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Andrew Pompa is 2L at Washington and Lee University with a background in economics and finance. Though his career path is undecided, he is very interested in securities regulation and insider trading. In this episode of Classroom Insiders with Professor Karen Woody, Andrew explores how misappropriation theory became legitimized by the court as a proper theory.
Andrew shares the differences between misappropriation theory and the classical theory of insider trading. In the classical theory, liability is premised on a breach of fiduciary duty, whereas misappropriation premises liability on a breach of confidentiality in a way that encapsulates people who would be deemed corporate outsiders. Carpenter v. SEC paved the way for the court’s acknowledgement of misappropriation theory.
Carpenter was an individual who received information from a Wall Street Journal reporter and traded it to stockbrokers, making roughly $690,000. The SEC successfully argued in the lower court that Carpenter and his accomplices breached a duty of confidentiality towards Wall Street Journal on the premise of misappropriation theory.
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Derek is 2L at Washington and Lee University with a background in K-9 search and rescue in California. He now balances being a law student, pet owner for a retired working dog, husband, and father. In this episode of Classroom Insiders, Derek discusses misappropriation theory and how it came about.
Justice Powell believed that the idea of equal access to information was not practical in relation to reality. While it may have been the ideal, the disclose-or-abstain rule was not a pragmatic approach to regulating insider trading, as no one would ever have equal access to information across the board. Powell expressed this in his ruling, arguing that if equal access to information was required, there wouldn’t be many people trading.
According to Justice Powell, misappropriation theory was an extension of insider trading regulation that was beyond of the SEC’s authority and the existing understanding of insider trading regulation. Unfortunately, he retires after convincing some of his colleagues to vote against it. As he was no longer on the bench, he could not contribute to the tied 4-4 voting results, so the Second Circuit’s opinion stood by default.
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Lillian is a second-year student at Washington and Lee and will be working at a civil litigation firm. She plans to work in the field of civil law. In this episode of Classroom Insiders, Lillian discusses how the cases of Chiarella and Carpenter impacted the SEC, and insider trading regulations.
Chiarella came about when an employee of a financial printer company broke codes that concealed the names of companies involved in tender offers, then purchased shares from those companies before the bid was announced. In this case, Justice Powell introduced fiduciary duty as the reason individuals needed to disclose or abstain. Years before Chiarella, the SEC knocked down case after case of insider trading in favor of the government. Chiarella was Powell's first opportunity to challenge the SEC'S policy of equal access, as well as crack down on the SEC'S attempt to broaden the interpretation of insider trading. Because Chiarella was not an employee, director, or officer of any of the companies whose stock was traded, there was no violation of securities law under that.
Misappropriation had a part to play in the case of Carpenter and The Wall Street Journal columns. Information on what dates and times certain columns that affected the stock market would be published were traded from Winans to his clients via Carpenter. Justice Powell himself requested to hear the case with the intention of dismissing misappropriation theory as a whole. Justices Rehnquist and O'Connor joined his descent but Powell retired before the case could be heard by him. This caused the Supreme Court to be split on whether misappropriation was valid for liability being imposed on Carpenter. In Powell's memos, it's stated that he wanted to reject the theory of misappropriation for insider trading under 10B5.
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Lidia Kurganova is a 2L at Washington and Lee, and a staff writer on Law Review. She plans to work at Weil, Gotshal and Manges this summer in their New York office, and hopes to specialize in either corporate or technology, or an intersection of the two. In this episode of Classroom Insiders, Lidia discusses how Justice Powell gradually loosened the SEC’s hold on insider trading regulation.
Insider trading was regulated by states up until the 1960’s, when President Kennedy appointed Chairman William Cary of Columbia Law, who wanted the SEC to have broad regulatory powers. Chairman Cary provided a new federal basis for broad enforcement powers of insider trading, which was then adopted by the Second Circuit in the Texas Gulf Sulphur case and birthed the disclose-or-abstain rule. This decision would stand for the next decade as the preeminent insider trading rule, until Chiarella and Justice Powell.
Justice Powell chipped away at the SEC’s regulatory overreach case by case, starting with Chiarella v. SEC where he introduced the fiduciary relationship element to the disclose-or-abstain rule, and then Dirks v. SEC where he is credited for adding a personal benefit element to the tipper-tippee rule. The majority opinion written by Justice Powell established a personal benefit test, which requires courts to determine whether an insider tipper personally benefits indirectly or directly from disclosure. Three examples of personal benefits are: pecuniary gain, reputation gain, and a presumption of benefit due to close friend or family member relationship.
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Colin Manchester is a J.D. Candidate at Washington and Lee and a former Summer Associate at Levene Gouldin and Thompson. He has experience in the defense and aerospace industry. He plans to work at Simpson Thatcher and Barlett in New York City next summer. In this episode of Classroom Insiders, Colin discusses how Justice Powell’s background translated into his understanding of the law and how this affected Dirks v. SEC.
It was Powell’s opinion that an individual should only be duty-bound to disclose information if there exists a relationship of trust and confidence between the parties, which is now recognized as a fiduciary duty. Therefore, if there is no fiduciary duty, there is no duty to disclose, which means you can’t be in violation of the disclose or abstain rule if you trade the information. His background as a corporate attorney helped him understand that equal access to the fair market was impossible, which influenced his opposition of the hard and fast disclose or abstain rule.
Dirks was an officer of a New York investment advisory firm who attempted to whistleblow on Equity Funding Corporation of America after receiving information about their fraudulent bookkeeping. He tried disclosing the information to the SEC and a Wall Street Journal publication. He then informed his clients, who sold their stocks before the information went public. The SEC saw this as Dirks attempting to get out early and avoid a huge loss, but Justice Powell argued that since Dirks received no pecuniary gain or reputational benefit, he could not be found liable.
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Staats Smith was a judicial intern with the Delaware Chancery Court this past summer, and plans to work with one of the large Delaware firms during the next. He is a 2L student at Washington and Lee. In this episode of Classroom Insiders, Staats talks about the pivotal case of Dirks v. SEC.
Chiarella was an employee for a financial printing publication, which was used by the company to disclose their material nonpublic information. To avoid premature disclosure, the company developed a code to prevent its employees from trading on the information before it went public. However, Chiarella was able to crack the code, and made hefty profits on his trades as he was always leading it before the news broke. He was convicted for violating the disclose-or-abstain rule by the District Court, which was affirmed by the Second Circuit. Justice Powell decided to reverse the conviction; it was in his view that Chiarella owed no duty to the sellers or shareholders, as he was not an insider or a fiduciary.
Any fiduciary relationship Chiarella had with his employer was not considered due to the application of a judicial waiver, Staats claims; an argument not briefed or argued is deemed waived. The theory of misappropriation was not brought up at all in the District Court, so it could not even be considered on review.
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Tianjiao Lyu studied international business law at Beijing Foreign Studies University. She plans to work at the Clifford Chance Beijing office after graduating from Washington and Lee. In this episode of Classroom Insiders, Lyu talks about insider trading between the 1960s and the 1980s.
Between 1941 and 1971, the disclose or abstain rule implemented by the SEC had become so expensive that it discouraged the development of the securities market, Lyu states. As a rule, it was not very pro-business. During that time, the SEC was very aggressive in their enforcement of insider trading regulation, and won every case they brought to court about insider trading. This changed, however, when Justice Powell joined the Supreme Court.
“Justice Powell’s close interactions with businessmen while lawyering led him to trust in their characters,” Lyu says. “That kind of trust made him hostile to what he saw as excessive regulation, which infringe on free enterprise.” He questioned the SEC’s use of Section 25 and their attempt to expand their reach. It was Powell’s view that the SEC’s rules were unrealistically intended to guarantee investors profit in their investments.
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Legislation changes month to month, year to year, but over the last century, the changes have been astounding. Classroom Insiders is the exciting new podcast where Karen Woody and her students from Washington and Lee University explore the arc and evolution of insider trading law for the past 100 years.
In this pilot episode of Classroom Insiders, Karen interviews Ben Richie. Ben is currently a Student Honors Intern in the U.S. Securities and Exchange Commission. Previously, he worked as a Corporate Paralegal in the Greater New York City Area. Ben talks about the history of insider trading law, including the events that inspired its inception, and how it has evolved into what we know today.
“Insider trading laws started formulating in the late 19th century, though they looked very different to how they are now,” Ben says. Each state handled them individually, and they created a minority and majority rule. The majority rule, founded in treatise law, stated that insiders weren’t duty-bound in their private dealings with stockholders. The minority rule, developed in 1903, stated that insiders had a duty to disclose all material information to shareholders before trading on it.
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Join Karen Woody and her Insider Trading Seminar students from Washington and Lee university as they explore the arc and evolution of insider trading over the last century. Each episode will feature a discussion between Karen Woody and a student about insider trading and regulation. Find out what the future lawyers of the university think about past and current legislation, and learn more about this fascinating area of law.
