In US v. O'Hagan, the SCOTUS explained that there are two theories on which one can be held liable for insider trading:
Under the "traditional" or "classical theory" of insider trading liability, §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 §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. See Dirks v. SEC, 463 U.S. 646, 655, n. 14 (1983).
The "misappropriation theory" holds that a person commits fraud "in connection with" a securities transaction, and thereby violates §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. See Brief for United States 14. 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 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." Ibid.
I had occasion today to look at Wikipedia's treatment of insider trading. It correctly recognizes that misappropriation is an alternative basis of liability, but in doing so it misstates the misappropriation theory:
A newer view of insider trading, the "misappropriation theory" is now part of US law. It states that anyone who misappropriates (steals) information from their employer and trades on that information in any stock (not just the employer's stock) is guilty of insider trading.
For example, if a journalist who worked for Company B learned about the takeover of Company A while performing his work duties, and bought stock in Company A, illegal insider trading might still have occurred. Even though the journalist did not violate a fiduciary duty to Company A's shareholders, he might have violated a fiduciary duty to Company B's shareholders (assuming the newspaper had a policy of not allowing reporters to trade on stories they were covering).
Let's start with the claim that liability arises where on "steals" information. As defined by the Court In O'Hagan, however, the misappropriation theory does not deal with theft of inside information--or, at least, not directly--but rather holds that a fiduciary's undisclosed use of information belonging to his principal, without disclosure of such use to the principal, for personal gain constitutes fraud in connection with the purchase or sale of a security and thus violates Rule 10b-5. Instead of basing liability on stealing information, the Court based the theory on “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."
I'm being a stickler here because this is a longstanding sore point. I have long argued that the only coherent basis for imposing insider trading liability is protection of property rights in information. From a policy perspective, those who steal information ought to be liable for insider trading. The trouble is that O’Hagan cannot be read to permit imposition of liability on such persons.
On to the next problem with the Wikipedia entry. The entry claims that the journalist in the hypothetical "might have violated a fiduciary duty to Company B's shareholders (assuming the newspaper had a policy of not allowing reporters to trade on stories they were covering)." Wrong. The journalist is an agent of the newspaper and owes the newspaper fiduciary duties regardless of whether or not the company has an explicit policy. Put another way, the journalist's relevant duties arise out of the employment relationship not a policy in the employee handbook.
What would happen if the newspaper had an explicit policy of allowing journalists to trade on the basis of such information? I discuss that here.
One thing the entry does get right is that "the journalist did not violate a fiduciary duty to Company A's shareholders."
The misappropriation theory's origins are commonly traced to Chief Justice Burger's Chiarella dissent. Burger contended that the way in which the inside trader acquires the nonpublic information on which he trades could itself be a material circumstance that must be disclosed to the market before trading. Accordingly, he argued, "a person who has misappropriated nonpublic information has an absolute duty [to the persons with whom he trades] to disclose that information or to refrain from trading."
In O’Hagan, the court’s majority opinion grounded liability under the misappropriation theory on deception of the source of the information. As the majority interpreted the theory, it addresses the use of "confidential information for securities trading purposes, in breach of a duty owed to the source of the information." Under this theory, the majority explained, "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." So defined, the majority held, the misappropriation theory satisfies § 10(b)'s requirement that there be a "deceptive device or contrivance" used "in connection with" a securities transaction.
The Supreme Court thus expressly declined to embrace Chief Justice Burger's argument in Chiarella that the misappropriation theory created a disclosure obligation running to those with whom the misappropriator trades. Instead, it is the failure to disclose one's intentions to the source of the information that constitutes the requisite disclosure violation under the O'Hagan version of the misappropriation theory.
