Class 11: Insider Trading - Part 1 Classical Theory & Misappropriation Theory
Elements of Insider Trading
1) the defendant bought or sold securities; 2) the defendant had a duty as an insider of the company the securities of which were traded OR was a temporary insider of the company the securities of which were traded AND/OR was a misappropriator of information from a person or entity to whom the defendant owed a fiduciary duty; 3) the defendant knowingly possessed material, nonpublic information 4) the defendant acted willfully.
Equifax Insider Trading
Equifax, one of largest CRAs in the world, learned of a massive data breach in May 2017 affecting 146M US consumers and 44M British consumers. Before public disclosure of the breach in Sept. 2017, at least two Equifax employees (including Chief Information Officer & Software Security Engineer) who learned of the breach sold their stock. For example, CIO sold $1M of stock options, saving $117K+ in losses that would have occurred if he held his stock until after disclosure, which caused 14% drop in Equifax share price. CIO and Security Engineer were charged by both SEC and DOJ. Both pled guilty
Chiarella v US (1980)
Facts: Employee of financial printing company gleans the identity of takeover target companies from redacted dealbooks and invests in those target companies. Holding: Not liable under Classical Theory. Reasoning: Since he had no relationship to the target company, he was not under a fiduciary duty to abstain or disclose. Note: The misappropriation theory wasn't yet recognized by the Supreme Court.
U. S. v. O'Hagan (1997)
Facts: O'Hagan was a lawyer in a firm hired to by Grand Met to arrange for a tender offer for the common stock of Pillsbury Co. It was critical that this transaction be kept confidential. O'Hagan knowing of the offer bought Pillsbury call options. When the offer was announced, O'Hagan sold, making a $4.3M profit. Issue: Can O'Hagan be liable for insider trading, even though his firm did not represent Pillsbury? Holding & Reasoning: Yes. O'Hagan can be liable under the misappropriation theory. He feigned and then breached a duty of confidentiality to his firm (and its client).
Classical theory of Insider Trading
People who take secret information from a company & then trade in that company's stock in violation of a duty to that company Defendants are usually: Insiders: corporate officers, directors or others who owe a fiduciary duty to the company whose stock is being traded and its shareholders Temporary Insiders: People who work, on a temporary basis, for the company whose stock is being traded (e.g., lawyers, accountants, etc.)
Misappropriation theory of Insider Trading
People who take secret information in breach of a fiduciary duty to someone other than the company whose stock is being traded (usually their employer) and then trade on it.
Trading "On the Basis" of Material Non-Public Information
duty to "disclose or abstain" Generally, to be liable, D need only be aware of material non-public information and then buy or sell a security.
Insider Trading
the purchase or sale of a security of any issuer, on the basis of material nonpublic information about that security or issuer, in breach of a duty of trust or confidence that is owed to the issuer of that security or the shareholders of that issuer, or to any other person who is the source of the material nonpublic information
Insider Trading Example(Classical Theory)
•Giggle has been under SEC investigation for the last six months in connection with violations of U.S. antibribery law. Its stock has suffered as a result of the investigation and currently trades at $10/share. On Thursday, the Board of Directors learned that the SEC intends to drop its investigation, which will likely cause the Giggle stock price to rise as investors regain confidence in the company. •Before the SEC decision is publicly announced, a member of the Giggle board buys 100,000 more Giggle shares at $10/share worth $1 million. •When he sells the Giggle stock, after the the announcement of the termination of the SEC investigation, he sell at $1.5 million and make a profit of $500,000.
