere to the commitment. During his time as a member of NLO,
Joon occasionally discussed confidential business information with other members. At no time
during those conversations did Joon or the other members promise to maintain each others’
confidences.
The CEO of Data, Inc. was also a member of the Northern California Forum. Data is a
publicly traded corporation that manufactures computer storage devices. On March 1, the
Northern California Forum members departed in a private plane for their annual retreat. Prior to
departure, the CEO of Data informed the Forum Moderator that he could not attend because Data
was involved in merger discussions with another company — Quantum Corporation. He
authorized the Forum Moderator to tell the other members why he would be absent but asked the
Moderator to emphasize the confidential nature of the information. The Forum Moderator relayed
the information to Joon and other members of the Northern California Forum.
Based on this confidential information, between March 1 and March 4 last year, Joon
purchased 187,300 shares of Data stock for between $2.00 and $4.12 per share. On May 11, Data
publicly announced that it had agreed to be acquired by Quantum. Data’s share price jumped to
$7.56. Joon, thereby, realized a profit of $832,627 on an investment of $583,360.
The government is investigating whether Joon violated the federal securities laws. Does
the government have a viable case against Joon? If so, what theory or theories should the
government use? What are the likely defenses?
5-2.
Alexandra Gogol owned an Internet-based stock brokerage firm. Last October 17, Gogol
hacked into the computer network of Thomas Financial Advisers, Inc., and gained access to ONC
Health’s soon-to-be-released negative earnings announcement for the third quarter. There had
been no media or analyst reports anticipating negative earnings for ONC Health, which was a
client of Thomas Financial. Approximately 35 minutes after hacking into Thomas Financial’s
computer network, and two hours before the earnings announcement was to be made public,
Gogol sold $300,000 worth of ONC Health stock that she owned. This purchase represented 90
percent of all sales of ONC stock that day. When the stock market opened at 9:30 the next
morning, ONC Health stock immediately dropped 50 percent on news of the negative earnings.
27

The SEC has alleged that Gogol, by “hacking and trading,” has violated Section 10(b)
and Rule 10b-5. Gogol has moved to dismiss the charge. How should the court rule? Why?
5-3.
Samantha Jones, a letter carrier, was serving on a federal grand jury investigating
accounting fraud at ABC Pharmaceuticals. Jones was aware that matters occurring before a grand
jury are confidential under federal law and that only witnesses appearing before a grand jury may
reveal their testimony. The Assistant United States Attorney in charge of the investigation, in
accordance with the law concerning grand jury secrecy, publicly revealed that the grand jury was
investigating ABC for accounting fraud but did not reveal any information relating to the
investigation. ABC’s stock price fell sharply after the announcement. Jones later learned during a
grand jury session that the government had decided not to seek an indictment. Before prosecutors
publicly announced their decision not to seek an indictment, Jones bought stock in ABC. After
the announcement, ABC’s stock price rose sharply. Jones then sold her stock, netting a $100,000
profit.
Has Jones committed securities fraud? Why or why not?
[4]
Tipper/Tippee Liability
The cases above show that a corporate insider, temporary insider, or misappropriator may
be liable for insider trading. However, what about a “tippee,” that is, one who is not an insider, a
quasi-insider, or a misappropriator but who has been “tipped” with secret information? The
United States Supreme Court first addressed this issue in the case that follows. As you read the
case, be sure to identify precisely what the government must prove in a case against a tippee,
particularly with respect to mens rea.
DIRKS v. SECURITIES AND EXCHANGE COMMISSION

463 U.S. 646 (1983)
JUSTICE POWELL delivered the opinion of the Court.
Petitioner Raymond Dirks received material nonpublic information from “insiders” of a

corporation with which he had no connection. He disclosed this information to investors who
relied on it in trading in the shares of the corporation. The question is whether Dirks violated the
antifraud provisions of the federal securities laws by this disclosure.
In 1973, Dirks was an officer of a New York broker-dealer firm who specialized in providing
investment analysis of insurance company securities to institutional investors. On March 6, Dirks
received information from Ronald Secrist, a former officer of Equity Funding of America. Secrist
alleged that the assets of Equity Funding, a diversified corporation primarily engaged in selling
life insurance and mutual funds, were vastly overstated as the result of fraudulent corporate
practices. Secrist also stated that various regulatory agencies had failed to act on similar charges
28

made by Equity Funding employees. He urged Dirks to verify the fraud and disclose it publicly.
Dirks decided to investigate the allegations. He visited Equity Funding’s headquarters in Los
Angeles and interviewed several officers and employees of the corporation. The senior
management denied any wrongdoing, but certain corporation employees corroborated the charges
of fraud. Neither Dirks nor his firm owned or traded any Equity Funding stock, but throughout his
investigation he openly discussed the information he had obtained with a number of clients and
investors. Some of these persons sold their holdings of Equity Funding securities, including five
investment advisers who liquidated holdings of more than $16 million.
While Dirks was in Los Angeles, he was in touch regularly with William Blundell, The Wall
Street Journal’s Los Angeles bureau chief. Dirks urged Blundell to write a story on the fraud
allegations. Blundell did not believe, however, that such a massive fraud could go undetected and
declined to write the story. He feared that publishing such damaging hearsay might be libelous.
During the two-week period in which Dirks pursued his investigation and spread word of
Secrist’s charges, the price of Equity Funding stock fell from $26 per share to less than $15 per
share. This led the New York Stock Exchange to halt trading on March 27. Shortly thereafter
California insurance authorities impounded Equity Funding’s records and uncovered evidence of
the fraud. Only then did the Securities and Exchange Commission (SEC) file a complaint against
Equity Funding and only then, on April 2, did The Wall Street Journal publish a front-page story
based largely on information assembled by Dirks. Equity Funding immediately went into
receivership.
The SEC began an investigation into Dirks’ role in the exposure of the fraud. After a hearing
by an administrative law judge, the SEC found that Dirks had aided and abetted violations of
Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934,
and SEC Rule 10b-5 by repeating the allegations of fraud to members of the investment
community who later sold their Equity Funding stock. The SEC concluded: “Where ‘tippees’ —
regardless of their motivation or occupation — come into possession of material ‘information that
they know is confidential and know or should know came from a corporate insider,’ they must
either publicly disclose that information or refrain from trading.” 21 S.E.C. Docket 1401, 1407
(1981) (quoting Chiarella v. United States, 445 U.S. 222, 230 n. 12 (1980)). Recognizing,
however, that Dirks “played an important role in bringing [Equity Funding’s] massive fraud to
light,” 21 S.E.C. Docket at 1412, the SEC only censured him.
Dirks sought review in the Court of Appeals for the District of Columbia Circuit. The court
entered judgment against Dirks “for the reasons stated by the Commission in its opinion.” … In
view of the importance to the SEC and to the securities industry of the question presented by this
case, we granted a writ of certiorari. We now reverse.
In the seminal case of In re Cady, Roberts & Co., 40 S.E.C. 907 (1961), the SEC recognized
that the common law in some jurisdictions imposes on “corporate ‘insiders,’ particularly officers,
directors, or controlling stockholders” an “affirmative duty of disclosure … when dealing in
securities.” Id. at 911, and n.13.10 The SEC found that not only did breach of this common-law
duty also establish the elements of a Rule 10b-5 violation,12 but that individuals other than
10
The duty that insiders owe to the corporation’s shareholders not to trade on inside information
differs from the common-law duty that officers and directors also have to the corporation itself not to
mismanage corporate assets, of which confidential information is one. In holding that breaches of this duty
to shareholders violated the Securities Exchange Act, the Cady, Roberts Commission recognized, and we
agree, that “[a] significant purpose of the Exchange Act was to eliminate the idea that use of inside
information for personal advantage was a normal emolument of corporate office.”
12
The SEC views the disclosure duty as requiring more than disclosure to purchasers or sellers:
29

corporate insiders could be obligated either to disclose material nonpublic information before
trading or to abstain from trading altogether. In Chiarella, we held that “a duty to disclose under
Section 10(b) does not arise from the mere possession of nonpublic market information.” 445
U.S. at 235. Such a duty arises rather from the existence of a fiduciary relationship.
Not “all breaches of fiduciary duty in connection with a securities transaction,” however, come
within the ambit of Rule 10b-5. Santa Fe Industries, Inc. Green, 430 U.S. 462, 472 (1977). There
must also be “manipulation or deception.” Id. at 473. In an inside-trading case this fraud derives
from the “inherent unfairness involved where one takes advantage” of “information intended to
be available only for a corporate purpose and not for the personal benefit of anyone.” In re
Merrill Lynch, Pierce, Fenner & Smith, Inc., 43 S.E.C. 933, 936 (1968). Thus, an insider will be
liable under Rule 10b-5 for inside trading only where he fails to disclose material nonpublic
information before trading on it and thus makes “secret profits.” Cady, Roberts, 40 S.E.C. at 916
n.31.
We were explicit in Chiarella in saying that there can be no duty to disclose where the person
who has traded on inside information “was not [the corporation’s] agent, … was not a fiduciary,
[or] was not a person in whom the sellers [of the securities] had placed their trust and
confidence.” 445 U.S. at 232. Not to require such a fiduciary relationship, we recognized, would
“depar[t] radically from the established doctrine that duty arises from a specific relationship
between two parties” and would amount to “recognizing a general duty between all participants in
market transactions to forgo actions based on material, nonpublic information.” Id. at 232, 233.
This requirement of a specific relationship between the shareholders and the individual trading on
inside information has created analytical difficulties for the SEC and courts in policing tippees
who trade on inside information. Unlike insiders who have independent fiduciary duties to both
the corporation and its shareholders, the typical tippee has no such relationships. 14 In view of this
absence, it has been unclear how a tippee acquires the Cady, Roberts duty to refrain from trading
on inside information.
The SEC’s position, as stated in its opinion in this case, is that a tippee “inherits” the Cady,
Roberts obligation to shareholders whenever he receives inside information from an insider… .
This view differs little from the view that we rejected as inconsistent with congressional intent
in Chiarella. Here, the SEC maintains that anyone who knowingly receives nonpublic material
information from an insider has a fiduciary duty to disclose before trading.
In effect, the SEC’s theory of tippee liability in both cases appears rooted in the idea that the
antifraud provisions require equal information among all traders. This conflicts with the principle
set forth in Chiarella that only some persons, under some circumstances, will be barred from
“Proper and adequate disclosure of significant corporate developments can only be effected by a public
release through the appropriate public media, designed to achieve a broad dissemination to the investing
public generally and without favoring any special person or group.” In re Faberge, Inc., 45 S.E.C. 249, 256
(1973).
14
Under certain circumstances, such as where corporate information is revealed legitimately to an
underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders may become
fiduciaries of the shareholders. The basis for recognizing this fiduciary duty is not simply that such persons
acquired nonpublic corporate information, but rather that they have entered into a special confidential
relationship in the conduct of the business of the enterprise and are given access to information solely for
corporate purposes. When such a person breaches his fiduciary relationship, he may be treated more
properly as a tipper than a tippee. For such a duty to be imposed, however, the corporation must expect the
outsider to keep the disclosed nonpublic information confidential, and the relationship at least must imply
such a duty.
30

trading while in possession of material nonpublic information. … We reaffirm today that “[a]
duty [to disclose] arises from the relationship between parties … and not merely from one’s
ability to acquire information because of his position in the market.” 445 U.S. at 231–32, n.14.
Imposing a duty to disclose or abstain solely because a person knowingly receives material
nonpublic information from an insider and trades on it could have an inhibiting influence on the
role of market analysts, which the SEC itself recognizes is necessary to the preservation of a
healthy market. It is commonplace for analysts to “ferret out and analyze information,” 21 S.E.C.
at 1406, and this often is done by meeting with and questioning corporate officers and others who
are insiders. And information that the analysts obtain normally may be the basis for judgments as
to the market worth of a corporation’s securities. The analyst’s judgment in this respect is made
available in market letters or otherwise to clients of the firm. It is the nature of this type of
information, and indeed of the markets themselves, that such information cannot be made
simultaneously available to all of the corporation’s stockholders or the public generally.
The conclusion that recipients of inside information do not invariably acquire a duty to disclose
or abstain does not mean that such tippees always are free to trade on the information. The need
for a ban on some tippee trading is clear. Not only are insiders forbidden by their fiduciary
relationship from personally using undisclosed corporate information to their advantage, but they
may not give such information to an outsider for the same improper purpose of exploiting the
information for their personal gain. Thus, the tippee’s duty to disclose or abstain is derivative
from that of the insider’s duty. As we noted in Chiarella, “[t]he tippee’s obligation has been
viewed as arising from his role as a participant after the fact in the insider’s breach of a fiduciary
duty.” 445 U.S. at 230 n.12.
Thus, some tippees must assume an insider’s duty to the shareholders not because they receive
inside information, but rather because it has been made available to them improperly.19 And for
Rule 10b-5 purposes, the insider’s disclosure is improper only where it would violate his Cady,
Roberts duty. Thus, a tippee assumes a fiduciary duty to the shareholders of a corporation not to
trade on material nonpublic information only when the insider has breached his fiduciary duty to
the shareholders by disclosing the information to the tippee and the tippee knows or should know
that there has been a breach. … Tipping thus properly is viewed only as a means of indirectly
violating the Cady, Roberts disclose-or-abstain rule.
In determining whether a tippee is under an obligation to disclose or abstain, it thus is
necessary to determine whether the insider’s “tip” constituted a breach of the insider’s fiduciary
duty. All disclosures of confidential corporate information are not inconsistent with the duty
insiders owe to shareholders. In contrast to the extraordinary facts of this case, the more typical
situation in which there will be a question whether disclosure violates the insider’s Cady, Roberts
duty is when insiders disclose information to analysts. In some situations, the insider will act
consistently with his fiduciary duty to shareholders, and yet release of the information may affect
the market. For example, it may not be clear—either to the corporate insider or to the recipient
analyst—whether the information will be viewed as material nonpublic information. Corporate
officials may mistakenly think the information already has been disclosed or that it is not material
enough to affect the market. Whether disclosure is a breach of duty therefore depends in large
part on the purpose of the disclosure. This standard was identified by the SEC itself in Cady,
Roberts: a purpose of the securities laws was to eliminate “use of inside information for personal
advantage.” Thus, the test is whether the insider personally will benefit, directly or indirectly,
19
The SEC itself has recognized that tippee liability properly is imposed only in circumstances
where the tippee knows, or has reason to know, that the insider has disclosed improperly inside corporate
information.
31

from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders.
And absent a breach by the insider, there is no derivative breach. …
The SEC argues that, if inside-trading liability does not exist when the information is
transmitted for a proper purpose but is used for trading, it would be a rare situation when the
parties could not fabricate some ostensibly legitimate business justification for transmitting the
information. We think the SEC is unduly concerned. In determining whether the insider’s purpose
in making a particular disclosure is fraudulent, the SEC and the courts are not required to read the
parties’ minds… . But to determine whether the disclosure itself “deceive[s], manipulate[s], or
defraud[s]” shareholders, Aaron v. SEC, 446 U.S. 680, 686 (1980), the initial inquiry is whether
there has been a breach of duty by the insider. This requires courts to focus on objective criteria,
i.e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a
pecuniary gain or a reputational benefit that will translate into future earnings. There are objective
facts and circumstances that often justify such an inference. For example, there may be a
relationship between the insider and the recipient that suggests a quid pro quo from the latter, or
an intention to benefit the particular recipient. The elements of fiduciary duty and exploitation of
nonpublic information also exist when an insider makes a gift of confidential information to a
trading relative or friend. The tip and trade resemble trading by the insider himself followed by a
gift of the profits to the recipient.
Determining whether an insider personally benefits from a particular disclosure, a question of
fact, will not always be easy for courts. But it is essential, we think, to have a guiding principle
for those whose daily activities must be limited and instructed by the SEC’s inside-trading rules,
and we believe that there must be a breach of the insider’s fiduciary duty before the tippee
inherits the duty to disclose or abstain. In contrast, the rule adopted by the SEC in this case would
have no limiting principle.
Under the inside-trading and tipping rules set forth above, we find that there was no actionable
violation by Dirks. It is undisputed that Dirks himself was a stranger to Equity Funding, with no
pre-existing fiduciary duty to its shareholders. He took no action, directly or indirectly, that
induced the shareholders or officers of Equity Funding to repose trust or confidence in him. There
was no expectation by Dirks’ sources that he would keep their information in confidence. Nor did
Dirks misappropriate or illegally obtain the information about Equity Funding. Unless the
insiders breached their Cady, Roberts duty to shareholders in disclosing the nonpublic
information to Dirks, he breached no duty when he passed it on to investors as well as to The
Wall Street Journal.
It is clear that neither Secrist nor the other Equity Funding employees violated their Cady,
Roberts duty to the corporation’s shareholders by providing information to Dirks. The tippers
received no monetary or personal benefit for revealing Equity Funding’s secrets, nor was their
purpose to make a gift of valuable information to Dirks. As the facts of this case clearly indicate,
the tippers were motivated by a desire to expose the fraud. In the absence of a breach of duty to
shareholders by the insiders, there was no derivative breach by Dirks. Dirks therefore could not
have been “a participant after the fact in [an] insider’s breach of a fiduciary duty.” Chiarella, 445
U.S. at 230 n.12.
We conclude that Dirks, in the circumstances of this case, had no duty to abstain from use of
the inside information that he obtained. The judgment of the Court of Appeals therefore is
Reversed.
JUSTICE BLACKMUN, with whom JUSTICE BRENNAN and JUSTICE MARSHALL join,
dissenting.
The Court today takes still another step to limit the protections provided investors by Section
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10(b) of the Securities Exchange Act of 1934. The device employed in this case engrafts a special
motivational requirement on the fiduciary duty doctrine. This innovation excuses a knowing and
intentional violation of an insider’s duty to shareholders if the insider does not act from a motive
of personal gain. Even on the extraordinary facts of this case, such an innovation is not justified.
***
No one questions that Secrist himself could not trade on his inside information to the
disadvantage of uninformed shareholders and purchasers of Equity Funding securities. Unlike the
printer in Chiarella, Secrist stood in a fiduciary relationship with these shareholders. …
The Court also acknowledges that Secrist could not do by proxy what he was prohibited from
doing personally. But this is precisely what Secrist did. Secrist used Dirks to disseminate
information to Dirks’ clients, who in turn dumped stock on unknowing purchasers. Secrist thus
intended Dirks to injure the purchasers of Equity Funding securities to whom Secrist had a duty
to disclose. Accepting the Court’s view of tippee liability, it appears that Dirks’ knowledge of this
breach makes him liable as a participant in the breach after the fact. …
The fact that the insider himself does not benefit from the breach does not eradicate the
shareholder’s injury. It makes no difference to the shareholder whether the corporate insider
gained or intended to gain personally from the transaction; the shareholder still has lost because
of the insider’s misuse of nonpublic information. The duty is addressed not to the insider’s
motives, but to his actions and their consequences on the shareholder. Personal gain is not an
element of the breach of this duty. …
The improper purpose requirement not only has no basis in law, but it rests implicitly on a
policy that I cannot accept. The Court justifies Secrist’s and Dirks’ action because the general
benefit derived from the violation of Secrist’s duty to shareholders outweighed the harm caused
to those shareholders — in other words, because the end justified the means. Under this view, the
benefit conferred on society by Secrist’s and Dirks’ activities may be paid for with the losses
caused to shareholders trading with Dirks’ clients.
Although Secrist’s general motive to expose the Equity Funding fraud was laudable, the means
he chose were not. Moreover, even assuming that Dirks played a substantial role in exposing the
fraud, he and his clients should not profit from the information they obtained from Secrist. …
In my view, Secrist violated his duty to Equity Funding shareholders by transmitting material
nonpublic information to Dirks with the intention that Dirks would cause his clients to trade on
that information. Dirks, therefore, was under a duty to make the information publicly available or
to refrain from actions that he knew would lead to trading. Because Dirks caused his clients to
trade, he violated Section 10(b) and Rule 10b-5. Any other result is a disservice to this country’s
attempt to provide fair and efficient capital markets. I dissent.
NOTES AND QUESTIONS
1.
The Dirks rule. What precisely must the government prove in order to gain a conviction
of a “tippee?” What element was missing in the case against Dirks?
2.
The role of market analysts. The Court was apparently concerned about imposing broad
33

liability on “tippees.” What exactly was the Court’s concern? According to the dissent, what are
the negative consequences of not imposing liability on tippees like Dirks? Who has the better of
the argument? Why?
According to the dissent, what actions should Dirks have taken? Was it appropriate for
Dirks to investigate Equity Funding’s finances on behalf of his clients? If so, once Dirks had the
information, what would have been the effect on Dirks’ clients if Dirks had publicly disclosed the
information before revealing it to his clients? How would his clients have likely reacted? Also,
how would Dirks have made the disclosure? Why did The Wall Street Journal decline to make
the information public? Finally, what was the effect of Dirks’ disclosure on the market’s
valuation of Equity Funding’s stock? Did the disclosure provide a market benefit? Why or why
not?
3.
The mens rea requirement. As noted above, § 32(a) of the Exchange Act makes it a crime
to commit a “willful” violation of the statute or rules and regulations adopted thereunder, and the
Supreme Court has confirmed that criminal insider trading liability requires proof that the
defendant “willfully violated [Rule 10b-5].” O’Hagan, 521 U.S. at 665. The Court has also noted,
however, that the word “willful” “is a word of many meanings.” Ratzlaf v. United States, 510
U.S. 135, 141 (1994). For criminal securities fraud in violation of Rule 10b-5, “willfully” has
been interpreted to mean “intentionally undertaking an act that one knows to be wrongful.”
United States v. Tarallo, 380 F.3d 1174, 1188 (9th Cir. 2004). In this context, “willfully” does
“not require that the actor know specifically that the conduct was unlawful.” Id. You may have
noticed, however, that the Dirks Court said that, if a tippee knows or “should know” of the breach
of fiduciary duty by the tipper, then the tippee can be held liable. This language, which sounds
like a negligence or recklessness standard, has produced a great deal of confusion in criminal
tipper-tippee cases. Professor Kelly Strader has noted that, given “the common understanding of
securities fraud as an intentional crime, the only rational explanation of the [Dirks] Court’s use of
the [‘should know’] language was that it was being sloppy.” Kelly J. Strader,
(Re)Conceptualizing Insider Trading: United States v. Newman and the Intent to Defraud, 80
BROOKLYN L. REV. 1419, 1473 (2015). Nevertheless, courts have regularly cited the “or should
have known” language from Dirks in articulating the relevant mens rea for tippees in criminal
insider trading cases. See, e.g., United States v. Newman, 773 F.3d 438, 455 (2d Cir. 2014). The
result has been that courts have applied a number of different mens rea tests for tippee liability,
ranging from knowledge to recklessness. See id. If you were a trader on Wall Street who received
a “hot tip” from an anonymous source concerning a company’s future earnings, how would legal
uncertainty concerning the relevant mens rea for tippee liability affect your trading?
4.
Remote tippees. What if A tips B, who then tips C. Can C be liable? So long as the Dirks
elements are met for both A and B as tippers, and for C as the tippee, then C can be liable. See,
e.g., Salman v. United States, 137 S. Ct. 420 (2016) (affirming conviction of a remote tippee).
5.
Tipper-tippee liability in misappropriation cases? The Dirks case arose under the
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classical theory of insider trading — Secrist was an insider of Equity Funding. Since the relevant
fiduciary duties are different under the classical theory (duty to the shareholder-counterparty) and
the misappropriation theory (duty to the source of the information), some have questioned
whether tipper-tippee liability applies in both contexts—and, if so, whether the elements are the
same (e.g., does the personal benefit test apply in misappropriation cases?). See, e.g., Donald C.
Langevoort, “Fine Distinctions” in the Contemporary Law of Insider Trading, 2013 COLUMBIA
BUS. L. REV. 429, 452 (2013); see also J. Kelly Strader, White Collar Crime and Punishment —
Reflections on Michael, Martha, and Milberg Weiss, 15 GEO. MASON L. REV. 45 (2007). As we
shall see below, both questions appear to have been answered (albeit implicitly) in Salman v.
United States, 137 S. Ct. 420 (2016). In Salman, the Supreme Court affirmed the criminal
conviction of a tippee under the misappropriation theory. Id. at 429. In the same case, the
government conceded that the Dirks “personal-benefit analysis applies in both classical and
misappropriation cases.” Id. at n. 2 (this footnote is not included in the edited version of the case
below). The Court therefore noted that it “need not resolve the question.” Id.
6.
What constitutes a personal benefit? Recall that the Dirks Court adopted the personal
benefit test for when a tipper has breach the relevant fiduciary or similar duty of trust and
confidence as a means of imposing some form of “limiting principle” on insider trading liability
in the tipper/tippee context. Dirks at 664. The Court explained that such a limiting principle was
important in order to offer market analysts (whose job it is to gather market information from
insiders and other sources) some clear guidance on when their efforts to “ferret out and analyze”
information have crossed the line. Id., 658-59. The SEC expressed concern at the time that, under
the personal benefit test, “it would be a rare situation when the parties could not fabricate some”
justification that does not involve self-dealing on the part of the tipper. Id. at 663. In response, the
Court offered “objective facts and circumstances” that could be relied upon as proof of a personal
benefit, such as when “the insider receives a direct or indirect personal benefit from the
disclosure, such as a pecuniary gain or a reputational benefit that will translate into future
earnings… .” Other objective evidence of a personal benefit could arise “when an insider makes a
gift of confidential information to a trading relative or friend. The tip and trade resemble trading
by the insider himself followed by a gift of the profits to the recipient.” Id. at 664.
In most tipper/tippee cases, the personal benefit test is not difficult to satisfy because
there is a payment to the tipper, a sharing of profits, or some clear reputational benefit. But
recently a great deal of controversy has centered around when a mere “gift” of information
satisfies the personal benefit test, particularly in the context of remote tippees. For example, who
counts as a “friend” or “relative” under Dirks? Also, how much does a remote tippee need to
know about the original tipper’s motives to satisfy the test for liability? The Second Circuit took
up these questions in United States v. Newman, 773 F.3d 438 (2d Cir. 2014). In that case, the
court held that a factfinder may not infer a tipper personally benefited from gifting material
nonpublic information to a trading relative or friend absent evidence “of a meaningfully close
personal relationship” between the tipper and tippee “that generates an exchange that is objective,
consequential, and represents at least a potential gain of a pecuniary or similar valuable nature.”
Id. at 452. This test was far more demanding of prosecutors than their preferred test that a
personal benefit could be inferred from any gift of confidential information for a noncorporate
purpose. The Newman court tied its meaningfully close personal relationship” requirement to the
Dirks Court’s expectation that the personal benefit test would provide a clear limiting principle.
According to the Newman court, if the government were allowed to meet its burden by proving
the “mere fact of friendship, particularly of a casual or social nature,” then the government would
35

be “allowed to meet its burden by proving that two individuals were alumni of the same school or
attended the same church.” This, according to the court, would render “the personal benefit
requirement … a nullity.” Id. In addition to this more circumscribed articulation of the personal
benefit test, the Newman court also held that tippee liability requires the government to prove that
the tippee knew of tipper’s personal benefit at the time of trading. Id. at 447.
The Second Circuit’s Newman decision spurred a number of persons who had recently
been convicted of insider trading to request rehearings and caused prosecutors to complain that
the court’s narrow interpretation of the personal benefit test would “limit the ability to prosecute
people who trade on leaked information.” Matthew Goldstein & Ben Protess, U.S, Attorney Preet
Bharara Challenges Insider Trading Ruling, N.Y. TIMES, (Jan. 23, 2015).
In our next case, a remote tippee, Bassam Salman, appealed his conviction for insider
trading on information he received from his brother-in-law. He claimed that his conviction should
be overturned in light of the personal benefit test articulated in Newman. The Ninth Circuit
affirmed the conviction and partially challenged the holding in Newman. The Supreme Court
granted certiorari to resolve the apparent circuit split.
SALMAN v. UNITED STATES
137 S. Ct. 420 (2016)
JUSTICE ALITO delivered the opinion of the Court.
Section 10(b) of the Securities Exchange Act of 1934 and the Securities and Exchange
Commission’s Rule 10b–5 prohibit undisclosed trading on inside corporate information by
individuals who are under a duty of trust and confidence that prohibits them from secretly using
such information for their personal advantage. Individuals under this duty may face criminal and
civil liability for trading on inside information (unless they make appropriate disclosures ahead of
time).
These persons also may not tip inside information to others for trading. The tippee acquires the
tipper’s duty to disclose or abstain from trading if the tippee knows the information was disclosed
in breach of the tipper’s duty, and the tippee may commit securities fraud by trading in disregard
of that knowledge. In Dirks v. Securities and Exchange Commission, 463 U.S. 646 (1983), this
Court explained that a tippee’s liability for trading on inside information hinges on whether the
tipper breached a fiduciary duty by disclosing the information. A tipper breaches such a fiduciary
duty, we held, when the tipper discloses the inside information for a personal benefit. And, we
went on to say, a jury can infer a personal benefit—and thus a breach of the tipper’s duty—where
the tipper receives something of value in exchange for the tip or “makes a gift of confidential
information to a trading relative or friend.” Id., at 664.
Petitioner Bassam Salman challenges his convictions for conspiracy and insider trading.
Salman received lucrative trading tips from an extended family member, who had received the
information from Salman’s brother-in-law. Salman then traded on the information. He argues that
he cannot be held liable as a tippee because the tipper (his brother-in-law) did not personally
receive money or property in exchange for the tips and thus did not personally benefit from them.
36

The Court of Appeals disagreed, holding that Dirks allowed the jury to infer that the tipper here
breached a duty because he made a “‘gift of confidential information to a trading relative.’”
Because the Court of Appeals properly applied Dirks, we affirm the judgment below.
Maher Kara was an investment banker in Citigroup’s healthcare investment banking group. He
dealt with highly confidential information about mergers and acquisitions involving Citigroup’s
clients. Maher enjoyed a close relationship with his older brother, Mounir Kara (known as
Michael). After Maher started at Citigroup, he began discussing aspects of his job with Michael.
At first he relied on Michael’s chemistry background to help him grasp scientific concepts
relevant to his new job. Then, while their father was battling cancer, the brothers discussed
companies that dealt with innovative cancer treatment and pain management techniques. Michael
began to trade on the information Maher shared with him. At first, Maher was unaware of his
brother’s trading activity, but eventually he began to suspect that it was taking place.
Ultimately, Maher began to assist Michael’s trading by sharing inside information with his
brother about pending mergers and acquisitions. Maher sometimes used code words to
communicate corporate information to his brother. Other times, he shared inside information
about deals he was not working on in order to avoid detection. Without his younger brother’s
knowledge, Michael fed the information to others—including Salman, Michael’s friend and
Maher’s brother-in-law. By the time the authorities caught on, Salman had made over $1.5
million in profits that he split with another relative who executed trades via a brokerage account
on Salman’s behalf.
Salman was indicted on one count of conspiracy to commit securities fraud, and four counts of
securities fraud… .
The evidence at trial established that Maher and Michael enjoyed a “very close relationship.”
Maher “love[d] [his] brother very much,” Michael was like “a second father to Maher,” and
Michael was the best man at Maher’s wedding to Salman’s sister. Maher testified that he shared
inside information with his brother to benefit him and with the expectation that his brother would
trade on it.… .
Michael testified that he became friends with Salman when Maher was courting Salman’s
sister and later began sharing Maher’s tips with Salman. As he explained at trial, “any time a
major deal came in, [Salman] was the first on my phone list.”…
After a jury trial…, Salman was convicted on all counts. He was sentenced to 36 months of
imprisonment, three years of supervised release, and over $730,000 in restitution. After his
motion for a new trial was denied, Salman appealed to the Ninth Circuit. While his appeal was
pending, the Second Circuit issued its opinion in United States v. Newman, 773 F.3d 438 (2014).
There, the Second Circuit reversed the convictions of two portfolio managers who traded on
inside information. The Newman defendants were “several steps removed from the corporate
insiders” and the court found that “there was no evidence that either was aware of the source of
the inside information.” The court acknowledged that Dirks and Second Circuit case law allow a
factfinder to infer a personal benefit to the tipper from a gift of confidential information to a
trading relative or friend. But the court concluded that, “[t]o the extent” Dirks permits “such an
inference,” the inference “is impermissible in the absence of proof of a meaningfully close
personal relationship that generates an exchange that is objective, consequential, and represents at
37

least a potential gain of a pecuniary or similarly valuable nature.”1
Pointing to Newman, Salman argued that his conviction should be reversed. While the evidence
established that Maher made a gift of trading information to Michael and that Salman knew it,
there was no evidence that Maher received anything of “a pecuniary or similarly valuable nature”
in exchange—or that Salman knew of any such benefit. The Ninth Circuit disagreed and affirmed
Salman’s conviction. The court reasoned that the case was governed by Dirks ‘s holding that a
tipper benefits personally by making a gift of confidential information to a trading relative or
friend… . To the extent Newman went further and required additional gain to the tipper in cases
involving gifts of confidential information to family and friends, the Ninth Circuit “decline[d] to
follow it.” We granted certiorari to resolve the tension between the Second Circuit’s Newman
decision and the Ninth Circuit’s decision in this case. 2
In this case, Salman contends that an insider’s “gift of confidential information to a trading
relative or friend,” is not enough to establish securities fraud. Instead, Salman argues, a tipper
does not personally benefit unless the tipper’s goal in disclosing inside information is to obtain
money, property, or something of tangible value. He claims that our insider-trading precedents,
and the cases those precedents cite, involve situations in which the insider exploited confidential
information for the insider’s own “tangible monetary profit. …” More broadly, Salman urges that
defining a gift as a personal benefit renders the insider-trading offense indeterminate and
overbroad: indeterminate, because liability may turn on facts such as the closeness of the
relationship between tipper and tippee and the tipper’s purpose for disclosure; and overbroad,
because the Government may avoid having to prove a concrete personal benefit by simply
arguing that the tipper meant to give a gift to the tippee. … Finally, Salman contends that gift
situations create especially troubling problems for remote tippees—that is, tippees who receive
inside information from another tippee, rather than the tipper—who may have no knowledge of
the relationship between the original tipper and tippee and thus may not know why the tipper
made the disclosure.
The Government disagrees and argues that a gift of confidential information to anyone, not just
a “trading relative or friend,” is enough to prove securities fraud. Under the Government’s view, a
tipper personally benefits whenever the tipper discloses confidential trading information for a
noncorporate purpose. Accordingly, a gift to a friend, a family member, or anyone else would
support the inference that the tipper exploited the trading value of inside information for personal
purposes and thus personally benefited from the disclosure… .
We adhere to Dirks, which easily resolves the narrow issue presented here. In Dirks, we
explained that a tippee is exposed to liability for trading on inside information only if the tippee
participates in a breach of the tipper’s fiduciary duty. Whether the tipper breached that duty
depends “in large part on the purpose of the disclosure” to the tippee. “[T]he test,” we explained,
“is whether the insider personally will benefit, directly or indirectly, from his disclosure.” Thus,
the disclosure of confidential information without personal benefit is not enough. In determining
whether a tipper derived a personal benefit, we instructed courts to “focus on objective criteria,
1
The Second Circuit also reversed the Newman defendants’ convictions because the Government
introduced no evidence that the defendants knew the information they traded on came from insiders or that
the insiders received a personal benefit in exchange for the tips. This case does not implicate those issues.
38

i.e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a
pecuniary gain or a reputational benefit that will translate into future earnings.” This personal
benefit can “often” be inferred “from objective facts and circumstances,” we explained, such as
“a relationship between the insider and the recipient that suggests a quid pro quo from the latter,
or an intention to benefit the particular recipient.” In particular, we held that “[t]he elements of
fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift
of confidential information to a trading relative or friend.” In such cases, “[t]he tip and trade
resemble trading by the insider followed by a gift of the profits to the recipient.” We then applied
this gift-giving principle to resolve Dirks itself, finding it dispositive that the tippers “received no
monetary or personal benefit” from their tips to Dirks, “nor was their purpose to make a gift of
valuable information to Dirks.” Dirks, at 667 (emphasis added).
Our discussion of gift giving resolves this case. Maher, the tipper, provided inside information
to a close relative, his brother Michael. Dirks makes clear that a tipper breaches a fiduciary duty
by making a gift of confidential information to “a trading relative,” and that rule is sufficient to
resolve the case at hand. As Salman’s counsel acknowledged at oral argument, Maher would have
breached his duty had he personally traded on the information here himself then given the
proceeds as a gift to his brother. It is obvious that Maher would personally benefit in that
situation. But Maher effectively achieved the same result by disclosing the information to
Michael, and allowing him to trade on it… . In such situations, the tipper benefits personally
because giving a gift of trading information is the same thing as trading by the tipper followed by
a gift of the proceeds. Here, by disclosing confidential information as a gift to his brother with the
expectation that he would trade on it, Maher breached his duty of trust and confidence to
Citigroup and its clients—a duty Salman acquired, and breached himself, by trading on the
information with full knowledge that it had been improperly disclosed.
To the extent the Second Circuit held that the tipper must also receive something of a “pecuniary
or similarly valuable nature” in exchange for a gift to family or friends, we agree with the Ninth
Circuit that this requirement is inconsistent with Dirks.
***
Salman’s conduct is in the heartland of Dirks’s rule concerning gifts. It remains the case that
“[d]etermining whether an insider personally benefits from a particular disclosure, a question of
fact, will not always be easy for courts.” But there is no need for us to address those difficult
cases today, because this case involves “precisely the ‘gift of confidential information to a trading
relative’ that Dirks envisioned.”
Salman’s jury was properly instructed that a personal benefit includes “the benefit one would
obtain from simply making a gift of confidential information to a trading relative.” As the Court
of Appeals noted, “the Government presented direct evidence that the disclosure was intended as
a gift of market-sensitive information.” And…this evidence is sufficient to sustain his conviction
under our reading of Dirks. Accordingly, the Ninth Circuit’s judgment is affirmed.
NOTES AND QUESTIONS
39

1.
Did Salman add anything to Dirks? The Supreme Court waited almost 20 years after
O’Hagan to take an insider trading case. Did the Court really offer any significant guidance
beyond simply reaffirming its prior holdings in Dirks?
2.
What (if anything) remains of Newman today? In affirming Salman’s conviction, the
Supreme Court expressly overruled Newman to the extent that it required that a “tipper must
receive something of a ‘pecuniary or similar valuable nature’ in exchange for a gift to family or
friends.” Salman, 137 S.Ct. at 428. The Salman Court did, however, appear to leave the
remainder of Newman’s other core limiting principles untouched (e.g., that the tippee must have
knowledge of the tipper’s personal benefit and the liability for a gift of information to a trading
relative or friend requires proof of a “meaningfully close personal relationship” between tipper
and tippee). Indeed, the Court explained that “[i]t remains the case that ‘[d]etermining whether an
insider personally benefits from a particular disclosure, a question of fact, will not always be easy
for courts.’ But there is no need for us to address those difficult cases today, because this involves
‘precisely the “gift of confidential information to a trading relative” that Dirks envisioned.’” Id. at
429. The implication is that there are some gifts that would not result in a personal benefit to the
tipper.
Yet despite the fact that the Salman Court appeared to have left Newman’s “meaningfully
close personal relationship” requirement intact, just one year later the Second Circuit itself
effectively overruled Newman on this point in U.S. v. Martoma, 894 F.3d 64 (2d Cir. 2017)
(Amended: June 25, 2018). In Martoma, the court held that a tipper receives a personal benefit
whenever the tipper “intended to benefit the tippee” with the disclosure of material nonpublic
information. Id. 76. Since arguably any gift intends to benefit the recipient, there appears to be
nothing left of the Newman “meaningfully close personal relationship” test—at least in the
Second Circuit. But if the personal benefit test under Martoma can be read so broadly, is it
consistent with Dirks? Recall the facts of Dirks; do you think Dirks would have been liable under
the Martoma test?
3.
The Blaszczak case and § 1348. With so much controversy and uncertainty surrounding
the personal benefit test for tipper-tippee liability pursuant to Section 10b insider trading liability,
prosecutors have recently looked to other statutory bases for obtaining convictions. As part of the
Sarbanes-Oxley Act of 2002, Congress enacted 18 U.S.C. § 1348, Securities and Commodities
Fraud. This general anti-fraud provision that provides that:
Whoever knowingly executes, or attempts to execute, a scheme or

artifice…[t]o defraud any person in connection with…any security…or
[t]o obtain, by means of false or fraudulent pretenses, representations, or
promises, any money or property in connection with the purchase or sale
of any…security… shall be fined under this title, or imprisoned not more
than 25 years, or both.
40

While the language of § 1348 is similar to Section 10b, very few insider trading cases have been
brought under it. This may, however, be changing in the wake of a recent Second Circuit decision
holding that the controversial personal-benefit test does not apply to tipper-tippee actions brought
under §1348. In United States v. Blaszczak, 947 F.3d 19 (2d Cir. 2019), the court held that § 1348
and Section 10b were adopted for different purposes. According to the court, “Congress enacted
[Section 10b’s] fraud provisions…with the limited ‘purpose of eliminate[ing] [the] use of inside
information for personal advantage,” and the personal benefit test is consistent with this purpose.
Id. at 35. By contrast, §1348 was adopted “to overcome the ‘technical legal requirements’ of
[Section 10b],” so the personal-benefit test should not be read into the latter’s elements. Id. at 36-
37. The Blaszczak decision raised a number of important questions. See, e.g., Karen E. Woody,
The New Insider Trading, 52 ARIZONA STATE L. J. 594 (2020). For example, going forward, why
would prosecutors ever bring a tipper-tippee case under Section 10b if they can simply bypass the
personal-benefit element by bringing it under § 1348? Commentators have also noted the problem
that the test for criminal insider trading liability under § 1348 (with a maximum penalty of 25
years imprisonment) is easier to satisfy under the Blaszczak rule than the test for civil liability
(which must be brought under Section 10b because the SEC has no enforcement authority under §
1348).
Highlighting these and other concerns, the Blaszczak defendants petitioned the Supreme
Court for writ of certiorari in September 2020. In an unusual move, the government responded by
asking the Court to grant the petitioners’ writs, vacate the Second Circuit’s decision, and remand
the case for consideration in light of the Court’s recent wire-fraud decision, Kelly v. United
States, 140 S. Ct. 1565 (2020). In Kelly, the Court held that “a scheme to alter ... regulatory
choice is not one to take the government’s property.” Id. at 1572. (Kelly is presented in Chapter 4,
Mail and Wire Fraud, supra.) Since the defendants in Blaszczak tipped and traded on confidential
government information concerning proposed medical treatment reimbursement regulations, the
government conceded that the Second Circuit should revisit the question of whether such
regulatory information is “property” for purposes of a § 1438 prosecution after Kelly. (The
request to vacate was pending at the time this text went to press.) The government only proposed
a remand on the limited issue of what constitutes “property,” not on the question of whether the
personal benefit test applies to insider trading prosecutions under § 1348. Nevertheless, if the
Court vacates Blaszczak, then Second Circuit’s controversial personal benefit holding will no
longer be law unless it is embraced on remand or in some other case. See Robert J. Anello &
Richard F. Albert, Days Seem Numbered for Circuit’s Controversial Insider Trading Decision,
264 N.Y.L. J. (Dec. 10, 2020), https://www.law.com/newyorklawjournal/2020/12/09/days-seem-
numbered-for-circuits-controversial-insider-trading-decision/.
NOTE ON RULE 10B5-1
In an insider trading case, the government must show that the defendant acted “on the
basis of” material nonpublic information. But what does this mean? For example, assume that
before Dirks spoke with Secrist, Dirks had done independent research into the value of Equity
Funding securities and had decided to recommend that his clients sell the stock. If Dirks had then
recommended the sale to his clients after speaking with Secrist, would the trading have been “on
the basis” of the secret information? In other words, is the element met when a person who
possesses inside information has another, independent reason for trading?
The circuit courts split on this issue. In United States v. Teicher, 987 F.2d 112 (2d Cir.
41

1993), for example, the defendants appealed their insider trading convictions, arguing that the
trial court erred by charging the jury that the defendants could be convicted if they traded while
merely in knowing possession of the inside information. The Second Circuit found that the
instruction was not erroneous. The court reasoned that requiring proof that the defendants actually
used the information would place too great an evidentiary burden on the government. The Ninth
and Eleventh circuits held to the contrary, reasoning that proof that the defendant knowingly used
the information is an essential element of the crime. See United States v. Smith, 155 F.3d 1051,
1067 (9th Cir. 1998); SEC v. Adler, 137 F.3d 1325, 1334–36 (11th Cir. 1998).
In 2000, the SEC issued Rule 10b5-1, which rejects the “use” standard and adopts the
knowing possession standard. The rule provides that, in the insider trading context, a person has
traded “on the basis” of inside information when the person was “aware” of the information when
making the purchase or sale. The rule does provide an affirmative defense where the person
making the purchase or sale demonstrates that, before becoming aware of the information, the
person had (a) entered into a binding contract to purchase or sell the security, (b) instructed
another person to purchase or sell the security for the instructing person’s account, or (c) adopted
a written trading plan for trading securities (a 10b5-1(c) trading plan). The rule further requires
that the contract, instruction, or trading plan meet specific conditions before the defense will be
allowed.
Although adopted to mitigate the potentially harsh consequences of the “awareness” test
and to allow corporate insiders (who are only rarely without knowledge of at least some of
material nonpublic information) to diversify their portfolios, the 10b5-1(c) trading plan
affirmative defense has been a source of controversy in its own right. A number of recent studies
have shown that insiders are using these trading plans strategically (e.g., by selectively
terminating established plans based on material nonpublic information). Since the termination of
a planned, future order is not itself the purchase or sale of security, it is not clear that such
strategic use of trading plans is illegal. See, e.g., John P. Anderson, Anticipating a Sea Change for
Insider Trading Law: From Trading Plan Crisis to Rational Reform, 2015 UTAH L. REV. 339
(2015). Nevertheless, Congress may soon act to close this potential loophole. For example, the
Promoting Transparent Standards for Corporate Insiders Act passed the House of Representatives
with bipartisan support in 2019. H.R. 624, 116th Cong. (1st Sess. 2019). This act would force the
SEC to revisit Rule 10b5-1(c) trading plans and propose reforms. For a discussion of some
challenges to trading-plan reform, see John P. Anderson, Undoing a Deal with the Devil: Some
Challenges for Congress’s Proposed Reform of Insider Trading Plans, 13 VA. L. & BUS. REV.
303 (2019).
Even with 10b5-1(c) trading plans available as an affirmative defense, is the “awareness”
rule fair? For example, in the hypothetical above, assume that Dirks had done his research and
made his decision to disclose the information to his clients before he learned of the inside
information but that he could not meet the affirmative defense requirements of Rule 10b5-1. Also
assume that Secrist breached a duty in giving Dirks the information. Would insider trading
liability be appropriate in such circumstances? Why or why not? Would such a result improperly
remove the “willfulness” element? For an argument that it would, see Carol B. Swanson, Insider
Trading Madness: Rule 10b5-1 and the Death of Scienter, 52 U. KAN. L. REV. 147 (2003).
42

PROBLEMS
5-4.
A grand jury has investigated Deana for securities fraud and has found the following
facts. Deana is a self-employed businessperson who bought an independent sidewalk newsstand
in New York City last January 3. She sells a wide variety of news and financial magazines,
including “Business News.” Business News magazine imposes a strict confidentiality policy on
all employees who work for and are paid by the magazine. The policy forbids the employees to
use nonpublic information contained in the magazine. Business News employees are required to
sign a copy of this policy when first hired.
In addition, on March 1 every year, a copy of the confidentiality policy is sent by U.S.
mail to all sellers of the magazine. A magazine representative testified that a copy of the policy
was sent last year to Deana’s business address, but there is no direct proof that Deana received,
read, or knew of the policy.
In its confidentiality policy and notice sent to sellers, the magazine states that material,
nonpublic information must be kept secret until the magazine appears on the newsstands. In
particular, the magazine knows that its “Wall Street Week” column tends to affect the amount of
trading and the prices of the stocks discussed in the column. The magazine arrives at stores each
Wednesday before 5:00 p.m. Attached to each magazine are instructions that the magazine is not
to be placed on shelves before 5:00 p.m. the following day. Individual subscribers generally
receive the magazine in the mail on Fridays.
The evening of Wednesday, June 6, Deana attended a movie. Deana’s brother Miles, a
stockbroker in New York City, accompanied her to the movie. Miles and Deana regularly discuss
the stock market. Waiting for the movie to begin, Deana told her brother that she had read the
latest issue of Business News magazine and told him that the magazine would appear on
newsstands late the next day. Deana also said that this issue’s Wall Street Week column repeated
a rumor, said to be based on inside sources, that Stealth Corp. was planning to announce a tender
offer for the stock of X-Ray Corp. within two weeks. Deana also said that she thought the
information was “probably hush-hush” and that Miles should not repeat or use the information in
any way.
Miles responded that the story sounded “interesting” and, based on his knowledge of the
market, was “probably true.” Miles had been following X-Ray stock for a number of months and
the previous week, he had sent his broker an e-mail instructing the broker to buy 1,000 shares no
later than June 8.
That night, Miles went home and logged on to a financial website where he researched
the financial conditions of the two companies involved in the rumored merger. At 9:00 a.m. the
next day, he called his broker and instructed the broker to execute the purchase immediately.
The following Wednesday, June 13, Stealth Corp. announced its tender offer bid for X-
Ray Corp. Miles later sold his stock at a large profit.
43

The government is preparing to indict Deana and Miles for insider trading. What theory
or theories will the government likely use? What defenses are Deana and Miles likely to raise?
5-5.
Albert Penn has owned and operated a barbershop for the past 45 years. Penn enjoys
investing in the stock market and often asks his clients about the corporations for which they
work. Max Davis, a district manager at Wooster Foods, a wholesale food distribution company,
has been getting his haircut by Penn for the past 15 years. During the barber appointments, Penn
and Davis discussed family and personal matters, but they were not close personal friends and did
not socialize with each other.
Penn knew that Davis worked for Wooster Foods in some capacity and had asked Davis
on several occasions if Wooster Foods was going to be sold. On one of those occasions, Davis
recommended that Penn buy stock in Wooster Foods because it was a good company and would
probably be acquired at some point.
Two weeks later, Davis told Penn, during a barber appointment, of a rumor that there
were one or two buyers interested in Wooster, that he was confident a deal was going to happen,
and that it was very likely Wooster’s stock price would double as a result. In fact, Davis knew of
negotiations between Wooster and Best Foods and had been actively participating in preparations
for the sale of Wooster to Best Foods. Davis also knew that Wooster had a policy prohibiting
insider trading, that he was prohibited from trading in Wooster stock based on his knowledge of
material, non-public information, and that he was also prohibited from tipping any others about
the information.
Based on his conversation with Davis, Penn began buying Wooster stock. He first bought
$14,000 worth of common stock, then another $18,000 in common stock. Penn sold all his
Wooster stock on the day Wooster’s sale to Best Foods was announced to the public. Penn’s total
profit from the sales was over $32,000.
Is Davis guilty of securities fraud? Is Penn guilty of securities fraud? Why or why not?
5-6.
Strommer was an executive at General Capital. Alliance hired General Capital to assist in
arranging financing for Alliance’s potential acquisition of SunBurst, Inc. General Capital
assigned Strommer the task of performing due diligence on the acquisition, including analysis of
SunBurst’s financial performance. Strommer called Blunt to discuss the potential deal. Blunt was
a college friend of Strommer’s who worked as a securities analyst at Winstrom Capital. Strommer
stated that the conversation was part of Strommer’s due diligence work and that he called Blunt
because he knew that Winstrom owned a large amount of SunBurst stock. Shortly after the phone
call, Blunt spoke with Oliver, Winstrom’s Chief Executive Officer. Two weeks later, Winstrom
bought a substantial additional amount of SunBurst stock. After Alliance’s bid to acquire
SunBurst was announced, Winstrom sold the stock that it bought after Blunt’s conversation with
Oliver, netting a profit of over $2 million.
44

Shortly after the deal was finalized, General Capital learned of the above facts. After an
internal investigation conducted by counsel, General Capital concluded that Strommer had not
breached a duty to General Capital by disclosing the information concerning the deal to Blunt.
The government seeks to charge Strommer, Blunt, and Oliver under Section 10b and Rule
10b-5, alleging that Strommer violated duties as a tipper under both the traditional and
misappropriation theories. The defendants have moved to dismiss the charge. How should the
court rule? Why?
5-7.
Dom Dornan was the Chairman and President of Horizons Corporation, a company
located in Newark, New Jersey. Horizons engaged in the business of providing temporary staffing
of computer and information technology personnel. The common stock of Horizons was
registered with the United States Securities and Exchange Commission and publicly traded on the
New York Stock Exchange. As Chairman and President of Horizons, Dornan participated in
negotiating mergers and acquisitions involving Horizons and other companies, including other
publicly traded companies.
Dornan socialized from time to time with other executives in the same field. One of
Dornan’s social acquaintances was Kris Karman, Chief Executive Officer of Compuware
Corporation. Compuware was also engaged in the business of providing temporary staffing of
computer and information technology personnel. Dornan and Karman were casual acquaintances,
having met at business conferences four different times over the last 10 years. During conference
meetings, they discussed their businesses, mentioning at times financial projections and other
business information that was only available to those persons within their respective businesses.
Neither Karman nor Dornan ever revealed this information for an improper purpose, and neither
ever explicitly said that the information they discussed should not be repeated.
Last April 12, Dornan met with Karman at Karman’s office. Karman told Dornan that
Compuware was interested in acquiring Horizons through a merger by means of a friendly tender
offer. Dornan responded positively, and the two engaged in an initial negotiation of the terms of
the acquisition. After the meeting, negotiations regarding the proposed acquisition continued. On
May 4, Compuware sent Horizons a letter of intent setting forth the proposed terms of
Compuware’s acquisition of Horizons through a tender offer.
In April and May, while the negotiations between Compuware and Horizons were
ongoing, representatives of Compuware met with executives from Millennium Corp. to discuss a
potential merger of those two companies. On May 26, Compuware advised Millennium Corp. that
it was interested in acquiring all of the shares of Millennium Corp. through a tender offer of $25
per share, a price substantially above the then-prevailing market price of Millennium Corp. On
June 2, Millennium Corp. privately advised Compuware that it would accept its $25 offer.
On June 21, Karman telephoned Dornan and advised Dornan that Compuware would not
acquire Horizons, and told Dornan that “we have had initiated very preliminary merger
negotiations with Millennium Corp. instead. We don’t have a clear idea whether this deal will
materialize, but I didn’t want to leave you in the lurch.” At the time of this conversation, as
45

Dornan knew, Compuware had not yet publicly announced its discussions with Millennium Corp.
The following day, Dornan placed two orders to purchase a total of 15,000 shares of
Millennium Corp. Shortly thereafter, Dornan’s orders were executed at prices of approximately
$13.25 per share. Dornan did not disclose to the sellers of the shares the information Dornan had
gotten from Compuware’s Chief Executive Officer concerning Millennium Corp.
On June 23, the Board of Directors of Millennium Corp. and Compuware voted to
approve Compuware’s acquisition of Millennium Corp. by tender offer for $24 per share. On
June 24, prior to the opening of trading on the New York Stock Exchange, Compuware and
Millennium Corp. issued a press release publicly announcing that Compuware would acquire
Millennium Corp. at approximately $24 per share. When trading began, the price of Millennium
Corp.’s stock opened at approximately $23.50 per share, representing an increase of
approximately $11.25 per share from the previous day’s closing price.
On June 24, following the public announcements of the tender offer for Millennium
Corp., Dornan sold the 15,000 shares of Millennium Corp. stock that Dornan had purchased on
June 22. The securities were sold at an average price of $23.31, yielding profits for Dornan of
approximately $150,937.50.
Is Dornan guilty of Insider Trading? Why or why not?
5-8.
Marcia is the CEO of Machine-Corp. In December, Marcia looks ahead to June 25 of the
next year when a $100,000 balloon payment will come due on her home mortgage and she
decides she would like to sell some of her Machine-Corp shares to make the payment. Marcia
does not want to sell the shares in December because of the tax consequences. She is, however,
also concerned that if she waits until June to sell the shares she will be aware of material
nonpublic information at the time of the sale (Machine-Corp always announces its earnings in late
June) and will therefore be exposed to insider trading liability. She talks to Machine-Corp’s
general counsel and he advises her to set up a 10b5-1(c) trading plan in December (when she is
not aware of material nonpublic information) that will execute the sale of her 10,000 shares in
June. She follows this advice and sets up a trading plan to sell 10,000 Machine-Corp shares on
June 20. On June 10, the CFO informs Marcia that Machine-Corp’s new product line far
exceeded expectations and the company is going to beat earnings estimates by 50%. Marcia
realizes that Machine-Corp’s stock will skyrocket when the company discloses this information to
the market on June 30. Marcia calls up her broker and tells her to cancel the trading plan she
entered into in December. The 10,000 shares Marcia did not sell under her December trading plan
end up increasing $50,000 in value after the company’s earnings are released on June 30.
Is Marcia liable for Section 10b insider trading?
[C]
PARALLEL CIVIL PROCEEDINGS
46

As noted above (at § [A][2]), and as evidenced by a number of cases included in this
chapter, some federal securities fraud statutes, such as Exchange Act Section 10b, can form the
basis of civil enforcement actions brought by the SEC. The courts have also consistently
recognized Section 10b as providing a private right of action against violators. With this in mind,
the wise white collar criminal defense counsel should be mindful of some of the particulars and
consequences of a possible parallel civil proceeding for securities fraud.
The remedies available to the SEC in a civil enforcement action for securities fraud are
varied and can be quite severe. The SEC has authority to pursue injunctive relief, disgorgement,
and monetary sanctions for violates of the securities laws.
For example, Exchange Act § 21(d) gives the SEC authority to pursue a temporary or
permanent injunction against any person to prevent them from continuing or prospective
violations of Section 10b. See 15 U.S.C. § 78u(d)(1). As Professor Stephen Bainbridge notes, the
courts have made it “quite easy” for the SEC to win such injunctions: “The SEC must make a
‘proper showing,’ but that merely requires the SEC to demonstrate that a violation of the
securities laws occurred and there is a reasonable likelihood of future violations.” STEPHEN M.
BAINBRIDGE, INSIDER TRADING: LAW AND POLICY 141 (2014). The Commission may also ask
the court to prohibit those who violate Section 10b “from acting as an officer or director of any
issuer that has a class of securities registered pursuant to [sections of this title] if the person’s
conduct demonstrates unfitness to serve as an officer or director of any such issuer.” 15 U.S.C. §
78u(d)(2). In addition, Exchange Act Section 21(d)(5) provides that “the Commission may seek,
and any Federal court may grant, any equitable relief that may be appropriate or necessary for the
benefit of investors.” 15 U.S.C. § 78u(d)(5). The SEC may pursue the equitable relief of
disgorgement of any profits obtained from securities fraud via the courts under this provision, or
through its own administrative proceedings pursuant to Exchange Act Section 21B. 15 U.S.C. §
78u-2(e).
In addition to such injunctive and other equitable relief, the SEC may seek money
penalties for securities fraud in civil actions before the federal courts. 15 U.S.C. § 78u(d)(3). The
Commission also has its own power to impose fines through administrative proceedings. 15
U.S.C. § 78u-2. The penalties in both fora are structured pursuant to a three-tiered scheme. Under
this scheme, available penalties per violation may increase from $5,000 to $100,000 for a natural
person (or the gross amount of the violator’s gain—whichever is greater). The penalties increase
depending on whether the violation involved “fraud, deceit, manipulation, or deliberate or
reckless disregard of a regulatory requirement,” and depending on whether the violation “directly
or indirectly resulted in substantial losses or created a significant risk of substantial losses to other
persons.” 15 U.S.C. § 78u(d)(3)(B); 15 U.S.C. § 78u-2(b).
Congress has imposed special statutory civil penalties available to the SEC in the context
of insider trading. The Insider Trading Sanctions Act of 1984 (ITSA) strengthened the SEC’s
hand by permitting it to seek treble damages (three times any profits gained or losses avoided) in
its civil enforcement actions. 15 U.S.C. § 78u-1(a)(2). The SEC may seek ITSA damages in
addition to disgorgement, potentially exposing the insider trader to a penalty of four times the
profits earned or losses avoided from any given trade. See, e.g., BAINBRIDGE, supra, at 146. The
Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA) later extended the
penalty of treble damages to controlling persons. 15 U.S.C. § 78u-1(a)(3). ITSFEA does,
however, limit the penalty of treble damages to only those controlling persons who (A) “knew or
recklessly disregarded the fact that [their] controlled person was likely to engage in the act or acts
47

[of insider trading] and failed to take appropriate steps to prevent such act or acts before they
occurred,” or (B) failed to establish and maintain effective insider trading compliance programs.
15 U.S.C. § 78u-1(b).
In addition to the risk of parallel proceedings brought by the SEC, counsel must be
mindful of the possibility of private party litigation for Section 10b securities fraud. Though
Section 10b does not expressly authorize a private party to bring and action under its provisions,
the courts have recognized an implied right of action. See, e.g., Herman & MacLean v.
Huddleston, 459 U.S. 375, 380 (1983) (noting that the implied right of private action under
Section 10b is “beyond peradventure”). In addition, Congress granted an express private right of
action to parties who trade contemporaneously with insider traders in Exchange Act Section 20A.
15 U.S.C. § 78t-1.
Finally, beyond the obvious financial and career risks of civil actions for securities fraud,
such proceedings also implicate important evidentiary and self-incrimination issues under the
Fifth Amendment for any parallel criminal action. Chapter 18, Civil Actions, Civil Penalties, and
Parallel Proceedings, infra, addresses these (and related) issues in detail.
48

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Securities Fraud

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The Quintessential White Collar Crime?

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Civil and Criminal Enforcement

The Federal Securities Regulation Scheme e

§ 1347 (Chapter 6, Health Care Fraud and Abuse, infra).

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Elements of Securities Fraud

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The Elements of Insider Trading

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government must prove that:

1. The defendant knowingly possessed material, nonpublic information;

2. The defendant bought or sold securities on the basis of that information;

(c) Was a misappropriator of the material, nonpublic information from a

4. The defendant acted willfully.

The Classical Theory

CHIARELLA v. UNITED STATES

Mr. JUSTICE POWELL delivered the opinion of the Court.

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Mr. CHIEF JUSTICE BURGER, dissenting.

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NOTES AND QUESTIONS

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Another difficulty in determining whether information is material for purposes of insider

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Additional arguments in favor of the criminalization of insider trading:

Additional arguments against the criminalization of insider trading:

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 The issuing firm authorizes the trading plan.

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The Misappropriation Theory

In Chiarella, the Supreme Court declined to consider whether an insider trading

UNITED STATES v. O’HAGAN

JUSTICE GINSBURG delivered the opinion of the Court.

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deception of those who entrusted him with access to confidential information.

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The misappropriation theory advanced by the government is consistent with Santa Fe

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JUSTICE SCALIA, concurring in part and dissenting in part. (Omitted.)

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NOTES AND QUESTIONS

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(2) The issuer of the securities sought or to be sought by

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(3) Any officer, director, partner or employee or any other

NOTE ON UNITED STATES v. CHESTMAN AND RULE 10B5-2

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17 C.F.R. § 240.10b5-2(b) (emphasis added).

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Given the paucity of jurisprudence on the question of what constitutes a

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Has Jones committed securities fraud? Why or why not?

DIRKS v. SECURITIES AND EXCHANGE COMMISSION

JUSTICE POWELL delivered the opinion of the Court.