521 U.S. 642 (1997), 96-842, United States v. O'Hagan
|Docket Nº:||Case No. 96-842|
|Citation:||521 U.S. 642, 117 S.Ct. 2199, 138 L.Ed.2d 724, 65 U.S.L.W. 4650|
|Party Name:||UNITED STATES v. O'HAGAN|
|Case Date:||June 25, 1997|
|Court:||United States Supreme Court|
Argued April 16, 1997
CERTIORARI TO THE UNITED STATES COURT OF APPEAL FOR THE EIGHTH CIRCUIT
After Grand Metropolitan PLC (Grand Met) retained the law firm of Dorsey & Whitney to represent it regarding a potential tender offer for the Pillsbury Company's common stock, respondent O'Hagan, a Dorsey & Whitney partner who did no work on the representation, began purchasing call options for Pillsbury stock, as well as shares of the stock. Following Dorsey & Whitney's withdrawal from the representation, Grand Met publicly announced its tender offer, the price of Pillsbury stock rose dramatically, and O'Hagan sold his call options and stock at a profit of more than $4.3 million. A Securities and Exchange Commission (SEC) investigation culminated in a 57-count indictment alleging, inter alia, that O'Hagan defrauded his law firm and its client, Grand Met, by misappropriating for his own trading purposes material, nonpublic information regarding the tender offer. The indictment charged O'Hagan with securities fraud in violation of § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5, with fraudulent trading in connection with a tender offer in violation of § 14(e) of the Exchange Act and SEC Rule 14e-3(a), and with violations of the federal mail fraud and money laundering statutes. A jury convicted O'Hagan on all counts, and he was sentenced to prison. The Eighth Circuit reversed all of the convictions, holding that § 10(b) and Rule 10b-5 liability may not be grounded on the "misappropriation theory" of securities fraud on which the prosecution relied; that Rule 14e-3(a) exceeds the SEC's § 14(e) rulemaking authority because the Rule contains no breach of fiduciary duty requirement; and that the mail fraud and money laundering convictions rested on violations of the securities laws, so could not stand once the securities fraud convictions were reversed.
1. A person who trades in securities for personal profit, using confidential information misappropriated in breach of a fiduciary duty to the source of the information, may be held liable for violating § 10(b) and Rule 10b-5. Pp. 649-666.
(a) Section 10(b) proscribes (1) using any "deceptive device" (2) "in connection with the purchase or sale of any security," in contravention of SEC rules. The Commission adopted Rule 10b-5 pursuant to its § 10(b) rulemaking authority; liability under Rule 10b-5 does not extend
beyond conduct encompassed by § 10(b)'s prohibition. See, e. g., Ernst & Ernst v. Hochfelder, 425 U.S. 185, 214. Under the "traditional" or "classical theory" of insider trading liability, a violation of § 10(b) and Rule 10b-5 occurs when a corporate insider trades in his corporation's securities on the basis of material, confidential information he has obtained by reason of his position. Such trading qualifies as a "deceptive device" because there is a relationship of trust and confidence between the corporation's shareholders and the insider that gives rise to a duty to disclose or abstain from trading. Chiarella v. United States, 445 U.S. 222, 228-229. Under the complementary "misappropriation theory" urged by the Government here, a corporate "outsider" violates § 10(b) and Rule 10b-5 when he misappropriates confidential information for securities trading purposes, in breach of a fiduciary duty owed to the source of the information, rather than to the persons with whom he trades. Pp. 650-653.
(b) Misappropriation, as just defined, is the proper subject of a § 10(b) charge because it meets the statutory requirement that there be "deceptive" conduct "in connection with" a securities transaction. First, misappropriators deal in deception: A fiduciary who pretends loyalty to the principal while secretly converting the principal's information for personal gain dupes or defrauds the principal. A company's confidential information qualifies as property to which the company has a right of exclusive use; the undisclosed misappropriation of such information constitutes fraud akin to embezzlement. Cf. Carpenter v. United States, 484 U.S. 19, 25-27. Deception through nondisclosure is central to liability under the misappropriation theory. The theory is thus consistent with Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 473-476, a decision underscoring that § 10(b) is not an all-purpose breach of fiduciary duty ban, but trains on conduct that is manipulative or deceptive. Conversely, full disclosure forecloses liability: Because the deception essential to the theory involves feigning fidelity to the information's source, if the fiduciary discloses to the source that he plans to trade on the information, there is no "deceptive device" and thus no § 10(b) violation. Second, § 10(b)'s requirement that the misappropriator's deceptive use of information be "in connection with the purchase or sale of [a] security" is satisfied by the misappropriation theory because the fiduciary's fraud is consummated not when he obtains the confidential information, but when, without disclosure to his principal, he uses the information in purchasing or selling securities. The transaction and the breach of duty coincide, even though the person or entity defrauded is not the other party to the trade, but is, instead, the source of the nonpublic information. Because undisclosed trading on the basis of misappropriated, nonpublic information both deceives the source of
the information and harms members of the investing public, the misappropriation theory is tuned to an animating purpose of the Exchange Act: to ensure honest markets, thereby promoting investor confidence. It would make scant sense to hold a lawyer-turned-trader like O'Hagan a § 10(b) violator if he works for a law firm representing the target of a tender offer, but not if he works for a firm representing the bidder. The statute's text requires no such result. Pp. 653-659.
(c) The Eighth Circuit erred in holding that the misappropriation theory is inconsistent with § 10(b). First, that court understood the theory to require neither misrepresentation nor nondisclosure; as this Court explains, however, deceptive nondisclosure is essential to § 10(b) liability under the theory. Concretely, it was O'Hagan's failure to disclose his personal trading to Grand Met and Dorsey, in breach of his duty to do so, that made his conduct "deceptive" under § 10(b). Second, the Eighth Circuit misread this Court's precedents when it ruled that, under Chiarella v. United States, 445 U.S. 222, 230, 232, 233; Dirks v. SEC, 463 U.S. 646, 655; and Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U.S. 164, 191, only a breach of a duty to parties to a securities transaction, or, at the most, to other market participants such as investors, is sufficient to give rise to § 10(b) liability. Chiarella, 445 U.S., at 238, 239, 240-243, 245, expressly left open the question of the misappropriation theory's validity, and Dirks, 463 U.S., at 665, 666-667, also left room for application of the misappropriation theory in cases such as this one. Central Bank 's discussion concerned only private civil litigation under § 10(b) and Rule 10b-5, not criminal liability. Pp. 660-665.
(d) Vital to this Court's decision that criminal liability may be sustained under the misappropriation theory is the Exchange Act's requirement that the Government prove that a person "willfully" violated Rule 10b-5 in order to establish a criminal violation, and the Act's provision that a defendant may not be imprisoned for such a violation if he proves that he had no knowledge of the Rule. The requirement of culpable intent weakens O'Hagan's charge that the misappropriation theory is too indefinite to permit the imposition of criminal liability. See Boyce Motor Lines, Inc. v. United States, 342 U.S. 337, 342. The Eighth Circuit may address on remand O'Hagan's other challenges to his § 10(b) and Rule 10b-5 convictions. Pp. 665-666.
2. As relevant to this case, the SEC did not exceed its rulemaking authority under § 14(e) by adopting Rule 14e-3(a) without requiring a showing that the trading at issue entailed a breach of fiduciary duty. Section 14(e) prohibits "fraudulent . . . acts . . . in connection with any tender offer," and authorizes the SEC to "define, and prescribe means reasonably designed to prevent, such acts." Adopted under that statutory
authorization, Rule 14e-3(a) forbids any person to trade on the basis of material, nonpublic information that concerns a tender offer and that the person knows or should know has been acquired from an insider of the offeror or issuer, or someone working on their behalf, unless within a reasonable time before any purchase or sale such information and its source are publicly disclosed. Rule 14e-3(a) imposes a duty to disclose or abstain from trading whether or not the trader owes a fiduciary duty to respect the confidentiality of the information. In invalidating Rule 14e-3(a), the Eighth Circuit reasoned, inter alia, that § 14(e) empowers the SEC to identify and regulate "fraudulent" acts, but not to create its own definition of "fraud"; that, under Schreiber v. Burlington Northern, Inc., 472 U.S. 1, 7-8, § 10(b) interpretations guide construction of § 14(e); and that, under Chiarella, supra, at 228, a failure to disclose information can be "fraudulent" for § 10(b) purposes only when there is a duty to speak arising out of a fiduciary or similar relationship of trust and confidence. This Court need not resolve whether the SEC's § 14(e) fraud-defining authority is broader than its like authority under § 10(b), for Rule 14e-3(a), as...
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