Of the Southern District of New York, sitting by designation. *

United States Court of Appeals

For the First Circuit

No. 06-1571

SECURITIES AND EXCHANGE COMMISSION,

Plaintiff, Appellee,

v.

PATRICIA B. ROCKLAGE; WILLIAM M. BEAVER; DAVID G. JONES,

Defendants, Appellants.

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF MASSACHUSETTS

[Hon. Morris E. Lasker, Senior U.S. District Judge] *

Before

 Torruella, Lynch, and Lipez,

Circuit Judges.

David H. Erichsen, with whom Peter Spaeth, Pratik A. Shah,

and Wilmer Cutler Pickering Hale and Dorr LLP were on brief, for

appellant Patricia B. Rocklage.

David E. Marder, with whom Benjamin D. Stevenson and Robins,

Kaplan, Miller & Ciresi LLP were on brief, for appellant William

M. Beaver.

Brian E. Whiteley and Scibelli, Whiteley and Stanganelli,

LLP on brief for appellant David G. Jones.

Randall W. Quinn, Assistant General Counsel, with whom Brian

G. Cartwright, General Counsel, Jacob H. Stillman, Solicitor, and

Jeffrey Tao, Senior Counsel, were on brief, for appellee.
November 14, 2006
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LYNCH, Circuit Judge. This is an interlocutory appeal

from the denial of defendants' motion to dismiss a civil complaint

based on an issue of law.

The complaint was brought by the SEC on a

misappropriation theory of insider trading. It alleged that

defendant Patricia B. Rocklage intentionally used deceptive means

to obtain from her husband highly negative and non-public

information about his publicly-traded company, in order to tip her

brother who owned company stock, which then led to trading of the

stock by her brother and another. Specifically, Mrs. Rocklage

initially concealed from her husband her prior agreement with her

brother to tip him if she learned significant negative information

about the company. She also concealed that she did not intend to

maintain the confidentiality that her husband had reasonably

understood to bind her. After Mrs. Rocklage acquired the

information on the basis of this deception, and shortly before she

actually tipped her brother, however, she told her husband that she

was going to give her brother the information. Her husband asked

her not to do so, but she did so anyway, pursuant to the agreement.

Under the circumstances and timing of the events, there was little

her husband could do to prevent her from tipping her brother or to

prevent her brother from trading on the information. Her brother

sold his stock in the company on the next day the market opened and

he passed the information on to a friend who did the same. The
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brother, William M. Beaver, and friend, David G. Jones, are also

defendants.

The three defendants moved under Federal Rule of Civil

Procedure 12(b)(6) to dismiss the SEC's complaint for failure to

state a claim; they argued that under language in United States v.

O'Hagan, 521 U.S. 642 (1997), Mrs. Rocklage's pre-tip disclosure to

her husband, telling him that she intended to tip-off her brother,

completely negated any liability under the misappropriation theory.

We conclude that O'Hagan does not require dismissal of this suit

for failure to state a claim.

I.

On January 12, 2005, the SEC filed a civil complaint

against the defendants. The complaint alleged the following key

facts, which we must take as true under Rule 12(b)(6). See Conley

v. Gibson, 355 U.S. 41, 45-46 (1957). We draw all reasonable

inferences in the SEC's favor. See Ramirez v. Arlequin, 447 F.3d

19, 20 (1st Cir. 2006).

Mrs. Rocklage was the wife of Scott M. Rocklage. Mr.

Rocklage was the Chairman and CEO of Cubist Pharmaceuticals, Inc.,

a publicly-traded biotechnology company. Mrs. Rocklage was not an

employee of Cubist.

On December 31, 2001, Mr. Rocklage learned that one of

the company's key drugs had failed its clinical trial. That

afternoon, he phoned Mrs. Rocklage to discuss the trial results and
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he reached her while she was in a limousine. Before discussing the

results with her, Mr. Rocklage made clear his intention that the

results be kept confidential. He told her that she was not to

react to what he was about to say, and he instructed her not to

discuss the results in front of the limousine driver. She agreed.

From the time that Mr. Rocklage joined Cubist in 1994, he had

routinely communicated material, nonpublic information to his wife,

and she had always kept the information confidential. Based on

Mrs. Rocklage's agreement, and based on their prior history of

sharing nonpublic information about the company and her keeping

that information confidential, Mr. Rocklage had a reasonable

expectation that she would not disclose the trial results to

anyone. Based on his understanding that she would keep the

information confidential, Mr. Rocklage informed his wife that the

clinical trial had failed. Before the results were disclosed to

her, Mrs. Rocklage understood her husband's expectation of

confidentiality.

Unbeknownst to her husband, Mrs. Rocklage had a

preexisting understanding with her brother, defendant Beaver, that

she would inform him with "a wink and a nod" if she learned

significant negative news about Cubist. At the time that Mrs.

Rocklage learned the negative trial results, she knew or had

reason to believe that Beaver owned Cubist stock. She also knew or
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had reason to know her brother would trade in Cubist securities if

she disclosed the nonpublic information to him.

On the evening of December 31, 2001, Mr. Rocklage

discussed the failure of the drug trial in more depth with Mrs.

Rocklage. He informed her that Cubist would be making a public

announcement about the results, and that until that happened the

results were nonpublic. Mrs. Rocklage asked how the news would

affect Cubist's stock, and Mr. Rocklage informed her that the stock

price would drop significantly. As before, at the time that Mr.

Rocklage originally conveyed this information to Mrs. Rocklage, he

had a reasonable expectation that she would keep it confidential

and would not otherwise have disclosed the information. In effect,

by her deception Mrs. Rocklage induced her husband to disclose

material non-public information he would not otherwise have

disclosed, and she did so with the intention of sharing this

information with her brother to allow him to trade securities.

After that conversation, and on or about the evening of

December 31, 2001, Mrs. Rocklage informed her husband that she

planned to signal her brother to sell his stock. Mr. Rocklage

urged her not to do so, and he expressed his displeasure at the

idea. Nevertheless, sometime before the morning of January 2,

2002, Mrs. Rocklage called Beaver and gave him "a wink and a nod"

regarding Cubist. Beaver interpreted this to mean that he should

sell his Cubist stock, and so on the morning of January 2, 2002 --
 The SEC also alleged that the defendants had violated 1

§ 17(a) of the Securities Act of 1933. See 15 U.S.C. § 77q(a).

All parties agree that the analysis under § 17(a) is identical to

the analysis under § 10(b) and Rule 10b-5. Accordingly, we analyze

the issues solely under the latter two provisions.

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the first possible trading day after he was tipped off -- Beaver

sold all of his 5,583 shares of Cubist stock. By tipping her

brother, Mrs. Rocklage was providing a gift of confidential

information to a relative, and so she personally benefitted.

Beaver also tipped off his close friend and neighbor,

defendant Jones. Jones knew that Beaver's brother-in-law, Mr.

Rocklage, was Chairman and CEO of Cubist. Jones sold all of his

7,500 shares of Cubist stock on the morning of January 3, 2002.

Cubist publicly announced the negative drug trial results

on January 16, 2002, after the market had closed for the day. By

selling when they did, Beaver and Jones avoided losses of $99,527

and $133,222, respectively.

The SEC alleged that on the basis of these facts all

three defendants were guilty of insider trading under § 10(b) of

the Securities Exchange Act of 1934, see 15 U.S.C. § 78j(b), and

Rule 10b-5 thereunder, see 17 C.F.R. § 240.10b-5. It sought both 1

injunctive relief and monetary penalties from the defendants.

All three defendants filed a Rule 12(b)(6) motion to

dismiss for failure to state a claim. On August 23, 2005, the

district court issued an opinion denying their motion. In its

opinion, the court explained that the Supreme Court has recognized
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two theories of insider trading liability: the "classical theory"

and the "misappropriation theory." The classical theory generally

only imposes liability when a trader or tipper is an insider of the

traded-in corporation. The classical insider-trader thus breaches

a fiduciary duty owed to the corporation's shareholders. The

misappropriation theory, however, creates liability when a tipper

or trader misappropriates confidential information from his source

of the information. The misappropriator thus breaches a fiduciary

duty owed to the source.

The district court agreed with defendants that Mrs.

Rocklage could not be held liable under the classical theory. She

was not a traditional insider at Cubist. And the court determined

that the relationship between Mrs. Rocklage and Cubist's

shareholders was not of the kind that could lead to "temporary

insider" status: no alleged facts demonstrated that Mr. Rocklage's

disclosure to her was "solely for corporate purposes." See Dirks

v. SEC, 463 U.S. 646, 655 n.14 (1983).

The district court disagreed, however, with the

defendants' argument that there was no liability under the

misappropriation theory. Although O'Hagan had said that disclosure

to the source would negate liability under the misappropriation

theory, the district court found O'Hagan distinguishable. However,

the court's grounds for distinguishing O'Hagan were based on a

misreading of O'Hagan's facts. The court reasoned that because
 The district court also rejected Jones' argument that the 2

complaint did not allege fraud with sufficient particularity. See

Fed. R. Civ. P. 9(b).

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O'Hagan's law firm had obligations to the traded-in company (as the

district court read the case), any hypothetical disclosure by

O'Hagan would have quickly made its way to the shareholders. In

Mrs. Rocklage's case, by contrast, the special nature of the

marital relationship meant that her disclosure would never make its

way to the shareholders; Mr. Rocklage's loyalties lay first and

foremost with his wife. Thus the district court found that the

complaint stated facts sufficient to support a misappropriation

theory of liability.

The district court also refused to dismiss the case

against the downstream tippees, Beaver and Jones. If a claim was

stated against Mrs. Rocklage, it held, then the tippees' liability

turned on whether they knew or should have known of Mrs. Rocklage's

breach of duty. The district court determined this last question

to be one of fact, and thus inappropriate for resolution on a

12(b)(6) motion.2

All three defendants moved the district court for

reconsideration, correctly arguing that the district court had

misread O'Hagan. Contrary to the court's reading, O'Hagan's firm

had represented the bidding company in a tender offer, not the

target company whose shares O'Hagan traded. See O'Hagan, 521 U.S.

at 647. Thus, the defendants argued that O'Hagan's firm had no
-10-

obligation to inform the target's shareholders, and any

hypothetical disclosure by him would not have had real effect. In

the alternative, the defendants asked the court to certify the

issue for interlocutory appeal pursuant to 28 U.S.C. § 1292(b).

On December 14, 2005, the district court denied the

motion for reconsideration. The court conceded that it had misread

O'Hagan but reasoned that O'Hagan was distinguishable because a

hypothetical disclosure by O'Hagan would have given either his firm

or the bidding company the opportunity and motivation to take

remedial action. By contrast, the nature of the marital

relationship meant that Mrs. Rocklage's disclosure did not give her

husband adequate opportunity to take similar remedial action. The

court certified the issue for an interlocutory appeal, see 28

U.S.C. § 1292(b), which this court accepted.

II.

This case turns on an understanding of the underpinnings

of the misappropriation theory, an understanding of the acts that

are the deceptive or manipulative device or devices alleged, and

a careful reading of the O'Hagan opinion. We first discuss the

misappropriation theory, examining why the Supreme Court concluded

that this theory came within the ambit of § 10(b). Then we explain

our resolution of the remaining disputed issues, and how our

resolution of those issues flows from O'Hagan.
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A. The Misappropriation Theory of Insider Trading Liability

The text of § 10(b) makes it unlawful to "use or employ,

in connection with the purchase or sale of any security . . . any

manipulative or deceptive device or contrivance in contravention

of" rules promulgated by the SEC. 15 U.S.C. § 78j(b). Rule 10b-5

furnishes further explication of this statute, providing inter alia

that it is unlawful to "engage in any act, practice, or course of

business which operates or would operate as a fraud or deceit upon

any person, in connection with the purchase or sale of any

security." 17 C.F.R. § 240.10b-5(c). From these two sources of

law on insider trading, the Supreme Court has fashioned two

theories of liability: the "classical" theory, and the

"misappropriation" theory. See O'Hagan, 521 U.S. at 651-52.

Under the classical theory, § 10(b) and Rule 10b-5 are

violated when an insider trades (without disclosure) in a

corporation's securities based on material, nonpublic information

that he has acquired. So long as that insider owes a fiduciary

duty to the corporation's stockholders, the Supreme Court has

deemed such trades to be deceptive because they constitute a breach

of that fiduciary duty. Id. However, when the trading individual

owes no fiduciary duty to the stockholders of the traded-in

corporation, and he has not obtained the information from one who

has breached such a duty, there can be no insider trading liability
-12-

under the classical theory. See Chiarella v. United States, 445

U.S. 222, 231-35 (1980).

In such cases, however, liability may still be premised

on a misappropriation theory. Liability under that theory is based

on deception of the source of the information, rather than on

deception of the shareholders; it is that deception which brings

this trading within the statutory language. See O'Hagan, 521 U.S.

at 652 ("[T]he misappropriation theory premises liability on a

fiduciary-turned-trader's deception of those who entrusted him with

access to confidential information."). Such deceptive trading

exploits unfair informational disparities in the securities market;

making such trading illegal also comports with the congressional

purposes underlying § 10(b). See id. at 658-59.

O'Hagan, the case in which the Supreme Court first

recognized the misappropriation theory, illustrates the theory's

underpinnings. The defendant, James O'Hagan, worked at a law firm

representing the bidding company in a contemplated tender offer.

Id. at 647. O'Hagan learned about the proposed deal and purchased

shares in the target company before the deal was made public. Id.

at 647-48. Because O'Hagan's firm represented the bidder, he owed

no fiduciary duty to the target's stockholders and could not be

prosecuted under the classical theory. Id. at 653 n.5.

Nevertheless, the Court held he was liable under a misappropriation

theory because he had deceived both his law firm and its client: he
 Since O'Hagan presented no issue of actual disclosure by 3

O'Hagan, the statement could be viewed as dicta. Even dicta in

Supreme Court opinions is looked on with great deference. See

United States v. Santana, 6 F.3d 1, 9 (1st Cir. 1993).

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had pretended to be loyal to them while secretly converting

information obtained from them into personal gain. See id. at 653-

55. The Court remarked that it would make "scant sense to hold a

lawyer like O'Hagan a § 10(b) violator if he work[ed] for a law

firm representing the target of a tender offer, but not if he

work[ed] for a law firm representing the bidder. The text of the

statute requires no such result." Id. at 659.

The Court did say, however, that "[b]ecause the deception

essential to the misappropriation theory involves feigning fidelity

to the source of information, if the fiduciary discloses to the

source that he plans to trade on the nonpublic information, there

is no 'deceptive device' and thus no § 10(b) violation." Id. at

655. It is this language in O'Hagan, arguably dicta, on which 3

defendants pin their argument: they contend that Mrs. Rocklage's

disclosure to her husband eliminated any deception involved with

her tipping, which would mean that her actions did not come within

the text of § 10(b).

B. Liability Under the Misappropriation Theory After

O'Hagan

To establish liability under the misappropriation theory,

the SEC must show that Mrs. Rocklage communicated material

nonpublic information, with scienter, in violation of a fiduciary
 In Sargent this court left open whether the SEC must also 4

show that a tipper received sufficient personal benefit. See 229

F.3d at 77. As in Sargent, we need not decide this issue here.

Even if there is a requirement that the tipper receive a personal

benefit, the mere giving of a gift to a relative or friend is a

sufficient personal benefit. See id. The gift of information Mrs.

Rocklage gave her brother meets that standard.

 This regulation, which the defendants do not challenge for 5

purposes of the Rule 12(b)(6) motion, provides that there is a

"duty of trust or confidence" for purposes of the misappropriation

theory when

a person receives or obtains material

nonpublic information from his or her spouse,

parent, child, or sibling; provided, however,

that the person receiving or obtaining the

information may demonstrate that no duty of

trust or confidence existed with respect to

the information, by establishing that he or

she neither knew nor reasonably should have

known that the person who was the source of

the information expected that the person would

keep the information confidential, because of

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duty she owed to her husband. See Ernst & Ernst v. Hochfelder, 425

U.S. 185, 193 (1976); SEC v. Sargent, 229 F.3d 68, 74-76 (1st Cir.

2000). Additionally, to satisfy the language of § 10(b), the SEC

must demonstrate that Mrs. Rocklage engaged in a "manipulative or

deceptive device," and that she did so "in connection with the

purchase or sale of any security." 15 U.S.C. § 78j(b); see also

O'Hagan, 521 U.S. at 653-56.4

The defendants do not dispute that the complaint meets

the scienter requirement, and that the disclosed information was

material and nonpublic. They also do not seriously challenge the

SEC's allegation that Mrs. Rocklage breached a duty she owed to her

spouse under 17 C.F.R. § 240.10b5-2(b)(3).5
the parties' history, pattern, or practice of

sharing and maintaining confidences, and

because there was no agreement or

understanding to maintain the confidentiality

of the information.

17 C.F.R. 240.10b5-2(b)(3) (emphasis added).

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The heart of this case is thus whether the SEC's

complaint has stated a claim that Mrs. Rocklage engaged in any

"manipulative or deceptive device" that was "in connection with the

purchase or sale of any security." In answering that question, we

find it helpful to examine the issue in two parts. First, we

identify exactly what "manipulative or deceptive devices" Mrs.

Rocklage was alleged to have engaged in and we assess whether they

were sufficiently "in connection with" a securities transaction.

Second, we examine Mrs. Rocklage's pre-tip disclosure to her

husband to determine whether that disclosure eliminated the

deception from her actions.

1. The Deceptive Devices

The SEC contends that Mrs. Rocklage engaged in deceptive

devices, in connection with a securities transaction, when she

tricked her husband into revealing confidential information to her

so that she could, and did, assist her brother with the sale of his

Cubist stock. We agree and think it helpful to view the devices in

terms of deceptive acquisition of information and then deceptive

tipping of her brother, both of which were steps in a broader

scheme to enable her brother to trade in Cubist securities. The
 Indeed, had Mrs. Rocklage legitimately acquired the 6

information, and then tipped her brother without disclosure, she

would have been in essentially the same position as the defendant

in O'Hagan. The defendants do not argue that her act of tipping

was not "in connection with" a securities transaction.

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question of whether Mrs. Rocklage's disclosure makes these acts

nondeceptive is a different question, which we address later.

We start with the second of these actions. Had Mrs.

Rocklage never made any disclosure of her intent to tip her

brother, there would have been deception in connection with a

securities transaction when she did tip her brother, without her

husband's consent, to enable her brother to trade in securities.

Under O'Hagan, this would have been the case irrespective of the

means by which Mrs. Rocklage acquired the information.6

Still putting aside for the moment any consideration of

the effects of disclosure, we turn to the other alleged deceptive

action -- Mrs. Rocklage's acquisition of information. Here more

analysis is required. We agree that this acquisition of

information was deceptive. The complaint alleges, and we must take

as true, that before her husband's initial disclosure about the

clinical trial, Mrs. Rocklage did absolutely nothing to correct his

mistaken understanding that she would keep the trial results

confidential. This was so even though Mrs. Rocklage knew that her

husband had this (mis)understanding, and even though she had a

preexisting arrangement to disclose certain confidential

information to her brother.
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The defendants argue that this acquisition of

information, even if deceptive, was not "in connection with" a

securities transaction. They point to language from O'Hagan

discussing the "in connection with" requirement and explaining that

"the fiduciary's fraud is consummated, not when the fiduciary gains

the confidential information, but when . . . he uses the

information to purchase or sell securities." O'Hagan, 521 U.S. at

656. In defendants' view, Mrs. Rocklage's deceptive acquisition of

information was simply too far removed from her brother's sale of

securities to satisfy § 10(b)'s "in connection with" requirement.

We disagree with defendants' reading of O'Hagan and of

the "in connection with" requirement. We read the quoted sentence

in O'Hagan as explaining when a misappropriator's deceptive scheme

ends, and not as indicating when it begins. See Webster's 3d New

International Dictionary of the English Language Unabridged 490

(Philip Babcock Gove ed., 1993) (defining the verb "to consummate"

as meaning "to bring to completion"). Next, O'Hagan had no

occasion to interpret the "in connection with" requirement in a

case alleging deceptive acquisition of information intended to be

used in a securities transaction. The opinion does not discuss

whether O'Hagan tricked or deceived his law firm into telling him

about the tender offer, and whether while doing so he knew he would

use the information for trading. The government's brief to the

Supreme Court stated that "[t]he record does not indicate how
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[O'Hagan] first learned" about the potential tender offer. See

Brief for the United States at 4 n.1, O'Hagan, 521 U.S. 642 (No.

96-842). There was no claim that O'Hagan had used deception to

obtain the information. On those facts, it is no surprise that the

Supreme Court based liability only on O'Hagan's act of undisclosed

trading itself. See United States v. Falcone, 257 F.3d 226, 233

(2d Cir. 2001) (noting that the defendant in O'Hagan "legitimately

possessed the information" and that any misappropriation only

occurred "when he used that information to trade securities").

Since the act of trading was itself deceptive in O'Hagan,

the "securities transaction and the breach of duty thus

coincide[d]." O'Hagan, 521 U.S. at 656. In this case it is true

there was no such exact coincidence. But that disjunction does not

mean the deception in obtaining the information was not in

connection with the sale of securities.

This case differs from O'Hagan in that the SEC squarely

alleges that Mrs. Rocklage deceptively obtained information, and

that she did so as part of a preexisting scheme to assist her

brother in the sale of securities. The question is how that

difference is relevant to the "in connection with" requirement.

Indeed, in a case raising somewhat similar concerns the Second

Circuit recognized that "the Supreme Court in O'Hagan did not

purport to set forth the sole combination of factors necessary to
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establish the requisite connection in all contexts." Falcone, 257

F.3d at 233.

The Second Circuit's opinion in Falcone held that O'Hagan

did not alter that circuit's long standing rule, stated in United

States v. Carpenter, 791 F.2d 1024, 1027 (2d Cir. 1986), aff'd by

an equally divided court and aff'd by the full court on other

grounds, 484 U.S. 19 (1987), that the government can satisfy the

"in connection with" requirement when a tipper misappropriates

information that his tippees later trade on. The court reasoned

that

the defendants' use of the misappropriated

information for the[ir] financial benefit

. . . and to the financial detriment of those

investors with whom [the defendants] traded

supports the conclusion that [the defendants']

fraud was "in connection with" the purchase or

sale of securities under section 10(b) and

Rule 10b-5. We can deduce reasonably that

those who purchased or sold securities without

the misappropriated information would not have

purchased or sold, at least at the transaction

prices [they obtained], had they had the

benefit of that information. Certainly the

protection of investors is the major purpose

of section 10(b) and Rule 10b[-]5.

Falcone, 257 F.3d at 230 (quoting Carpenter, 947 F.2d at 566).

Although neither Carpenter nor Falcone was a case in which the

court relied on the tipper specifically engaging in deception in

order to acquire information, both stand for the proposition that

the "in connection with" requirement may be satisfied even when the

act of misappropriation in breach of a duty (in those cases,
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tipping), and the act of trading, do not coincide. In our view

O'Hagan not only left this untouched, see id. at 233-34, but

reinforced it.

Indeed, O'Hagan's discussion of the "in connection with"

requirement actually bolsters the SEC's position in this case.

O'Hagan discussed a hypothetical in which a person defrauds a bank

into giving him a loan and then uses the proceeds to purchase

securities. See 521 U.S. at 656-57. That hypothetical thus dealt

with a case of deceptive acquisition, albeit the deceptive

acquisition of money. Importantly, the Supreme Court indicated

that such deception was not "in connection with" a securities

transaction because the acquired item was money and not

information. See id. The wide variety of uses for money made this

deceptive acquisition "sufficiently detached from a subsequent

securities transaction." Id. at 657. But the information Mrs.

Rocklage deceptively obtained and gave her brother did not have

that same variety of uses; it was instead the sort of information

"that misappropriators ordinarily capitalize upon to gain no-risk

profits through the purchase or sale of securities." Id. at 656.

Thus her deceptive acquisition of the information is fairly

regarded as an act that was part of a broader scheme of deception

in connection with the sale of securities.

Moreover, we think that Mrs. Rocklage's actions fit

within a natural reading of the "in connection with" requirement.
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Mrs. Rocklage's preexisting arrangement with her brother can easily

be understood as a "scheme" or "practice" or "course of business,"

17 C.F.R. § 240.10b-5(a),(c), whose goal was to enable her brother

to trade in Cubist securities at a substantially reduced level of

risk. Her deception of her husband was a natural and integral part

of this scheme; she induced her husband to reveal material negative

information to her about Cubist, knowing full well that in

obtaining that information she would enable her brother to execute

a securities transaction. She then actively facilitated a

securities transaction by tipping her brother, and securities were

in fact sold based on her information. These events show that her

deceptive acquisition of material inside information was "in

connection with" a securities transaction.

Finally, our interpretation finds further support in the

investor protection purposes of § 10(b). See SEC v. Zandford, 535

U.S. 813, 819-20 (2002) (interpreting § 10(b)'s "in connection

with" requirement "flexibly" so as to further the statute's broad

investor protection purposes); O'Hagan, 521 U.S. at 658-59 (same).

One of the animating purposes of the statute was to "insure honest

securities markets and thereby promote investor confidence."

O'Hagan, 521 U.S. at 658. It furthers that purpose if the "in

connection with" requirement reaches schemes in which one party

deceptively and intentionally obtains material nonpublic

information to enable another to trade with an unfair informational
-22-

advantage. See id. at 658-59 (discussing how informational

disparities can negatively impact securities markets).

2. The Effect of Mrs. Rocklage's Pre-Tip Disclosure of her

Intent to Tip her Brother

We have determined that the complaint alleges that Mrs.

Rocklage engaged in a scheme involving devices that would have been

deceptive in the absence of disclosure, and we have concluded that

these devices were employed "in connection with" a securities

transaction. We now turn to the heart of defendants' argument:

whether Mrs. Rocklage's pre-tip disclosure to her husband,

indicating her intent to pass the information to her brother,

nonetheless means no claim of deception is stated by virtue of

O'Hagan's language about disclosure.

The defendants' view is that a pre-tip disclosure to the

source of an intention to trade or tip completely eliminates any

deception involved in the transaction. They rely on O'Hagan's

language that "if the fiduciary discloses to the source that he

plans to trade on the nonpublic information, there is no 'deceptive

device' and thus no § 10(b) violation." Id. at 655. The

defendants argue that O'Hagan put no qualifiers on what is meant by

"disclos[ure] to the source" of a plan to trade on nonpublic

information, and so the SEC is not free to qualify the concept. 

The SEC disagrees, arguing that the disclosure referenced

in O'Hagan must mean disclosure that is "useful" to the fiduciary's

principal. The SEC draws support from a footnote in O'Hagan which
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may be read as implying that disclosure enables a source to take

remedial action. See id. at 659 n.9 (explaining that "once a

disloyal agent discloses his imminent breach of duty, his principal

may seek appropriate equitable relief under state law"). As the

SEC sees it, disclosure to the source serves a useful purpose when

"the source of material non-public information reasonably could be

expected to, and reasonably could, prevent the unauthorized use of

the information for securities trading."

Under that standard, the SEC argues, Mrs. Rocklage's

disclosure was not a useful one for her source -- and in this

regard was unlike O'Hagan's hypothetical disclosure. The SEC

argues this is so due to both the timing of the events and the

marital relationship of the people involved. The timing of Mrs.

Rocklage's disclosure that she intended to tip her brother --

coming during or right before the New Year's holiday -- meant that

Mr. Rocklage would have had a great deal of difficulty pursuing

remedial action to stop the sale of the securities. In fact, the

sale was effectuated immediately at the next opening of the market.

Also, the SEC argues it would be unreasonable to expect Mr.

Rocklage to have risked marital discord by taking action against

his wife; once she made clear she would tell her brother despite

her husband's wishes, his interest may have shifted to protecting

her against liability. The SEC makes the point that under

Massachusetts law Mr. Rocklage was probably unable to pursue legal
 There are difficulties with both sides' proposed tests on 7

the effect of disclosure. The SEC's general "usefulness" test does

not provide clear lines, and to the extent that the test depends on

state law it has the potential for creating a lack of uniformity in

the application of federal securities law. On the other hand,

defendants' position would lead to the conclusion that even a

useless and pro forma disclosure could preclude insider trading

liability; their theory would protect from liability a disclosure

made only a few seconds before a trade was executed. Such a result

clearly would not advance § 10(b)'s investor protection purposes.

Cf. O'Hagan, 521 U.S. at 658-59.

-24-

action against his wife in reaction to her disclosed intention to

tip (such as by seeking to enjoin her from tipping). See Mass.

Gen. L. ch. 233 § 20 (preventing husbands and wives from testifying

about their private conversations).7

In our view this case presents a narrower question. We

start by asking about the nature of the various acts in the

deceptive scheme before considering the role of and the nature of

the disclosure. Unlike this case, O'Hagan was not a case which

involved the deceptive acquisition of information. Arguably, the

language in O'Hagan can be read to create a "safe harbor" if there

is disclosure to the fiduciary principal of an intention to trade

on or tip legitimately acquired information. This is because under

O'Hagan's logic such a "safe harbor" applies, if at all, when the

alleged deception is in the undisclosed trading or tipping of

information. In those cases, disclosure of the intent to trade

arguably will eliminate the sole source of deception. But a case

of deceptive acquisition of information followed by deceptive

tipping and trading is different. It makes little sense to assume
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that disclosure of an intention to tip using deceptively acquired

information would necessarily negate the original deception.

Indeed, by framing the issues this way, we see a second

important distinction between O'Hagan and the case at bar. O'Hagan

was a case in which only one deceptive device was alleged:

undisclosed trading on confidential information. In this case the

SEC's complaint is fairly read as alleging sequential acts that

could each constitute deceptive devices: (1) the acquisition of

material non-public information through the deception of Mrs.

Rocklage's husband, and (2) Mrs. Rocklage's use of this information

to tip off her brother without her husband's consent, followed by

the tippees' use of the information to trade. Perhaps, under

O'Hagan, Mrs. Rocklage's disclosure made the second of these

devices non-deceptive. But then the proper question becomes

whether disclosure that negates deception as to one set of actions

in a scheme necessarily renders all prior deceptive acts nondeceptive.

While that question was not directly addressed in

O'Hagan, the opinion does offer helpful clues. In a passage that

leads to a third distinction between O'Hagan and the fact pattern

here, the Court in O'Hagan seemed to contemplate that any

liability-avoiding disclosure would come before the defendant

engaged in the deceptive activity. See O'Hagan, 521 U.S. at 655

(explaining that there would be no liability "if the fiduciary
-26-

discloses to the source that he plans to trade on the nonpublic

information") (emphasis added). There is no indication that

O'Hagan meant to change the earlier understood view of § 10(b),

albeit one articulated outside the insider trading context, that a

disclosure "is not effective if it comes after the positions of the

parties have changed" in reliance on an earlier deceptive

statement. 5C Jacobs, Disclosure and Remedies Under the Securities

Laws, § 12:110, at 12-502.7 (2006) (citing In re Commonwealth

Oil/Tesoro Petroleum Corp. Sec. Litig., 467 F. Supp. 227, 246-47

(W.D. Tex. 1979)). Indeed, in a non-insider trading § 10(b) case,

this court has sustained liability in the face of post-transaction

disclosures; the after-the-fact disclosures did not cure the fact

that the key information was originally withheld. See Holmes v.

Bateson, 583 F.2d 542, 559 (1st Cir. 1978). On the facts of this

case, we are unwilling to say that O'Hagan requires us to conclude

that Mrs. Rocklage's post-acquisition disclosure of her intention

to tip somehow rendered her acquisition of information nondeceptive.

Our analysis is bolstered by the Supreme Court's

explanation that the misappropriator "defrauds the principal of the

exclusive use of [his] information." O'Hagan, 521 U.S. at 652

(emphasis added). Mr. Rocklage was deprived of the exclusive use

of the information, before his wife stated her intention to tip,
-27-

through Mrs. Rocklage's deceptive acquisition. Her later

disclosure did nothing to change this.

Once the various distinctions between this case and

O'Hagan are understood, defendants' position is really that because

some of Mrs. Rocklage's actions may have been non-deceptive, her

scheme as a whole had no deceptive elements. We do not believe

that O'Hagan requires such an understanding of § 10(b), and we in

fact conclude that O'Hagan rejects such an understanding.

In related areas of the law, it is well accepted that a

scheme can be deceptive or fraudulent even if not all parts of the

scheme are deceptive or fraudulent. The Supreme Court's decision

in Carpenter, discussing the mail and wire fraud statutes, is

especially instructive. O'Hagan cited with apparent approval the

government's argument that Carpenter's discussion of fraud was "a

particularly apt source of guidance . . . because [the mail fraud

statute] (like section 10(b)) has long been held to require

deception." 521 U.S. at 654 (alteration in original) (quoting

Brief for the United States, supra, at 18 n.9) (internal quotation

marks omitted); see also id. (describing Carpenter as addressing a

"fraud of the same species" as the fraud that the misappropriation

theory targets); 2 Welling et al., Federal Criminal Law and Related

Actions § 17.5, at 8 (1998) (recognizing the "central role of

deception" in the mail and wire fraud statutes at issue in

Carpenter).
-28-

The scheme in Carpenter was fraudulent insofar as the

defendants were misappropriating articles from the Wall Street

Journal in advance of publication. See 484 U.S. at 25-28. They

did so in order to trade in stocks the articles covered, with the

understanding that the Journal's future coverage would affect stock

prices. In sustaining the defendants' convictions for mail and

wire fraud, the unanimous Court noted that it was sufficient that

the Journal itself, in its final published form, was ultimately

distributed to customers via the wires and the mail. Id. at 28.

Importantly, the Court deemed distribution of the articles to

Journal customers to be "an essential part of the scheme." Id.

There was no suggestion in that case, nor could there be, that the

distribution of the Journal to its regular customers was somehow

fraudulent. Yet the defendants' actions as a whole still comprised

a "scheme or artifice to defraud," see 18 U.S.C. §§ 1341,1343, and

so the Court sustained their convictions under the mail and wire

fraud statutes. See id. at 25; see also Schmuck v. United States,

489 U.S. 705, 714-15 (1989) (holding that innocent and nonfraudulent mailings can support a conviction under the mail fraud

statute if they are part of a scheme that has a fraudulent

element); cf. Carpenter, 791 F.2d at 1027-34 (finding, under a

misappropriation theory, that the Carpenter events constituted a

deceptive scheme for § 10(b) purposes), aff'd by an equally divided

court, 484 U.S. at 24.
 See, e.g., Karmel, Outsider Trading on Confidential 8

Information -- A Breach in Search of a Duty, 20 Cardozo L. Rev. 83,

95 (1998); Langevoort & Gulati, The Muddled Duty To Disclose Under

Rule 10b-5, 57 Vand. L. Rev. 1639, 1675-77 (2004); Nagy, Reframing

the Misappropriation Theory of Insider Trading Liability: A PostO'Hagan Suggestion, 59 Ohio St. L.J. 1223, 1256-59 (1998); Painter

et al., Don't Ask, Just Tell: Insider Trading After United States

v. O'Hagan, 84 Va. L. Rev. 153, 180-81 (1998); Prakash, Our

Dysfunctional Insider Trading Regime, 99 Colum. L. Rev. 1491, 1506-

32 (1999); Quinn, The Misappropriation Theory of Insider Trading in

the Supreme Court: A (Brief) Response to the (Many) Critics of

United States v. O'Hagan, 8 Fordham J. Corp. & Fin. L. 865, 893-95

(2003).

-29-

In light of her disclosure to her husband, Mrs.

Rocklage's mechanism for "distributing" the information to her

brother may or may not have been rendered non-deceptive by her

stated intention to tip. But because of the way in which Mrs.

Rocklage first acquired this information, her overall scheme was

still deceptive: it had as part of it at least one deceptive

device. Thus as a matter of the facts alleged in the complaint,

and taking all facts and inferences in favor of the plaintiff, a

§ 10(b) claim is stated.

Contrary to the parties' arguments, we decline to

articulate a broad, generalized test for exactly when disclosure

will negate deception under a § 10(b) misappropriation theory.

That is deliberate. The import and reach of the Supreme Court's

language in O'Hagan about disclosure as a cure for deception has

created uncertainty in the courts and has provoked a great deal of

academic commentary. Until the Supreme Court has clarified its 8

language about disclosure, this uncertainty is an important factor
-30-

in why we are unwilling to state generalized rules. Our task is to

decide cases on an individual basis, and it suffices for us to say

that on the facts asserted in the complaint, the SEC has stated a

claim. Given the variety of types of deception and types of

disclosure, caution is warranted until the complexity and variety

of problems are understood. Furthermore, the SEC may wish to

address this issue through the regulatory process.

We acknowledge that defendants' argument is both strong

and very well presented. In the end, only the Supreme Court,

Congress, or the SEC can bring the needed clarity to these

questions.

III.

The defendants' brief does not challenge the district

court's finding that if Mrs. Rocklage is liable under the

misappropriation theory, the complaint also states a claim against

the downstream tippees, Beaver and Jones. Also, because we find

that the complaint states a claim under the misappropriation

theory, we decline to reach the issue of whether it also states a

claim under the classical theory because Mrs. Rocklage was a

temporary insider. Finally, we have no occasion to reach the

contingent issue of whether Beaver and Jones can be liable for

insider trading even if the complaint states no valid claim against

Mrs. Rocklage.
-31-

The district court's decision is affirmed, and the case

is remanded for further proceedings consistent with this opinion.

Costs are awarded to the SEC.