Opinion ID: 774028
Heading Depth: 3
Heading Rank: 1

Heading: The Theory In The Second Circuit

Text: 19 The Second Circuit was the first to recognize a different theory of insider trading: the misappropriation theory. See generally United States v. Chestman, 947 F.2d 551, 566-67 (2d Cir. 1991) (en banc) (setting forth history of application of misappropriation theory in this Circuit). Under the misappropriation theory, 20 a person violates Rule 10b-5 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. In contrast to [the traditional theory], 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 (emphasis added), we have 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. 21 Chestman, 947 F.2d at 566. 22 Under this theory, this Court (prior to Chestman) upheld the securities fraud convictions of a newspaper reporter, a former newspaper clerk, and a stockbroker who traded securities based on misappropriated information similar to the type of information at issue in this case: the timing and content of the Wall Street Journal's confidential schedule of columns of acknowledged influence in the securities market. United States v. Carpenter, 791 F.2d 1024, 1027 (2d Cir. 1986). While under the misappropriation theory, the duty that had been breached no longer was a duty owed to a party to a securities transaction, we found in Carpenter that such deception still satisfied the in connection with standard because 23 the use of the misappropriated information for the financial benefit of the defendants and to the financial detriment of those investors with whom appellants traded supports the conclusion that appellants' fraud was in connection with the purchase or sale of securities under section 10(b) and Rule 10 b-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, 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. Further, investors are endangered equally by fraud by non-inside misappropriators as by fraud by insiders. 24 Id. at 1032 (internal citations omitted). Rejecting the argument made by the Carpenter dissent that the in connection with requirement was not met because no securities-related information had been misappropriated, we added that the deception was in connection with securities transactions because the misappropriated information regarding the timing and content of certain Journal columns had 'no value whatsoever [to appellants] except in connection with their subsequent purchase[s] [and sales] of securities.' Id. at 1033 (quoting SEC v. Materia, 745 F.2d 197, 203 (2d Cir. 1984)). Furthermore, we pointed out that [t]he'sole purpose' of the scheme was to purchase and sell securities, id. (quoting United States v. Newman, 664 F.2d 12, 18 (2d Cir. 1981)), and thereby virtually to 'reap instant no-risk profits in the stock market,' id. (quoting Materia, 745 F.2d at 203). 2 25 We found ourselves applying the theory in the context of information obtained from a publication again in 1993 in United States v. Libera, 989 F.2d 596 (2d Cir. 1993). Libera involved the same magazine at issue in this case - Business Week - and a similar scheme involving the pre-release misappropriation of the Inside Wall Street column. Id. at 598-99. However, unlike in Carpenter, in Libera, the misappropriators of the information did not trade - or have others trade on their behalf - based on the misappropriated information. Id. The initial misappropriator in Libera, in fact, did not receive any financial payment at all for advance copies of the column; eventually, when that individual was unable to continue, his replacement was paid $20 and later $30 per column. Id. 26 The main issue in Libera was whether, in order to find the tippees liable under Section 10(b) pursuant to the misappropriation theory, the tipper must have known that his breach of a fiduciary obligation would lead to the tippee's trading on the misappropriated information. Id. at 597. Under the traditional theory of insider trading, tippee liability was in fact premised on the intent of the tipper to provide the tippee with information that the tippee could use to make money in securities trading. See Dirks, 463 U.S. at 664 (holding that tippees and tippers would be liable where there existed a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient. The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend.) Libera held, however, that tippee liability under the misappropriation theory did not require this type of knowledge by the tipper, and that 27 [t]he tipper's knowledge that he or she was breaching a duty to the owner of confidential information suffices to establish the tipper's expectation that the breach will lead to some kind of a misuse of the information. This is so because it may be presumed that the tippee's interest in the information is, in contemporary jargon, not for nothing. To allow a tippee to escape liability solely because the government cannot prove to a jury's satisfaction that the tipper knew exactly what misuse would result from the tipper's wrongdoing would not fulfill the purpose of the misappropriation theory, which is to protect property rights in information. 28 Libera, 989 F.2d at 600. 29 Thus, Libera held that the only required elements for tippee liability were: (i) a breach by the tipper of a duty owed to the owner of the nonpublic information; and (ii) the tippee's knowledge that the tipper had breached the duty. Id. at 600. Other than in its recitation of the standard set forth in Rule 10b-5, Libera made no mention of the in connection with requirement.