Insider trading and the dual role of information.

• Author: ten Oever, Jonathan E.A.

United States v. O'Hagan 92 F.3d 612 (8th Cir. 1996).

I

James H. O'Hagan--accused of insider trading--is escaping conviction with over $4 million of questionable trading profits. In United States v. O'Hagan,(1) the Eighth Circuit rejected the misappropriation theory of insider trading and, in doing so, removed the legal foundation on which O'Hagan was convicted of securities fraud.(2) Besides enriching O'Hagan, the decision aggravated a growing circuit split over the misappropriation theory: Accepted by four circuits, the theory has now been rejected by two.(3) The government has petitioned for a rehearing en banc.(4) Whatever the outcome of that petition--and any rehearing that may follow--it is likely that one of the parties will appeal to the Supreme Court, which deadlocked four to four in its only previous consideration of the misappropriation theory.(5) Thus, O'Hagan presents an opportunity to resolve two splits: one among the circuits and another among the Justices.

No matter what the courts decide in O'Hagan, final resolution of the controversy surrounding insider trading awaits a coherent policy rationale that would simultaneously support and limit insider trading liability. Several commentators have offered promising analyses that treat insider trading cases as information cases. I argue in this Case Note that these "information analyses" suffer from a serious deficiency: They fail to account for the dual role of information in our economy.

II

The O'Hagan litigation grew out of Grand Met PLC's takeover of Pillsbury Company. In July 1988, Grand Met retained the law firm of Dorsey & Whitney, of which O'Hagan was a partner. O'Hagan learned of the impending takeover and purchased call options for Pillsbury stock. When Grand Met publicly announced its tender offer in October 1988, O'Hagan exercised his options, earning over $4 million. He was subsequently convicted on fifty-seven counts of securities fraud, mail fraud, and money laundering.(6) On the basis of his criminal convictions, the SEC ordered O'Hagan to disgorge his profits.(7) The Eighth Circuit's rejection of the misappropriation theory relieved O'Hagan of criminal liability and reimbursed his profits.

The vitality of the misappropriation theory depends upon whether it is supported by section 10(b) of the Securities Exchange Act.(8) Section 10(b) prohibits manipulation and deception in the securities market. However, neither section 10(b) nor Rule 10b-5(9)--promulgated by the SEC under section 10(b)--provides significant guidance as to what constitutes "deception."(10) Traditionally, courts have described "deception" in the context of insider trading(11) as a violation of the fiduciary duty owed by corporate management to shareholders.(12) The SEC developed the misappropriation theory as a means of reaching section 10(b) violators not covered by the conventional analysis. Under this theory, section 10(b) "is violated when a person (1) misappropriates material nonpublic information (2) by breaching a duty arising out of a relationship of trust and confidence and (3) uses that information in a securities transaction, (4) regardless of whether he owed any duties to the shareholders of the traded stock."(13)

The O'Hagan court found that the misappropriation theory required too broad an interpretation of "deception." Specifically, the court held: (1) that "deception" under section 10(b) requires either misrepresentation or nondisclosure in violation of a duty to disclose;(14) and (2) that if liability is premised on nondisclosure, the underlying duty to disclose must be owed to the purchasers or sellers of the securities in question.(15) For the first proposition, the court relied upon Santa Fe Industries, Inc. v. Green.(16) In Santa Fe, the Supreme Court stated that the language of section 10(b) "gives no indication that Congress meant to prohibit any conduct not involving manipulation or deception," and therefore a claim of fraud and fiduciary breach is actionable under Rule lOb-5 "only if the conduct alleged can be fairly viewed as 'manipulative or deceptive' within the meaning of the statute."(17) For the second proposition, the court relied upon Chiarella v. United States.(18) In Chiarella, the Supreme Court held that section 10(b) liability "is premised upon a duty to disclose arising from a relationship of trust...