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United States v. Chestman - 947 F.2d 551 (2d Cir. 1991)

Rule:

Under the misappropriation theory, a person violates Rule 10b-5, 17 C.F.R. § 240.10b-5 (1988), when he misappropriates material nonpublic information in breach of a fiduciary duty or similar relationship of trust and confidence and uses that information in a securities transaction. The misappropriation theory does not require that the buyer or seller of securities be defrauded. Focusing on the language fraud or deceit upon any person, the court has held that the predicate act of fraud may be perpetrated on the source of the nonpublic information, even though the source may be unaffiliated with the buyer or seller of securities.

Facts:

Robert Chestman is a stockbroker. He was convicted of insider trading in violation of Rule 14e-3(a), 17 C.F.R. § 240.14e-3(a)Rule 10b-517 C.F.R. § 240.10b-5 (1988), and 18 U.S.C.S. § 1341Chestman had bought shares of a company after he received information from a client that the company was about to be sold. 

Issue:

Did Chestman violate Rule 10b-5 or 18 U.S.C.S. § 1341 when he bought shares of a company after he received information from a client that the company was about to be sold?

Answer:

No

Conclusion:

On appeal, the court held that the Securities and Exchange Commission had been given broad authority to promulgate rules that would prohibit tender offer insider trading, and had not exceeded its authority in promulgating Rule 14e-3(a). Further, Congress was aware of the rule and had not altered it. Additionally, Chestman could not be convicted for Rule 10b-5 or 18 U.S.C.S. § 1341 violations since he owed no fiduciary duty to the company nor did his client. As a result, the court affirmed Chestman's conviction under Rule 14e-3(a), but reversed his convictions for Rule 10b-5 and 18 U.S.C.S. § 1341 violations.

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