COMMENT
THE MISAPPROPRIATION THEORY: ARE THE BOUNDARIES
LIMITLESS?
I.
INTRODUCTION
Insider trading' has increased significantly in recent years.2
Correspondingly, the Securities and Exchange Commission
(SEC) has undertaken efforts to thwart such activity.3 There has
been a favorable public reaction to the SEC's campaign against
insider trading, which is primarily based upon traditional no1.
See 3 A.
BROMBERG & L. LOWENFELS, SECURITIEs FRAUD AND COMMODrrIEs FRAUD
BROMBERG & LOWENFELs] "Insider. Trading" prohibited securities trading utilizing material non-public information when the trader has a
duty to disclose the information or abstain from trading. Id. "Insider trading" a term
used to describe the unlawful buying or selling of securities based upon material nonpublic information. Id. See also Insider Trading Sanctions Act of 1984, Energy and
Commerce Comm., H.R. Rep. No. 355, 98th Cong., 1st Sess. 21 n.33 (1983), reprinted in
1984 U.S. CODE CONG. & ADMIN. NEws 2274, 2293 n.33.
2. 134 Cong. Rec. h7470 (daily ed. Sept. 13, 1988). See also The Insider Trading
Sanctions Act of 1983: Hearings on H.R. 559 Before the Subcomm. on Securities of the
Senate Comm. on Banking, Housing and Urban Affairs, 98th Cong., 2d Sess. 33 (1984).
[hereinafter Hearings] During the hearings, the SEC Chairman John Shad reported on
the increased number of proceedings which have alleged insider trading violations. Id. at
33-34. Commentators have noted the sharp increase in insider trading actions by the
SEC since 1970, yet expressed doubt that such trading has been significantly affected,
§ 7.4(100) (Nov. 1984) [hereinafter
even by successful prosecutions See also BROMBERO & LOWENFELS, supra note 1, at §
7.4(144); Dooley, Enforcement of Insider Trading Restrictions, 66 VA. L.REv. 1, 2, 74-83
(1980); Illegal Insider TradingSeems to Be on Rise: Ethics Issues Muddled, Wall St. J.,
Mar. 2, 1984, at 1, col. 6.
3. See supra note 2 for a discussion of the increased actions undertaken by the
SEC to thwart insider trading.
BRIDGEPORT LAW REVIEW
[Vol. 12:317
tions of fair play.4
The United States Supreme Court's position concerning insider trading has caused a limitation on the SEC's power to pursue and penalize market outsiders5 and tippees. The Court has
stated that despite the absence of statutory language or legislative history addressing the issue of nondisclosure, silence in connection with the purchase or sale of securities may give rise to a
common law fraud action under Section 10(b) of the Securities
and Exchange Act of 1934.7 The Court has held that for nondisclosure of information in securities transactions to constitute
fraudulent misrepresentation, a relationship of trust and confidence must exist between the parties.'
Premised upon this holding, the SEC and the Second Circuit Court of Appeals have adopted a misappropriation of information theory." The misappropriation theory extends liability to
4. See Arkin, Insider Trading - Distinguishing Unequal Advantage from Fraud,
N.Y.L.J., June 19, 1986, at'l col. 3 (favorable public reaction to the SEC campaign).
5. See Aldave, Misappropriation:A General Theory for Trading on Non-public
information, 13 HOPSTRA L. REv. 101, 112 (1984). "Outsiders" are those individuals who
have access to material non-public information although they have no direct relationship
to the corporation or shareholders. Id.
6. Dirks v. S.E.C., 463 U.S. 646, 665 (1983). A "tippee" is a person who buys or is
given non-public information from an insider or a corporation when no one else is given
that information. In Re Cady, Roberts, 40 S.E.C. 907, 912 (1961). See Chiarella v. United
States, 445 U.S. 222, 231-35 (1980) (employee of a financial printer had no fiduciary
relationship with the shareholders from whom he purchased stock; therefore he had no
duty to disclose before trading). The Chiarella Court held that a market outsider, who
had no fiduciary relationship with the shareholders from whom he purchased stock, had
not violated section 10(b) and Rule 10b-5 since he did not have a duty to disclose before
trading. Id. See infra notes 35-49 and accompanying text for a discussion of the
Chiarella decision. Three years later, in Dirks v. S.E.C., the Court held that a tippee
violates section 10b and Rule 10b-5 only if the insider breached a fiduciary obligation for
personal gain and if the tippee knew or had reason to know of the breach. 463 U.S. at
660-63; See infra notes 50-69 and accompanying text for a discussion of the Dirks
decision.
7. Chiarella v. United States, 445 U.S. at 230. 15 U.S.C. § 78j (1982). See infra
notes 12-28 and accompanying text for a discussion of 10b-5 and its application to insider trading cases.
8. See Dirks, 463 U.S. at 654; Chiarella,445 U.S. at 229-30.
9. See United States v. Carpenter, 791 F.2d 1024 (2d Cir. 1986), cert. granted, 484
U.S. 19 (1987), aff'd, 484 U.S. 19 (1987) (employee of financial newspaper breached
newspaper's policy by misappropriating confidential information as part of insider trading scheme); S.E.C. v. Materia, 745 F.2d 197 (2d Cir. 1984) (employee of financial printer
traded on corporate information entrusted to his employer by employer's client), cert.
denied, 471 U.S. 1053 (1985); See United States v. Newman, 664 F.2d 12 (2d Cir. 1981),
aff'd without opinion, 722 F.2d 729 (2d Cir. 1981) (investment bankers breached duties
1991]
MISAPPROPRIATION THEORY
those who trade on non-public information in breach of a fiduciary duty owed to a person or persons who entrusted the information to the fiduciary. 10 .For example, an employee breaches a
duty to his employer when he misappropriates confidential information belonging to his employer by using the information
for his own personal gain.
This Comment examines the decision of the United States
District Court for the Southern District of New York in United
States v. Willis" in light of the United States Supreme Court
decisions concerning liability under Rule 10b-5. 12 Part II examto employer by disclosing confidential information concerning proposed mergers), cert.
denied, 464 U.S. 863 (1983); S.E.C. v. Peters, 735 F. Supp. 1505 (D. Kan. 1990) (partner
in an investment consultant company had an obligation to keep confidential any information relating to his partner's consulting work which was excluded from the work of
the partnership). United States v. Elliott, 711 F. Supp. 425 (N.D. Ill. 1989) (a former
partner in a law firm misappropriated confidential client information about planned acquisitions by purchasing stock in the target company expecting prices would rise when
the prospective acquisitions became public); S.E.C. v. Tome, 638 F. Supp. 596 (S.D.N.Y.
1986) (defendant exploited his relationship with an executive officer of Joseph Seagram
& Co., to gain access to material non-public information regarding Seagrams plans for a
hostile tender offer and thereafter traded on the securities of the target company);
United States v. Reed, 601 F.Supp. 685 (S.D.N.Y.) rev'd in part, 773 F.2d 477 (2d Cir.
1985) (misappropriation theory supported the indictment of a tippee even though he
would not have been liable under Dirks); S.E.C. v. Musella, 578 F. Supp. 425 (S.D.N.Y.
1984) (tippee of a law firm violated Rule 10b-5 by trading on non-public information
which employee misappropriated from his employer by trading on confidential client
information).
10. United States v. Newman, 664 F.2d 12 (2d Cir. 1981) (employees guilty of securities fraud for breach of a fiduciary duty to employer). The misappropriation theory is
based on the principle that the one who trades on material confidential information acquired during the course of employment, breaches a fiduciary duty to his employer and,
therefore, is guilty of securities fraud if the information is used to obtain personal gain
from the purchase or sale of securities. See Note, Insider Tradingand the Misappropriation Theory: Has the Second Circuit Gone too Far?, 61 ST. JOHN'S L. REV. 78, 98-100
(1986) (history of the SEC and securities regulations) [hereinafter Second Circuit]. In
response to the limitations imposed by the Supreme Court, the SEC advocated a misappropriation theory which imposes liability on nontraditional insiders and tippees. Id. at
98. See also LANGEVOORT,
INSIDER TRADING REGULATION
177-79 (1988) (misappropriation
theory applies 10b-5 liability to persons who trade on non-public information in breach
of a fiduciary duty owed to the person or persons who entrusted the information to the
fiduciary); See also Note, The SEC's Regulation of the FinancialPress: The Legal Implications of the MisappropriationTheory, 52 BROOKLYN L. REV. 43, 54-63 (1978) (history of the misappropriation theory).
11. 737 F. Supp. 269 (S.D.N.Y. 1990)
12. Chiarella v. United States, 445 U.S. 222, 232-35 (1980) (mere possession of nonpublic information does not bring with it corresponding duty to disclose information or
abstain from trading on information). Dirks v. Securities Exchange Commission, 463
U.S. 646, 665 (1983) (possession of material non-public information does not give rise to
BRIDGEPORT LAW REVIEW
(Vol. 12:317
ines the evolution of 10b-5. Part III summarizes the facts of the
Willis case and reviews the decision of the District Court. Additionally, the Comment suggests that the decision of the District
Court neither comports with the United States Supreme Court's
guidelines nor effectuates the objectives of the securities laws.
II.
BACKGROUND
In 1934, the United States Congress enacted the Securities
and Exchange Act of 1934 which provided a broad mechanism
for the regulation of the sale and purchase of securities. I3 The
primary goal of the Act is to require full and fair disclosure of
material facts to the prospective purchasers of securities to prevent inequitable and unfair practices in securities transactions. 4
Section 10(b) of the 1934 Act 5 makes it unlawful to defraud or
engage in fraudulent business in both the purchase and sale of
securities and thus provides the statutory basis for the proscriptions of insider trading."e Pursuant to Section 10(b) the SEC
duty to disclose or abstain from trading absent relationship of trust and confidence between parties).
13. Securities and Exchange Act of 1934, 15 U.S.C. §§ 78a-78kk (1982). See also
Second Circuit, supra note 10, at 86-90 for a discussion of the parameters and limitations of the Securities and Exchange Act of 1934.
14. R. SHIELDS & R. STROUSE, SECURITIES AND PRACTICE HANDBOOK (5th ed. 1987).
See, e.g., Eichler v. Berner, 472 U.S. 299, 315 (1985) (primary objective of securities laws
is the protection of investing public and national economy); United States v. Carpenter,
791 F.2d 1024, 1032 (2d Cir. 1986) (protection of investors is the major purpose of Section 10(b) and Rule 10b-5).
15. 15 U.S.C. § 78j (1982). Section 10b provides:
It shall be unlawful for any person, directly or indirectly, by use of any means
or instrumentality of interstate commerce or of the mails, or of any facility of
any national securities exchange (a) To effect a short sale, or to use or employ any stop loss order in connection with the purchase or sale, of any security registered on a national securities exchange, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for
the protection of investors. (b) To use or employ, in connection with the
purchase or sale of any security registered on a national securities exchange or
any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may
prescribe as necessary or appropriate in the public interest or for the protection of investors.
Id.
16. See 15 U.S.C. §§ 77q(a), 78(b) (1982). These provisions do not specifically prohibit insider trading. The Securities and Exchange Act has been administratively and
judicially interpreted as encompassing such activity. See, e.g., Affiliated Ute Citizens of
19911
MISAPPROPRIATION THEORY
promulgated Rule 10b-5 to effectuate the purpose of 10(b).1 7
For almost twenty years after the enactment of Rule 10b-5,
courts limited their analyses of insider trading to activities of
traditional corporate insiders, i.e., directors, officers and controlling shareholders.' Because of their position with the corporation, traditional insiders were said to have a fiduciary relationship to the shareholders of the corporation requiring them to
adhere to the "disclose or abstain rule."' 19 Pursuant to this rule,
anyone in possession of material ° inside information must eiUtah v. United States, 406 U.S. 128, 151-52 (1972) (bank employees liable under Section
10(b) for failure to disclose material information regarding stock value); In Affiliated
Ute, the Supreme Court recognized that the provisions of 10(b) and Rule 10b-5 "are
broad and by repeated use of the word 'any' obviously meant to be inclusive." Id. In re
Cady, Roberts & Co., 40 S.E.C. 907, 912 (1961) (brokerage firm liable for trading on basis
of material information received from insider pursuant to sections 17(a), 10(b) and Rule
10b-5).
17. 17 C.F.R. § 240.10b-5 (1987) which states as follows:
It shall be unlawful for any person directly or indirectly, by the use of any
means or instrumentality of interstate commerce, or of the mails or of any
facility of any national securities exchange, (a) To employ any device, scheme,
or artifice to defraud, (b) To make any untrue statement of a material fact or
to omit to state a material fact necessary in order to make the statements
made, in light of the circumstances under which they were made, not misleading or, (c) To engage in any act, practice, or course of business which operates
or would operate as a fraud or deceit upon any person, in connection with the
purchase or sale of any security.
Id. The SEC promulgated Rule 10b-5 to close a loophole in the protection against fraud
under Section 10(b) of the Securities Act of 1934. See Second Circuit, supra note 10, at
86-89. Rule lOb-5 was created by the SEC pursuant to its rule-making power to regulate
securities trading. Id. Prior to 1942, the SEC had promulgated rules under Section 10(b)
but they did not prohibit insider trading. Id.
18. Speed v. Transamerica Corp., 99 F. Supp. 808, 828-29 (D. Del. 1951) (traditional insiders are corporate officers, directors, or majority shareholders).
19. See S.E.C. v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968). Officers
of Texas Gulf purchased stock in the corporation after finding out that one of the company's properties had tested positive for an ore discovery. Id. at 843-44. They traded
without first disclosing the drilling rights. Id. at 841-42. See generally Brudney, Insiders,
Outsiders and other Informational Advantages under the Federal Securities Laws, 93
HARV. L. REV. 322 (1979) (history of the disclose or abstain rule).
20. The Texas Gulf court stated that "the basic test of materiality... is whether a
reasonable man would attach importance ... in determining his choice of action in the
transaction in question ....This of course, encompasses any fact ...which in reasona-
ble and objective contemplation might affect the value of the corporation's securities ...." 401 F.2d at 849 (emphasis in original) (quoting List v. Fashion Park, Inc.,
340 F.2d 457, 462 (2d Cir. 1965). See also TSC Industries v. Northway, Inc., 426 U.S. 438
(1976). The Court held that information is material "if there is a substantial likelihood
that a reasonable shareholder would consider it important in deciding how to vote." Id.
at 449. See Basic, Inc. v. Levinson, 485 U.S. 224 (1988). Information is material if there
BRIDGEPORT LAW REVIEW
[Vol. 12:317
ther disclose2 ' the information to the investing public or abstain
from trading on such information.22 This duty is predicated
upon a relationship affording one access to information intended
to be available only for corporate purposes and the inherent unfairness that can result when a person uses that information
knowing it is unavailable to those with whom they are dealing. 28
The Securities and Exchange Commission and various
courts have broadened the reach of Rule 10b-5 by expanding the
category of persons who owe a duty to disclose or abstain.2 ' In
In re Cady, Roberts & Co., 25 the SEC extended this rule by plac-
ing liability on "anyone who traded on material non-public information, regardless of whether they owed a duty to the corporation. ' 2 Additionally, the Second Circuit Court of Appeals in
is a substantial likelihood that a reasonable investor would consider it important in deciding his choice of action in a particular securities transaction. Id. at 231. See also
S.E.C. v. MacDonald, 699 F.2d 47, 49 (1st Cir. 1983) (violation of § 10b when defendant
made purchases of RIT stock without disclosing material inside information learned in
his capacity as chairman of the board of RIT); TSC Indus., Inc. v. Northway, Inc., 426
U.S. 438, 449 (1976) (proxy statement issued to recommend approval of the acquisition
of TSC to National was incomplete and misleading).
21. Texas Gulf, 401 F.2d at 848-49. Disclosure is effectuated if it is disseminated
by the public at large. Id. "Material facts include not only information disclosing the
earnings of a company but also those facts which affect the probable future of the company and those which may affect the desire of investors to buy, sell or hold the 'company's securities." Id. at 849. The SEC views disclosure as requiring more disclosure to
buyers than to purchasers or sellers. Id. See In re Faberge, Inc., 45 S.E.C. 249, 256
(1973). Proper disclosure is achieved by a public release through the appropriate public
media designed to achieve dissemination to the investing public generally. Id.
22. Texas Gulf, 401 F.2d at 848-49. See also Brudney, supra note 19, at 324-35
(insiders who possess information of a consequential nature must either disclose it or
abstain from trading unless information becomes public).
23. In re Cady, Roberts, 40 S.E.C. 907, 912 (1961). Chairman Carey set forth a two
prong test for imposition of the duty to disclose beyond the traditional corporate insiders: first, the existence of a relationship which gives access, directly or indirectly, to information intended to be available only for corporate purposes and not for the personal
benefit of anyone, and second, the inherent unfairness involved where a party takes advantage of such information knowing it is unavailable to those with whom he is dealing.
Id. at 912.
24. Texas Gulf, 401 F.2d at 848. Chairman Carey reaffirmed the expansion of liability under 10(b) to include those persons who are in a special relationship with a company and privy to its affairs. Id.
25. 40 S.E.C. 907 (1961).
26. Id. Rule 10b-5 restricts trading activities of "any person who has a relationship
that allows access to material non-public information." Id. See also Speed v. Transamerica Corp., 99 F. Supp. 808, 829 (D. Del. 1951) (extending fiduciary duties to majority
shareholders); New Park Mining Co., v. Cranmer, 225 F. Supp. 261, 266 (S.D.N.Y. 1963)
(corporation allowed to sue former officers and directors, thus relaxing privity require-
1991]
MISAPPROPRIATION THEORY
S.E.C. v. Texas Gulf Sulphur Co. 27 and Shapiro v. Merrill
Lynch, Pierce, Fenner & Smith, Inc.2" held that Rule 10b-5
lia29
bility extends to "tippees" as well as corporate insiders.
Although both the Securities and Exchange Commission
and the Second Circuit Court of Appeals extended liability
under Rule 10b-5, the basis for the liability was quite different.
The SEC's decision in Cady, Roberts rested on the "fiduciary"
theory to define the boundaries of the duty to disclose or abstain.30 The fiduciary theory protects the relationship of trust
between an insider and the shareholders of a corporation.3" If an
insider trades on non-public information without first disclosing
such information and subsequently earns a profit, he has
breached his fiduciary duty.3 2 In S.E.C. v. Texas Gulf Sulphur
Co., the Second Circuit Court of Appeals defined Rule 10b-5 in
such a way as to ensure that all investors have equal access to
information regardless of whether a traditional or fiduciary relationship exists. 3 According to the Texas Gulf rule, anyone in
possession of material non-public information has a duty to disclose the information or abstain from trading on it. 4 This theory
ments under Rule 10b-5); Pettit v. American Stock Exchange 217 F. Supp. 21, 28
(S.D.N.Y. 1963) (suit against variety of persons accused of defrauding an insurer of
stock).
27. 401 F.2d 833 (2d Cir. 1968). In Texas Gulf, several officers and directors purchased additional shares in the corporation's stock based on confidential information
concerning a possible mineral strike. In addition, the defendants selectively disclosed the
information to a number of individuals who also purchased shares. Id. at 839-43.
28. 495 F.2d 228 (2d Cir. 1974). Merrill Lynch was advised of material adverse
information regarding Douglas aircraft earnings. Id. at 232. Merrill Lynch tipped information to certain customers who then sold stock before the information was public. Id.
29. Id. In Shapiro, the court stated that the purpose of 10b-5 is to prevent corporate insiders and their tippees from taking advantage of uninformed outsiders. Id. at 235.
The Shapiro court held that the defendant tippees knew or should have known of the
confidential source of the earnings information, and that they were under a duty not to
trade Douglas stock without disclosing the information. Id. at 238. See also, In re Cady,
Roberts, 40 S.E.C. 907. A "tippee" is a person who is given non-public information from
an insider or a corporation when no one else is given that information.
30. Cady, Roberts, 40 S.E.C. at 912.
31. Id.
32. See Cady, Roberts, 40 S.E.C. at 916 n.31. The SEC in Cady, Roberts provided
the following description of the duty one owes to the shareholders of a corporation: "he
would have a duty not to take a position adverse to them, not to take secret profits at
their expense, not to misrepresent facts to them, and in general to place their interests
ahead of their own." Id.
33. S.E.C. v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968).
34. Id. at 848.
BRIDGEPORT LAW REVIEW
[Vol. 12:317
espouses informational parity; all investors in the market should
have equal access to all material investment information.3 5
The United States Supreme Court in United States v.
Chiarella3 settled the different approaches taken by the Securities and Exchange Commission and the Second Circuit and held
that a duty to disclose or abstain could only apply to those who
had a fiduciary relationship.3 7 Liability under Rule 10b-5 could
not be upheld absent a relationship of trust and confidence between the parties to a transaction.3 8
In Chiarella,the United States Supreme Court in a 6-3 decision rejected the expansive view taken by the Second Circuit
and reaffirmed the traditional theory that liability under Rule
10b-5 is premised upon a breach of a fiduciary duty. 9 The defendant, Chiarella, was an employee of a financial printing company, Pandick Press.4 0 His position afforded him access to various forms and statements relating to corporate acquisitions that
35. Id. at 849. Judge Skelly Wright in Dirks v. S.E.C., 681 F.2d 824 (D.C. Cir. 1982)
stated that those cases adopting the information theory "imply that the securities laws
impose a duty to disclose or refrain from trading based on the nature of the undisclosed
information." Id. at 835. Judge Skelly Wright, however, went on to state that a "full
equality of access to information is an illusory goal." Id. at 835 n.14.
36. 445 U.S. 222 (1980).
37. Id. at 230.
38. Id. The Chiarefla Court stated that liability under section 10(b) is "premised
upon a duty to disclose arising from a relationship of trust and confidence between parties to a transaction. Id. Application of a duty to disclose prior to trading guarantees that
corporate insiders, who have an obligation to place the shareholders welfare before-their
own, will not benefit personally through fraudulent use of material non-public information." Id.
39. Id. at 224-25. Justice Powell wrote the opinion for the Court in which Justices
Stewart, White, Rehnquist and Stevens joined. Justice Brennan wrote a concurring opinion. Id. at 238. The applicable law is that a person violates section 10b whenever he
improperly obtains or converts, to his own benefit, non-public information which he uses
in connection with the purchase or sale of securities. Id. at 239. Justice Stevens also
wrote a concurring opinion. He stated that the identification of a duty is necessary for
liability under Rule 10b-5. Stevens agreed with the majority but established two duties
which Chiarellaarguably violated: (1) a duty to disclose owed to sellers from whom he
purchased stock; (2) a duty of silence owed to acquiring companies. Id. at 237. Chief
Justice Burger dissented. Burger argued that a person who misappropriated non-public
information has a duty to disclose that information or refrain from trading. These provisions reach any person engaged in any fraudulent scheme. Id. at 240, and Justice Blackmun wrote a dissenting opinion in which Justice Marshall joined. The dissent opined
that persons having access to confidential market information that is not legally available to others are prohibited from using that information to their advantage through trading in affected securities. Id. at 249.
40. ChiareUa, 445 U.S. at 224.
19911
MISAPPROPRIATION THEORY
Jzo
41
the documents he
Pandick prepared for its customers. Among
takeover bids with the
handled were five announcements of
concealed to protect the confinames of the acquiring companies
2 Chiarella, however, managed to
dentiality of the information.'
s Without disclosing the indeduce the names of the companies.'
of the target company
formation, he used it to purchase shares
for a profit after the takeover attempts
and then sold his shares
44
were made public.
the SEC, and he
Chiarella's activities were uncovered by
Section 10(b) and Rule
was indicted and convicted of violating
of Appeals for the Sec10b-5.1 A divided United States Court
e
held that
The majority
ond Circuit affirmed his conviction.4
regularly receives mawho
not
or'
"[alnyone - corporate insider
information to
use that
terial non-public information may not
an affirmative duty to
trade in securities without incurring
disclose."'4
the parity of inThe United State Supreme Court rejected as to the scope
view
formation rule and adopted a more limited "a duty to disclose
that
of a duty to disclose .' The Court held
between parconfidence
and
arises from a relationship of trust
nonpossession of material
0
ties to a transaction."' The mere
disclose.
a duty to
public information does5 not require States Supreme Court furUnited
In Dirks v. S.E.C., ' the
duty doctrine by deciding the
ther developed the 10b-5 fiduciary
5
the Court held that a
liability of a stock "tippee." In Dirks,
41. Id.
42. Id.
43. Id.
44. Chiaiella, 445 U.S. at 224.
45. Id. at 224-25.
46. Id. at 224.
Cir.
United States, 588 F.2d 1358, 1365 (2d
47. Id. at 231, (citing Chiarella v.
1978)).
48. Chiarella,445 U.S. at 235.
an
40 S.E.C. 907 (1961), the SEC stated that
49. Id. at 230. In Inre Cady, Roberts,
(officers,
insiders
corporate
on
imposed
been
affirmative duty to disclose has traditionally
belief
at 912. The duty is premised on both the
Id.
shareholders).
corporate
and
for
directors
available
be
to
intended
access to information
that the party's position afforded them
advantage of the
take
to
insider
an
allowing
of
corporate purposes, and the unfairness
Id.
information by trading without disclosing.
235.
at
U.S.
445
Chiarella,
50.
51. 463 U.S. 646 (1983).
was the first case establishing "tippee"
52. Dirks, 463 U.S. at 655. Cady, Roberts
BRIDGEPORT LAW REVIEW
[Vol. 12:317
tippee violates Rule 10b-5 if: (1) an insider breaches a fiduciary
duty to the corporation's insiders by divulging material nonpublic information;5" (2) the tippee knew or should have known
that the tipper breached a duty;5' and (3) the tippee traded on
the information.
Dirks was a security analyst who specialized in providing investment analysis of insurance company securities to institutional investors. 56 On March 6, 1973, Dirks was contacted by
Ronald Secrist, a former officer at Equity Funding, a diversified
corporation primarily engaged in selling life insurance and mutual funds.57 Secrist alleged that the assets of Equity Funding
had been vastly overstated as a result of fraudulent practices
within the corporation. 8 Moreover, Secrist informed Dirks that
a number of regulatory agencies had failed to take action on it.59
Thereafter, Dirks began to investigate the allegations.60 He verified the existence of the fraud and advised his clients of the
findings.6 Many of these people, in response to the circulating
rumors, sold their holdings in Equity Funding before the price
liability under Rule 10b-5. 40 S.E.C. at 907. The tip involved reporting of a dividend by
Curtis-Wright Corporation. Id. A director of the firm revealed information that the Curtis-Wright dividend had been cut to a stockbroker prior to the official publication by
Dow Jones. Id at 908-10. Gintel, the stockbroker, proceeded to trade shares of stock in
Curtis-Wright for client accounts. Id. When the dividend announcement later appeared
on the Dow Jones ticker tape, trading of Curtis-Wright stock was suspended because of
the large number of sell orders. Id. The emphasis in Cady, Roberts was on expanding the
category of insiders, see id. at 912-13, and it was not until S.E.C. v. Texas Gulf when the
issue of the receipt of material non-public information was specifically addressed. See
S.E.C. v. Texas Gulf, 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976 (1969). The
Court adopted the Cady, Roberts delineation of insider status, but focused on the equal
access to material information regardless of whether traditional facts of fiduciary concepts were applied. Id. at 848.
53. Dirks, 463 U.S. at 659-61.
54. Id. at 660 (Tipper must know or have reason to know the information is nonpublic and improperly obtained). See A. JAcoBs, THE IMPACT OF RULE 1OB-5 § 167 (1980).
55. Dirks, 463 U.S. at 659-61. To determine whether the insider breached a duty,
the court will consider if the insider received a direct or indirect personal benefit from
disclosure, such as a pecuniary gain or a reputational benefit that will translate into
future earnings. In Re Cady, Roberts, 40 S.E.C. at 912 n.15. The insider by giving information, in effect, selling it for value to himself. Id.
56. Dirks, 463 U.S. at 648.
57. Id. at 649.
58. Id. Secrist urged Dirks to verify the fraud and disclose it publicly. Id.
59. Id.
60. Dirks, 463 U.S. at 649.
61. Id. He met with several officers and employees of the corporation. Id. Senior
management denied any wrongdoing but certain employees corroborated the fraud. Id.
MISAPPROPRIATION THEORY
1991] .
could decline."2 After the exposure of the fraud, the Securities
and Exchange Commission found Dirks guilty of aiding and
abetting those who sold stock based on non-public information."
The United States Supreme Court reversed the Dirks conviction." The Court stated that whether a tippee breaches a fiduciary duty depends upon the insider's purpose in disclosing
the information. 8 Accordingly, the Court found that Dirks was
not liable under Rule 10b-5 because the insider who gave the
information to Dirks had not breached a duty to the corporation
when he passed along the information. 6 Since Dirks was not a
tippee under the Court's analysis, he could freely divulge the information to others without incurring liability. 7 Thus, the insider's act of tipping must be a breach of the insider's fiduciary
duty before a tippee can inherit a derivative duty.68 The tippee
must know or have reason to know that the tipper has breached
a fiduciary obligation by revealing that information. 9 In addition, whether the insider's tip constitutes a breach depends on
whether the insider receives a direct or indirect personal
70
benefit.
62. Id. at 649-50. Throughout the investigation Dirks openly discussed the information he obtained with a number of clients. Id. After the purchase the price of Equity
stock fell from $26 per share to $15 per share. Id.
63. Id. at 650-51.
64. Dirks, 463 U.S. at 667.
65. Id. at 663. The Court stated that the test is an objective one focusing on
"whether the insider receives a direct or indirect personal benefit from disclosure." Id. at
663. The Court held that an insider's tip is improper only if he benefits personally. Id. at
664. In his dissent, Justice Blackmun criticized the test, but conceded that Dirk's informant did not benefit from the tip. Id. at 669.
66. Id. at 666-67. The corporate insider who revealed the information to Dirks did
not violate their Cady, Roberts duty to the corporation by providing the information to
Dirks. Id. at 666. Thus, the Court found no derivative duty to the corporation by Dirks.
Id. at 887.
67. Id. The Court, however, suggested the definition of "insider" might be enlarged
to include those who enter into a special relationship and have access to information
solely for corporate purposes. Id. at 655 n.14. Those persons become constructive insiders
and violate Rule lob-5 when they use confidential information for the purchase or sale of
securities. Id. at 660.
68. Dirks, 463 U.S. at 667.
69.
Id. at 660-61.
70. Id. at 662. Whether an insider receives direct or indirect personal benefit from
disclosure is a question of fact. The Court provided examples of personal benefits: pecuniary gain, enhanced reputation which would translate into future earnings, gifts of inside information to friends or relatives, or, in general, any quid pro quo transaction. Id.
at 663-64. See also Cady, Roberts, 40 S.E.C. at 912, n.15.; Brudney, supra note 19 at 348.
BRIDGEPORT LAW REVIEW
[Vol. 12:317
In response to Dirks and Chiarella, the SEC and the Second Circuit have advocated a misappropriation theory71 to impose liability on non-insiders who traded on inside information.72 This theory was first advanced in Chiarella.7 ' Although
the United States Supreme Court never directly addressed the
validity of the misappropriation theory, several members of the
Court expressed support for its use.7
Based on this indication of support, the government advocated the misappropriation theory in United States v. Newman.75 In Newman, two employees of investment banking firms
conveyed information to Newman, a securities trader, concerning proposed mergers and acquisitions.7 6 Newman used the information to purchase stock in the companies that were merger
and takeover targets. 77 When the mergers or takeovers were announced and the market price rose, Newman reaped substantial
gains. 78 In reversing the District Court's dismissal of the indictment, the Second Circuit approved the misappropriation theory. 79 The Court held that the employees' breach of their duty of
"The theory ... is that the insider, by giving information out selectively, is in effect
selling the information to its recipient for cash, reciprocal information, or other things of
value for himself ....
Id.
71. See supra notes 9-10 and accompanying text for a discussion of the misappropriation theory and its application.
72. See United States v. Reed, 601 F. Supp. 685, 699 (S.D.N.Y. 1985) (misappropriation theory supported the indictment of a tippee even though he would not have been
liable under Dirks). See also Rothberg v. Rosenbloom, 771 F.2d 818 (3d Cir. 1985) (implicitly approving use of misappropriation theory in an in pari delecto defense case).
73. See Chiarella,445 U.S. at 234-37.
74. Id. at 238-51. In his concurrence, Justice Stevens stated that an argument
could be made that his actions constituted a "fraud or deceit" upon those acquiring corporations, but they would not be able to recover damages because they were neither
purchasers nor sellers of the traded securities. Id. at 237-38. Chief Justice Burger and
Justice Brennan would have imposed liability on Chiarella on the theory that any person
who has misappropriated non-public information has an absolute duty to disclose that
information and refrain from trading. Id. at 239-45.
75. 664 F.2d 12 (2d Cir. 1981), cert. denied, 464 U.S. 863 (1982).
76. Id. at 15. Since 1972 both employees, Antinou and Curtois, worked for Morgan
Stanley. Id. In 1975 Antinou left Morgan Stanley to work for Kuhn Loeb. Id.
77. Id. The stock purchased was that of companies that were merger and acquisition targets-clients of Morgan Stanley and Kuhn Loeb. Id.
78. Id. Newman shared his profits with Curtois and Antoniu, the sources of the
wrongfully acquired information. Id.
79. See Newman, 664 F.2d at 17 (quoting Chiarella 445 U.S. at 245 (Burger, C.J.,
dissenting)). The Newman court quoted Justice Burger's statement in Chiarella that
"the defendant 'misappropriated-stole to put it bluntly-valuable non-public information entrusted to him in utmost confidence.'" Id.
1991]
MISAPPROPRIATION THEORY
confidence by misappropriating information for their own use
satisfied the requirements set forth in Chiarella for Rule 10b-5
liability.80
Four years later, in S.E.C. v. Materia,8 1 the Second Circuit
held that Materia, a copy reader for a firm specializing in financial documents, violated Rule 10b-5 by misappropriating confidential information concerning proposed tender offers by trading in the securities of the target companies.8 2 Additionally, the
Second Circuit in United States v. Grossman"s held that Grossman, an attorney, breached firm policy by disclosing information
entrusted to his employer by his employer's client. 84 Grossman
misappropriated information he received from a colleague at his
law firm regarding a client's planned recapitalization."s
The Second Circuit expanded its application of the misap6 In Carpenpropriation theory in United States v. Carpenter.8
ter, Winans, a reporter for The Wall Street Journal, wrote a
daily column discussing selected stocks, giving positive and negative information about them and then taking a position on in80. Newman, 664 F.2d at 16.
81. 745 F.2d 197 (2d Cir. 1984), cert. denied, 471 U.S. 1053 (1985).
82. Id. at 199-201. A tender offer occurs when an individual, corporation or some
group gain control over a corporation by offering to buy the shares of the corporation. D.
VAGTS, BASIC CORPORATION LAW 834 (2d ed. 1973). See S.E.C. v. Materia, 745 F.2d at
199. Word of an upcoming tender offer may send prices of the target company's stock
soaring. Id. Because of this the firm drafting the documents uses code names for the
company until the eve of publication, when the names are filled, in. Id. Materia, despite
efforts to keep the identities confidential, was able to decipher the entities of four tender
offers. Id.
83. 843 F.2d 78 (2d Cir.), cert. denied, 488 U.S. 1040 (1988), reh'g denied, 490 U.S.
1059 (1989).
84. Id. at 82. Kramer Levin-the law firm employing Grossman- circulated a memorandum while Grossman was affiliated with the firm stating that attorneys receiving information from clients could not use that information for trading or pass it on to someone else. Id. at 80.
85. Grossman, 843 F.2d at 80-81. Events occurring after the meeting between
Grossman and his colleague were in dispute but substantial circumstantial evidence was
produced. Id. Recapitalization is the procedure of changing the rights of one class of
stock. D. VAGTS, BASIC CORPORATION LAW 831 (2d ed. 1973). This allows the entity to
reduce the par or stated value of stock or the number of shares therefore diminishing
capital and eliminating a retained earnings deficit. Id.
86. United States v. Carpenter, 791 F.2d 1024 (2d Cir. 1986), aff'd, 479 U.S. 1016
(1987). In Carpenter,Winans and Felis were found guilty of securities fraud by misappropriating non-public information from The Wall Street Journal. Carpenter, 791 F.2d
at 1026. Carpenter was convicted of aiding and abetting in the commission of securities
fraud and mail and wire fraud. Id. at 922.
BRIDGEPORT LAW REVIEW
[Vol. 12:317
vestments in that particular stock. 7 The column had the potential to affect the price of a stock depending upon what Winans
reported."' Winans enlisted the assistance of another Wall Street
Journal employee, David Carpenter, to contact a stock broker
about selling the contents of the column before publication."
Prior to publication, Winans gave confidential information to a
broker/dealer who in turn traded prior to publication. 0 The
Court found that Winans violated Rule 10b-5 by misappropriating information obtained in the course of his employment with
the Wall Street Journal.9 1 Carpenter was convicted of aiding and
abetting Winans. 2
The Second Circuit upheld the convictions under Rule 10b5 and the wire and mail fraud statutes.9 3 The Court held that
"87. See United States v. Winans, 612 F. Supp. 827, 830 (D.C.N.Y. 1985).
88. Id. The Wall Street Journal had a regulation that the contents of all articles
were confidential and the property of the Journal prior to publication. Id.
89. Id. at 831-32.
90. Id. at 832. The net profit from the trading amounted to $690,000.00. Id. at 834.
91. United States v. Winans, 612 F. Supp. 827, 850 (D.C.N.Y. 1985).
92. Id.
93. United States v. Carpenter, 791 F.2d 1024, 1034-35 (2d Cir. 1986). In addition
to prosecution for insider trading under Rule 10b-5 federal prosecutors can also bring
actions for securities fraud under the wire and mail fraud statutes. See also United
States v. Newman, 664 F.2d 12 (2d Cir. 1981) (defendant charged with violating Rule
10b-5 and the wire and mail statutes, 18 U.S.C. §§ 1341, 1343 (1976)).
Title 18, Section 1341 of the United States Code provides:
Whoever, having devised or intended to devise any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises, or to sell, dispose of, loan, exchange, alter,
give away, distribute, supply or furnish or procure for unlawful use any counterfeit or spurious coin, obligation, security, or other article, or anything represented to be or intimated or held out to be such counterfeit or spurious article,
for the purpose of executing such scheme or artifice or attempting so to do,
places in any post office or authorized depository for mail matter, any matter,
or thing whatever to be sent or delivered by the Postal Service, or takes or
receives therefrom, any such matter or thing, or knowingly causes to be delivered by mail according to the direction thereon, or at the place at which it is
directed to be delivered by the person to whom it is addressed, any such matter or thing, shall be fined not more than $1,000 or imprisoned not more than
five years, or both.
Id.
Title 18, Section 1343 of the United States Code provides:
Whoever, having devised or intended to devise any scheme or artifice to defraud, or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises, transmits or causes to be transmitted by
means of wire, radio, or television communication in interstate or foreign commerce, any writings, signs, signals, pictures, or sounds for the purpose of exe-
MISAPPROPRIATION THEORY
1991]
Winans violated Rule 10b-5 when he misappropriated material
non-public information that he gained in the course of his employment and sold in violation of a fiduciary duty to his employer.
4
The United States Supreme Court, in an evenly divided
four to four opinion, affirmed the lower court's application of the
misappropriation theory without discussion."
III.
A.
THE DECISION
Facts
Jane Doe's 6 husband, Sanford I. Weill, served as Chief Executive Officer of Shearson Loeb Rhodes between 1970 and
1981. 91 In 1981, Weill sold his interest in Shearson to the American Express Company, and he subsequently became president of
American Express. 8 In late October 1985, Weill developed an
interest in becoming the Chief Executive Officer (CEO) of
BankAmerica. 99 "As part of his effort to become CEO of
BankAmerica, Weill secured a commitment from Shearson to invest one billion dollars in BankAmerica."' 100 The investment was
contingent on Weill's success in the negotiations. 10 1 Weill attempted to meet with representatives of BankAmerica to discuss
his proposal.1 02 These contacts were not disclosed publicly.103
cuting such scheme or artifice, shall be fined not more than $1,000 or impris-
oned not more than five years, or both.
Id.
94. United States v. Carpenter, 791 F.2d 1024, 1026 (1986).
95. Carpenter v. United States, 479 U.S. 1016 (1986), af'd, 484 U.S. 19 (1987). The
Court stated: "The Court is evenly divided with respect to the convictions under the
securities laws and for that reason affirms the judgement below on those counts." Id.
96. United States v. Willis, 737 F. Supp. 269, 271 n.1 (S.D.N.Y. 1990). "The indictment refers to the patient as 'Jane Doe.'" Id. Both the government and the defendant
agree that Jane Doe is really Joan Weill, the wife of Sanford I. Weill. Id.
97. Id. at 270. Shearson Loeb Rhodes and subsidiaries is collectively Shearson. Id.
98. Id. Willis served as president of American Express from 1981 to 1985. Id.
99. Id. at 270.
100. Willis, 737 F. Supp. at 270.
101. Id.
102. Id. Weill attempted to meet with representatives in January and February of
1986. Id.
103. Id. At the same time Weill attempted to negotiate with BankAmerica, the
public perception of BankAmerica was unfavorable; BankAmerica had reported huge
losses. Id. Losses included $178 million in the fourth quarter of 1985, and $337 million in
the calendar year 1985. Id. In addition, $5.7 billion of debt owed by BankAmerica was
reportedly downgraded by Moody's Investor Service. Id.
BRIDGEPORT LAW REVIEW
(Vol. 12:317
Throughout the negotiations Weill openly discussed his efforts
to become CEO of BankAmerica with his wife."" Because of the
effect Weill's interest in and contact with BankAmerica could
have on Jane Doe's life, she discussed these matters with her
1 05
psychiatrist, Dr. Robert H. Willis.
From January 14, 1986 through February 6, 1986, Willis disclosed to his broker the information he received from Jane Doe
and purchased a total of 13,000 BankAmerica shares for himself,
his wife, and his children.10 6 On February 20, 1986, BankAmerica announced that it had been approached by Weill. 107 On this
date, BankAmerica shares traded at prices ranging from 13 7/8 to
15 %/ per share."' 8 On the following day, February 21,
BankAmerica traded at prices ranging from 14 to 15 1/2.109 On
this day, Willis sold all 13,000 shares of BankAmerica at a price
of 15 /s per share. 110 He yielded a profit of approximately
$27,475.79.111
Willis purchased the BankAmerica shares in twenty-three
separate transactions." 2 Willis' activities were uncovered and he
was charged with twenty-three counts of securities fraud in violation of Sections 10(b) and 32 of the Securities and Exchange
Act of 1934, 15 U.S.C. Sections 78j, 78ff, and Rule 10(b)5, 17
C.F.R. Section 240.10b-5 and twenty-three counts of mail fraud
in violation of 18 U.S.C. Sections 1341 and 1342.113 The United
States District Court Judge Cedarbaum denied a motion to dismiss the indictment and held that Willis could be subject to lia114
bility under the securities laws.
104.
Willis, 737 F. Supp. at 271.
105. Id. at 271. Jane Doe's spouse discussed these evento with Jane Doe on a contemporaneous basis within the context of their marital relationship. Id. Jane Doe also
told Willis that Shearson had committed to invest $1 million in BankAmerica if Weill
was successful in becoming Chief Executive Officer. Id.
106. Id.
107. Id. BankAmerica announced that they were not interested in Weill's proposal.
Id.
108. Willis, 737 F. Supp. at 271.
109. Id.
110. Id.
111. Id.
112. Willis, 737 F. Supp. at 271.
113. Id. The securities fraud was based upon the twenty-three purchases. Id. Willis
is also charged with twenty-three counts of mail fraud because the confirmations of the
purchases were sent through the mail. Id.
114. Id. at 275. Willis made a motion to dismiss pursuant to the Rule 12(b) of the
MISAPPROPRIATION THEORY
1991]
B.
Opinion
In order to -prove securities fraud the government intended
to utilize the misappropriation theory.1 1 The indictment
charged that Willis breached the physician's traditional duty of
confidentiality to his patient when he misappropriated non-public information for his own benefit.1 1 Willis purchased
BankAmerica stock while in possession of, and in reliance on,
confidential, non-public information given to him by Jane Doe
concerning her husband's attempt to become Chief Executive
Officer of BankAmerica." 7 The key to this theory of liability is a
breach of a fiduciary or similar duty of trust or confidence. 1
The court relied upon the relationship between doctor and patient and based it on a physician's ethical obligation to his patient." 9' "A person who receives secret business information from
another because of an established relationship of trust and confidence between them has a duty to keep that information confidential."1 10 Jane Doe did not breach a duty of trust and confidence to her husband when she revealed the information to
Willis. 2 ' Good therapy depends on her confidence in being candid and frank.'2 2 Willis, by not disclosing to his patient his intention to use information obtained from her during consultation, fraudulently induced her to confide in him in connection
with his purchase and sale of securities. 2 '
Federal Rules of Criminal Procedure. Id. at 270.
115. Id. at 271. See Chiare~la,445 U.S. at 235-37; See also Carpenter,484 U.S. 19
(convictions under securities laws affirmed without discussion by an evenly divided
court.) See supra notes 9-10, 70-94 and accompanying text for a discussion of the misappropriation theory.
116. Willis, 737 F. Supp. at 272. The Court classified the information as non-public
business information. Id.
117. Id.
118. Id.
119. Id. The Court cites the "oath" of Hippocrates, which has guided the medical
practice for more than 2,000 years. Id. The public is aware of the oath and has a right to
rely upon this warranty of silence. Id. The oath concludes with the following words:
"Whatsoever things I see or hear concerning the life of men, in my attendance on the
sick or even apart therefrom, which ought not be noised abroad, I will keep silence
thereon, counting such things to be as sacred secrets." Id.
120. Willis, 737 F. Supp. at 274.
121. Id. at 275.
122. Id. at 274.
123. Id. The fiduciary, Willis, defrauded the confider, Jane Doe, who was entitled
to rely on the fiduciary's tacit representation of confidentiality. Id.
BRIDGEPORT LAW REVIEW
[Vol. 12:317
Willis contended that the indictment did not allege that his
patient suffered an injury.12 4 Additionally, Willis argued that the
indictment did not allege that any market participant was
harmed by the defendant's trades. 125 Nevertheless, the court recognized that a patient has a cause of action against a doctor who
discloses confidential information obtained during consultation.'26 This is because a patient has a property interest in continuing psychiatric treatment.12 7 Willis' disclosures jeopardized
this relationship and subjected Jane Doe's financial investment
28
1
to risk.
Willis renewed his motion to dismiss after the Second Circuit's decision in United States v. Chestman 2 9 on the basis that
Jane Doe did not tell him the information was confidential or
that he, Willis, should not disclose it.'30 In Chestman,
Chestman, a stockbroker, received inside information from a
member of the Waldbaum family, Keith Loeb regarding
Waldbaum, Inc.' 3 ' Using the information, Chestman purchased
shares of Waldbaum stock for himself and for Loeb. 13 2 He later
was convicted of securities fraud because he aided and abetted
Loeb in misappropriating non-public information in breach of
124. Willis, 737 F. Supp. at 274.
125. Id.
126. Id.
127. Id. Success of a psychiatrist/patient relationship often depends on confidentiality of information revealed during consultation. Id. Jane Doe had an economic interest
in the preservation of the confidentiality of information revealed during her consultation.
Id. Willis' use of that information may have impacted her husband's success in his negotiations with BankAmerica. Id.
See also Heller, Some Comments on the Practice of Psychiatry, 30 Temple L.Q.
401, 405-06 (1957). Heller observed as follows:
This need to keep in confidence all disclosures made by a patient ...
true of the psychiatric relationship ....
is ...
the patient is called upon to discuss in
a candid and frank manner personal material of the most intimate and disturbing nature .... to speak of things ... requires trust, confidence and toler-
ance .... Patients will only be helped only if they can form a trusting relationship with the psychiatrist.
Id.
128. Willis, 737 F. Supp. at 274. Jane Doe's financial investment in treatment was
put at risk, "either by provoking the termination of the relationship and increasing the
cost of treatment by requiring that she find a new psychiatrist, or by requiring additional
treatment time to discuss the impact of his disclosures on their relationship." Id.
129. 903 F.29 75 (2d Cir. 1990).
130. Willis, 737 F. Supp. at 275.
131. Chestman, 903 F.2d at 77.
132. Id.
MISAPPROPRIATION THEORY
19911
Loeb's duty to the Waldbaum family.1 33 The Second Circuit reversed his conviction because there was no evidence that the
family member revealed the critical information in breach of a
34
duty of trust and confidence known to Chestman.
The court in Willis distinguished this case from
Chestman.135 The court stated that Jane Doe was not in the position of Loeb and that Willis was not in the position of tipper/
tippee.1 3 6 The court concluded that the information revealed to
Willis, by virtue of the nature of their doctor/patient relationship, was obviously confidential." 7
Willis knew that he was receiving confidential information,
and by disclosing it he breached a duty of trust and confidence
which he owed to his patient.33 Accordingly, the court found
this case distinguishable from Chestman because the information did not lose its confidential character by "passing through
several family channels" as it did in Chestman.1 3 9 The information was confided directly by the insider to his wife and by her
to the psychiatrist.1 0
133.
Id. at 78.
134. Id. at 77-82. Chestman, a stockbroker, traded shares of stock for himself and
clients including Keith Loeb, based on information he received from Keith Loeb, a client. Id. Loeb revealed critical information to Chestman concerning Waldbaum stock. Id.
Chestman was aware that Loeb was a member of the Waldbaum family. Id. Since there
was no evidence of a breach of a duty or trust by Loeb, Chestman's conviction for securities fraud and mail fraud was reversed. Id. The information concerning Waldbaum was
passed from Ira Waldbaum who told his sister; she told her daughter, Susan Loeb; and
Susan told her husband Keith Loeb. Id. There was no showing of confidentiality to
Chestman in view of the attenuated passage of information. Id. There was no showing
that family relationship implied that confidentiality would be maintained. Id.
135.
Willis, 737 F. Supp. at 275.
136. Id. Evidence that Keith Loeb revealed critical information in breach of a duty
of trust and confidence known to Chestman is essential to the imposition of liability on
Chestman as an aider/abettor or as a tippee. Id. The Willis court stated that it was
irrelevant whether Willis knew that the information imparted to him by Jane Doe was
confidential. Id. It was relevant, however, that Willis knew he was receiving the information in confidence, that it was valuable, non-public information, and that by disclosing it
he was breaching a duty of trust and confidence that he owed to his patient. Id.
137. Id. The Information has significant meaning because it concerns Jane Doe's
personal life. Id.
138. Id. Jane Doe did not breach a duty to her husband. Id.
139.
Willis, 737 F. Supp. at 275.
140.
Id.
BRIDGEPORT LAW REVIEW
IV.
[Vol. 12:317
ANALYSIS
The District Court based its decision in United States v.
Willis on allegations that Willis purchased BankAmerica stock
while in possession of confidential information given to him by
Jane Doe. 141 The information was given to Willis in the context
of a physician-patient relationship. 142 He then traded on the information in violation of his duty to his patient of trust and confidence.14 The act of trading in violation of his duty to Jane Doe
constituted criminal securities fraud in violation of Section 10b5.1 The complaint did not assert that Willis owed any duty to
Sanford I. Weill or to BankAmerica. 45 In addition, the complaint did not charge that Jane Doe had any obligation not to
disclose the information to Willis. Nor did the complaint allege
that she imparted the information for any wrongful purpose. 46
The conviction was premised upon a breach of Willis's duty
to his patient. The complaint asserted no duty owed to a market
participant or to any participant in the corporate world. 147 Jane
Doe was neither an insider nor a market participant.148 The premise upon which liability was found was not within the traditional securities fraud/duty analysis that the United States Supreme Court has approved.149
Trading securities on the basis of material non-public information is fraud under Section 10(b) and Rule 10b-5 only where
the trader owed a duty of disclosure.15 The United States Su-
preme Court in Chiarella held that the mere possession of nonpublic information did not bring with it a corresponding duty to
publicly disclose that information or to abstain from trading on
141. Id.
142. Id. at 272.
143. Willis, 737 F. Supp. at 272.
144. Id. at 270.
145. Id. at 272, 274.
146. Id. at 273. Jane Doe had a duty not to trade on the information acquired
through marital confidence. Id.
147. Willis, 737 F. Supp. at 274.
148. Id. at 271.
149. See Chiarella v. United States, 445 U.S. 222, 235 (1980) (the mere possession
of non-public, confidential market information does not bring with it a corresponding
duty to publicly disclose information or to abstain from trading on basis of that knowledge). Id. at 234. See also Dirks v. S.E.C., 463 U.S. 646, 654-55 (1983) (restating principles set forth in Chiarella).
150. See Dirks, 463 U.S. at 654; Chiarella, 445 U.S. at 229-30.
1991]
MISAPPROPRIATION THEORY
the basis of that information."5 In Dirks, the United States Su-
preme Court restated the principle that the mere possession of
material non-public information does not give rise to a duty to
disclose or abstain from trading absent a relationship of trust
and confidence between the parties to the transaction. The Supreme Court in Dirks held that a tippee who receives information from an insider only assumes a fiduciary duty when the insider breached his fiduciary duty to the shareholders by
disclosing the information improperly and the tippee knew or
should have known that there has been a breach." 52 The District
Court did not view Willis as a tippee, thus he would have needed
a direct duty to the corporation before he would have been
under an obligation to disclose or abstain.'"3
In Willis, the complaint did not allege that Willis owed any
duty to BankAmerica or its shareholders."" Nor did the complaint allege that Jane Doe was an insider or that she disclosed
the information concerning her husband's desire to become chief
executive officer of BankAmerica with the idea that she would
personally benefit from disclosure.55 Since there was no duty
owed nor breached in the transaction there can be no liability
under Section 10(b). 5 e
In order to circumvent the fiduciary relationship requirement, however, the Second Circuit has applied the misappropriation theory. 5 ' The District Court premised liability on Willis'
breach of a duty owed to his patient, i.e., his misappropriation of
non-public information received in confidence. 51 Jane Doe was
in lawful possession of material non-public information.5 e She
communicated this to Willis in the context of a relationship of
151. Chiarella,445 U.S. at 235; See also In re Cady, Roberts & Co., 40
S.E.C. 907
(1961) (the obligation to "disclose or abstain" imposed upon corporate
insiders.)
152.
153.
154.
155.
Dirks, 463 U.S. at 666-67.
Id.
Willis, 737 F. Supp. 269, 273 (S.D.N.Y. 1990).
Id. at 270, 272.
156.
See supra note 148 and accompanying text for a discussion of the United
States Supreme Court's bases of liability under 10b-5.
157. Willis, 737 F. Supp. at 271.
158. Id. at 271-72. Central to this theory is a breach of a duty of trust
and confidence. Id. at 272. The court speaks of relationship between doctor and
patient which
requires a high degree of trust and confidence. Id.
159.
Id. at 274.
BRIDGEPORT LAW REVIEW
[Vol. 12:317
trust and confidence.16 0 Consequently, Willis breached his duty
to Jane Doe by misappropriating the information and using it
for his own personal benefit."6 1
The Second Circuit has held that Section 10(b) and Rule
10b-5 prohibit the purchase and sale of securities while in possession of material non-public information that has been improperly misappropriated. 6 2 In light of the foregoing, the Section 10(b) counts do validly allege a federal offense. However,
the misappropriation theory has never been adopted by the Supreme Court.16 3 Because this theory was only affirmed by the
United States Supreme Court, it is of no precedential value. 6 It
remains an open question whether the four justices who voted
against the affirmation of liability under 10b-5 did so because of
the theory to the particular facts of Carpenter or a general dis6
approval of the misappropriation theory.1 5
The facts of Willis make it distinguishable from Carpenter,
Materia, Grossman, and Newman. In Carpenter,Materia, and
Newman the fact pattern involved an employee breach of a duty
of confidence to his employer by misappropriating information
received during the course of employment.' All of the employ160. Id. at 272.
161. Willis, 737 F. Supp. at 276.
162. See United States v. Grossman, 843 F.2d 78, 84 (2d Cir. 1988) (associate in
law firm breached firm policy by disclosing information entrusted to his employer by his
employer's client regarding the client's planned recapitalization); United States v. Carpenter, 791 F.2d 1024, 1031-32 (2d Cir. 1986) (employee of financial newspaper breached
newspaper's policy by misappropriating confidential information as part of insider trading scheme); S.E.C. v. Materia, 745 F.2d 197, 201 (2d Cir. 1984) (employee of a financial
printer traded on corporate information entrusted to his employer by his employer's client); United States v. Newman, 664 F.2d 12, 18 (2d Cir. 1981) (investment bankers
breached duties to employers and employers' corporate clients), cert. denied, 464 U.S.
863 (1983).
163. See United States v. Carpenter, 791 F.2d 1024 (2d Cir. 1986), aff'd, 484 U.S.
19 (1987). The Supreme Court was evenly divided in affirming the conviction based on
the securities laws but did not address the misappropriation theory in its opinion. Id.
164. See Neil v. Biggers, 409 U.S. 188 (1972) (an evenly split affirmance is not considered an actual adjudication of the case); Trans World Airlines, Inc., v. Hardison, 432
U.S. 63 (1977) (judgment entered by an evenly divided court is not entitled to precedential weight); Arkansas Writers' Project, Inc. v. Ragland, 481 U.S. 221 (1987) (an affirmance by an equally divided court is not entitled to precedential weight); See also J.
NOWACK, R. ROTUNDA & J. YOUNG, CONSTITUTIONAL LAW § 2.5, at 33 (1986). (Commentators have recognized the weakness of the Carpenter decision and have urged legislation
that would codify the misappropriation theory).
165. See Langevoort, supra note 10, at 185.
166. See supra notes 74-94 for a discussion of the misappropriation theory and the
19911
MISAPPROPRIATION THEORY
ers in these cases were involved in the securities industry.'67 In
Willis, on the other hand, Willis's breach of a duty to his patient
had no relation to any business involved in the securities industry. Nor was it a breach concerning a relationship of employer/
employee. In addition, Jane Doe did not suffer any injury. She is
not alleged to have had a genuine business purpose for acquiring
the information from her husband which she then imparted to
Willis. The court delineates this information as "business information" and characterizes Jane Doe as an "employer.' 6 8 However, Jane Doe gave Willis the confidential information because
of personal, nonbusiness reasons. The government attempted to
satisfy the requirement of injury to the defrauded person by asserting that because Willis disclosed information received in
confidence, it created a cognizable wrong. However, no facts
were presented which suggest that Jane Doe actually or potentially suffered any harm. Furthermore, the United States Supreme Court has held that not every breach of a fiduciary duty
constitutes securities fraud under70 10b-5. ss The Court has rejected a general duty to disclose.1
Willis, the employee, breached a duty of confidentiality to
his employer, Jane Doe. This constitutes fraud against the employer, not against investors in the securities market.17 1 There
was no relationship between Jane Doe's psychiatric treatment
and the securities market. Since the United States Supreme
facts and holding of Carpenter, Materia, Grossman, and Newman.
167. See supra notes 10, 74-94 for a discussion of some misappropriation cases.
Carpenter, 484 U.S. 19 (the Wall Street Journal was actively involved in the securities
industry and gathered information about the securities industry); Newman, 664 F.2d 12
(investment banking was an integral part of the securities industry); Materia, 745 F.2d
197 (financial printers served as a vital service to participants in the securities industry);
See also, Grossman, 843 F.2d 78 (a law firm represented a client regarding their capital
position); United States v. Elliott, 711 F. Supp. 425 (N.D. Ill. 1989) (a law firm represented clients in merger and acquisitions transactions); S.E.C. v. Tome, 638 F. Supp. 596
(S.D.N.Y. 1986) (the information concerned a hostile tender offer of Seagram); S.E.C. v.
Peters, 735 F. Supp. 1505 (D. Kan. 1990) (partnership information concerning a possible
investor to purchase ERG was misappropriated by a partner); S.E.C. v. Musella, 578 F.
Supp. 425 (S.D.N.Y. 1984) (lawyer traded on confidential information of his firm's client
regarding the client's potential acquisition).
168. Willis, 737 F. Supp. 269, 276 (S.D.N.Y. 1990).
169. Id.
170. See Chiarella v. United States, 445 U.S. 222, 232. n.14 (1980).
171. There was no claim in Willis that he perpetrated a fraud against investors in
BankAmerica. Rather the emphasis was on the fraud against Jane Doe which was held
sufficient to support a 10b-5 claim. Willis, 737 F. Supp. at 272.
BRIDGEPORT LAW REVIEW
(Vol. 12:317
Court did not resolve any of the questions presented concerning
the misappropriation theory, it's proper application is still undetermined. " 2 The District Court's expansion of this theory in
Willis converts liability under 10b-5 into a vehicle to protect a
doctor/patient relationship which is not interrelated with the securities industry. The misconduct at issue here, whether ethical
or unethical, does not fall within the reach of the securities
laws. 3 A breach under the securities laws must have some relation to the securities market. 74
V.
CONCLUSION
The United States Supreme Court has set forth the basis
for liability under Rule 10b-5 in a coherent and logical manner.
The Supreme Court, while recognizing that Section 10(b) is a
catch-all provision, realizes that what it catches must be
fraud.'" Nondisclosure can only be fraudulent when there is a
duty to speak, and a relationship that gives rise to a duty must
exist before 10b-5 can be violated.176 The Supreme Court has
continually stated that while Section 10(b) was intended to prevent common law fraud, the Court is not empowered to expand
the reach of the rule beyond the statute so as to judicially rewrite it.'" The district court's, decision illogically extends the
reach of federal securities laws by eliminating the requirement
of fraudulent nondisclosure. Not every moral or ethical violation
in conjunction with the trading of securities necessarily violates
172. See Langevoort, supra note 10 at 185. Although the exact vote was not disclosed, one commentator suggests the four votes in favor of upholding the conviction
were Justices Brennan, Marshall, Stevens, and Blackmun. Id. Whether the Justices voting against the theory signal their disapproval of the theory or the application in this
particular case is unknown. Id. According to Langevoort's analysis the four Justices vot-
ing against the use of the misappropriation theory were Chief Justice Rehnquist and
Justices O'Connor, Scalia, and White. Id.
173. See Chiarella,445 U.S. at 232.
174. See supra note 16-22 for the requirements of the securities fraud provisions.
"These anti-fraud provisions are not intended as a specification of particular acts or
practices which constitute fraud, but rather are designed to encompass the infinite variety of devices by which undue advantage may be taken of investors and others." In re
Cady, Roberts, 40 S.E.C. 907, 911 (1961).
4
175. Chiarella, 445 U.S. at 234-35.
176. Id. at 235.
177. See Blue Chip Stamps v. Manor Drug Store, 421 U.S. 723, 748-49, 756 (1975).
Before a court can extend Section 10(b) to include the offer to sell any security there
must be support in the structure of the legislation. None exists in this case. Id. at 756.
1991]
MISAPPROPRIATION THEORY
341
the federal securities laws. Federal Courts must set boundaries
to allow the rules to satisfy the objectives upon which they are
based.
Suzanne Krudys