Misappropriation Theory

Lawyer Percival Anand-Ruiz learns of a client company's confidential takeover bid, tells no one, and buys shares of the target. He owes no duty to the target or its shareholders. Liability here rests on which theory of insider trading?

1. A.The classical theory, because he is a corporate insider of the targetHe has no relationship with the target at all, so no classical insider duty arises.
2. B.No theory, because he owed no duty to the target's shareholdersMisappropriation supplies liability precisely where no duty to the traded company exists.
3. C.The misappropriation theory, because he breached a duty owed to the source of the informationCorrect. Trading on confidential information in breach of a duty to its source is securities fraud under the misappropriation theory.
4. D.Tipper-tippee liability, because he received the information from the companyHe is the one who obtained and used the information; there is no tipper who received a personal benefit.

Why: Under the misappropriation theory, a person commits securities fraud by trading on confidential information in breach of a duty owed to the source of that information, even though he owes no duty to the company whose shares he trades. The Supreme Court endorsed this theory in United States v. O'Hagan. The classical theory, by contrast, reaches corporate insiders and temporary insiders who breach a duty owed to the shareholders of the company traded.

Analyst Seraphina Duarte learns of an unannounced merger from her spouse, a partner at the acquirer's outside law firm, who told her in confidence. She buys the target's shares for her own account. Her conduct is:

1. A.Lawful, because she is neither an officer, director, nor employee of either company involved in the mergerClassical insider liability does depend on a duty to the issuer's shareholders, but it is not the only route. The misappropriation theory captures outsiders who exploit confidential information belonging to someone else.
2. B.Lawful, because she received the information from her spouse rather than paying for it or soliciting itNeither payment nor solicitation is an element. What matters is that the information was conveyed in confidence and that she traded on it knowing its character.
3. C.Unlawful only if her spouse personally profited from disclosing the information to herA personal benefit to the source can matter in a classical tipping analysis, but the misappropriation theory turns on the breach of a duty owed to the source, and a benefit may be inferred from a gift to a close relative in any event.
4. D.Unlawful under the misappropriation theory, because she traded on confidential information taken in breach of a duty owed to its sourceHer spouse owed his firm and its client a duty of confidentiality, and trading on information disclosed in confidence in breach of that duty is deceptive conduct reached by the antifraud provisions regardless of any connection to the issuers.

Why: Duarte has no relationship with either issuer, but liability does not require one. Under the misappropriation theory, a person who trades on material nonpublic information in breach of a duty owed to the source of that information violates the antifraud provisions. Her spouse owed a duty of confidentiality to his firm and its client, and she traded on information conveyed in confidence, which is the deception the theory reaches.

An adviser learns material nonpublic information about an issuer from a corporate insider who breached a duty. The adviser proper course is to:

1. A.Trade immediately for clients since the adviser has a fiduciary duty to use all informationIncorrect - fiduciary duty does not authorize illegal insider trading.
2. B.Trade only in the adviser personal account, not client accountsIncorrect - trading personally on the information is still illegal.
3. C.Share the tip with select clients as a value-added serviceIncorrect - tipping is prohibited.
4. D.Refrain from trading in that security and from tipping others until the information is publicCorrect - the adviser must abstain and not tip until the information is public.

Why: Trading or tipping on misappropriated material nonpublic information violates insider-trading law. Fiduciary duty never authorizes illegal trading; the adviser must abstain and not tip until the information is public.