It took nearly a decade for the Supreme Court to revisit the applicability of the misappropriation doctrine they had deadlocked on in Carpenter. That is not to say that the SEC sat on the sidelines waiting for a case to arise. In fact, after the Carpenter deadlock, the SEC actively enforced insider trading cases, urging lower courts to adopt the misappropriation theory. But the lower courts divided on the issue, and the Eighth Circuit overturned the conviction of James O'Hagan for securities and mail fraud and for violation of Rule 14e-3, because the court found that O'Hagan owed no duty to Pillsbury, the company in whose stock he had traded. The Supreme Court resolved to settle the disputes among the circuit courts in United States v O'Hagan.(53)
O'Hagan, a Minneapolis legal icon, was charged with violating Section 10 and Rules 10b-5 and 14e-3 by trading on misappropriated, non-public information he acquired while at his law firm. O'Hagan was neither a classic nor a constructive insider, nor could he be held liable under the disclose or abstain rule. The SEC and the U.S. Justice Department prosecutors advocated a broad, expansive reading of Rule 10b-5 to cover any deceit, meaning that for O'Hagan, his misappropriation of his employer's information was for his personal benefit, in connection with the purchase or sale of a security. At oral argument, Chief Justice Rehnquist quizzed Deputy Solicitor General Michael Dreeban about the SEC theory.
"What bothers me about this case," queried Rehnquist, "is what is the connection between the ‘deceptive device' and the ‘purchase or sale' of the security" since O'Hagan didn't deceive anyone who sold him the Pillsbury stock."
The misappropriation theory, replied Dreeban, "had a broader aim to pick up the cunning devices that people might use." The issue in O'Hagan, he remarked, was "a unique kind of fraud, unique to the securities markets" in which a person could profit from misappropriated information only by trading or tipping someone else off.
But John D. French, O'Hagan's lawyer, dismissed the SEC attempt to expand the misappropriation theory. "If Congress wants to get the misappropriation theory into law, it has to write it into law." Otherwise, he added, remembering the troika of Justice Powell-inspired cases from the 1980s, "you cannot disconnect the misappropriation from the purchase and sale."(54)
On June 25, 1997, in an opinion written by Justice Ruth Bader Ginsburg, the Supreme Court upheld the misappropriation theory as a valid basis on which to impose insider trading liability. While the Supreme Court acknowledged that misappropriators had no independent duty to disclose to persons with whom they traded, the legal obligation under the Securities Acts was founded on the theory that "a fiduciary's undisclosed, self-serving use of a principle's information to purchase and sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information."
So defined, the misappropriation theory thus satisfied the 10(b) requirement of a "deceptive device or contrivance" used "in connection with a securities transaction." SEC Chairman Arthur Levitt Jr. commented that the decision reaffirmed "the SEC's efforts to make the stock market fair to all people, whether you're a Wall Street veteran or a Main Street newcomer." The misappropriation theory was well-tuned to the animating principle of federal securities law: to insure honest securities markets and thereby promote investor confidence.
The success of the SEC was the result of a long and persistent strategy that avoided congressional definitions that it felt would make actual enforcement more difficult, while advocating for common law interpretations that promoted a somewhat nebulous definition of insider trading based on principles of equal access to market information. Opting for a common law interpretation while developing administrative rules of enforcement allowed the SEC to react to market abuses, but not overreact in a way that might damage its enforcement flexibility or the stability of the markets. The ideological and legal persistence of the SEC won the day in 1997, but insider trading issues remain an ongoing debate.
(54) Linda Greenhouse, "S.E.C. Argues Insider-Trade Theory Before High Court," The New York Times, April 17, 1997, D1.
