US v. Newman and the Rewriting of the Law of Insider Trading (Part 6)
Of course, the most noticeable gap in the Court’s requirement of a fiduciary relationship concerned the application to officers aware of material nonpublic information about other companies. During the takeover waive of the 1980s, the Court’s analysis threatened to give a pass to any insider of a bidder who became aware of an impending offer for the shares of a target company. The officer of the bidder had no fiduciary obligation to the shareholders of the target company and could, at least to the extent that Dirks required a fiduciary relationship, trade without triggering the prohibitions on insider trading.
Ultimately, this gap in the analysis was filled with the invention of the doctrine of misappropriation. Misappropriation allowed authorities to treat as insider trading instances where persons (not just fiduciaries) traded on material nonpublic information in violation not of a fiduciary duty but of a duty of trust and confidence. Freed of the need for a fiduciary duty, an insider of a bidder who traded in the shares of a target could be guilty of insider trading.
Of course, even this fix contained analytical holes and silly evidentiary requirements. Insider trading suddenly depended upon whether husbands and wives, parents and children, psychiatrists and patients, had obligations of trust and confidence. Decisions turned on the closeness of buddies on the golf course.
Insider trading cases, therefore, required an exploration of the marital relationship, the closeness of family members, and the strength of friendships. Moreover, the tipper always had an incentive to argue that a relationship of trust and confidence existed (so that tipper was not really a tipper since the “tip” was conveyed within a relationship of trust and confidence) and the tippee always had an incentive to argue that the relationship did not exist (so that the tippee was not really a tipper since he/she did not violate a duty of trust and confidence). These cases where, therefore, invariably a she said, he said, raising considerable uncertainty and litigation risk.
The Supreme Court eventually affirmed the misappropriation theory. See US v. O’Hagan, 521 U.S. 642 (1997). Today, O’Hagan and approval of the misappropriation theory has an air of inevitability. That, however, was not true.
First, O’Haganstill drew a dissent from three Justices (Scalia, Thomas and Rehnquist). More importantly, the doctrine had, apparently, come close to rejection by the Supreme Court only a decade earlier. In 1987, the Supreme Court had divided 4-4 on a case raising the misappropriation theory. See Carpenter v. United States, 484 U.S. 19 (1987) (“The Court is evenly divided with respect to the convictions under the securities laws and for that reason affirms the judgment below on those counts. For the reasons that follow, we also affirm the judgment with respect to the mail and wire fraud convictions.”).
What happened between Dirks and O’Hagan? Most noticeably, the Court experienced a significant turnover. The majority in Dirksconsisted of Justices Powell (the author of the opinion), Berger, Stevens, White, O’Connor, and Rehnquist. Justice Blackmun wrote a dissent, joined by Justices Brennan and Marshall. In Carpenter, the lineup was the same except that Justice Kennedy had replaced Powell. By 1997, however, Chief Justice Burger was gone. So were Justices Brennan, Blackmun and Marshall. Instead, the Court included Breyer, Thomas, Souter, Ginsburg and Scalia. From the original decision in Dirks, only Rehnquist, Stevens and O’Connor remained.
In other words, approval of the misappropriation theory by the Supreme Court took 14 years from the Dirks decision and only occurred where the Court experienced significant turnover and consisted mostly of justices with no direct attachment to the decision in Dirks. Only in these circumstances was the misappropriation theory affirmed.
With respect to Newman, the decision and the request for rehearing en banc is posted, along with the SEC’s amicus brief, at the DU Corporate Governance web site. The amicus filed by a small group of law professors that supports the decision is here.