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Law School Case Brief

United States v. O'Hagan - 521 U.S. 642, 117 S. Ct. 2199 (1997)


Under the traditional or classical theory of insider trading liability, § 10(b) of the Securities Exchange Act of 1934 (15 U.S.C.S. § 78j(b)) and Securities Exchange Commission Rule 10b-5 ( 17 C.F.R. § 240.10b-5) are violated when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information. Trading on such information qualifies as a deceptive device under § 10(b) because a relationship of trust and confidence exists between the shareholders of a corporation and the corporate insiders. That relationship gives rise to a duty to disclose or to abstain from trading. The classical theory applies not only to officers, directors, and other permanent insiders of a corporation, but also to attorneys, accountants, consultants, and others who temporarily become fiduciaries of a corporation.


When a law firm began representing a client regarding the client's confidential tender offer for a company's common stock, a firm partner, who did no work on the offer, purchased company stock and stock options that the partner sold at a profit of more than $4.3 million after the client publicly announced the tender offer and the stock price per share rose substantially. The partner, who was charged with defrauding the firm and the client by using material nonpublic information regarding the tender offer for the partner's trading purposes, was convicted in a Federal District Court of (1) 20 counts of mail fraud (2) 17 counts of securities fraud, (3) 17 counts of fraudulent trading in connection with a tender offer and (4) 3 counts of money laundering, in violation of federal law. On appeal, the United States Court of Appeals for the Eighth Circuit, reversed all of the partner's convictions. It expressed the view that (1) liability under 10(b) and Rule 10b-5 could not be grounded on the misappropriation theory of securities fraud (the theory that a person committed fraud in connection with a securities transaction, and thereby violated 10(b) and Rule 10b-5, when the person misappropriated confidential information for securities trading purposes, in breach of a duty owed to the source of the information) on which the prosecution had relied; (2) Rule 14e-3(a) exceeded the SEC's 14(e) rule-making authority, because the rule contained no breach-of-fiduciary-duty requirement; and (3) the mail fraud and money laundering convictions could not stand because they rested on violations of the securities laws.


Were the convictions against the law partner proper?




The United States Supreme Court reversed the judgment of the Eighth Circuit reversing the convictions, holding that criminal liability under the Securities Exchange Act of 1934 may be predicated on the misappropriation theory. The Court also held that Securities Exchange Commission Rule 14e-3(a) was the proper exercise of the Commission's prophylactic powers under § 14e of the Securities Exchange Act of 1934, regarding the prevention of the misappropriation charged against respondent.

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