Opinion ID: 692992
Heading Depth: 3
Heading Rank: 1

Heading: Statutory sections and background.

Text: 26 The district court found that Maio and Ladavac violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act, as well as Rule 10b-5. Section 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 such rules and regulations as the [SEC] may prescribe ... 15 U.S.C. Sec. 78j(b). Thus, a practice must contravene a rule promulgated by the SEC in order to violate Sec. 10. SEC v. Clark, 915 F.2d 439, 443 (9th Cir.1990). Pursuant to its statutory authority, the SEC has promulgated Rule 10b-5 which provides: 27 It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, 28
29 (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or 30 (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, 31 in connection with the purchase or sale of any security. 17 C.F.R. Sec. 240.10b-5. 32 Section 17(a) of the Securities Act provides: 33 It shall be unlawful for any person in the offer or sale of any securities ... 34
35 (2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or(3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser. 15 U.S.C. Sec. 77q(a). 36 As applied in this case, the proscriptions contained in Sec. 10(b), Rule 10b-5, and Sec. 17(a) are substantially the same. SEC v. International Loan Network, Inc., 770 F.Supp. 678, 694 (D.D.C.1991), aff'd 968 F.2d 1304 (D.C.Cir.1992); Teamsters Local 282 Pension Trust Fund v. Angelos, 762 F.2d 522, 531 (7th Cir.1985) (equating elements of claim under Rule 10b-5 and Sec. 17(a)); U.S. S.E.C. v. Lauer, 864 F.Supp. 784, 793 (N.D.Il.1994) (same). The principal difference is that Sec. 10(b) and Rule 10b-5 apply to acts committed in connection with a purchase or sale of securities while Sec. 17(a) applies to acts committed in connection with an offer or sale of securities. International Loan Network, Inc., 770 F.Supp. at 694. As we have both situations before us, we treat these sections together. 37 Trading on the basis of material nonpublic information violates these sections where the trading arises in connection with a breach of a fiduciary duty. See Dirks v. SEC, 463 U.S. 646, 663, 103 S.Ct. 3255, 3266, 77 L.Ed.2d 911 (1983); Chiarella v. U.S., 445 U.S. 222, 232-36, 100 S.Ct. 1108, 1116-19, 63 L.Ed.2d 348 (1980); SEC v. Cherif, 933 F.2d 403, 410 (7th Cir.1991). Currently there are two theories under which a breach of fiduciary duty can be established such that a violation of Rule 10b-5 arises: (1) classical theory, and (2) misappropriation theory. Cherif, 933 F.2d at 408-09. Under the classical theory, a person violates [Rule 10b-5] when he or she buys or sells securities on the basis of material, non-public information and at the same time is an insider of the corporation whose securities are traded. Id. at 408. Under misappropriation theory a person violates Rule 10b-5 by misappropriating and trading upon material information entrusted to him by virtue of a fiduciary relationship.... Id. at 410. 38 The relationship between the corporation whose stock is traded and the person who breaches a fiduciary duty by trading or tipping determines which theory is applied. Classical theory applies to trading by insiders (or their tippees) in the stocks of their own corporations. Cherif, 933 F.2d at 408. Misappropriation theory extends the reach of Rule 10b-5 to outsiders [or their tippees] who would not ordinarily be deemed fiduciaries of the corporate entities in whose stock they trade. Id. at 409. Thus, under misappropriation theory one need not be an insider of the corporation whose stocks are traded in order for that trading to violate Rule 10b-5. 10 Instead, the misappropriation of material non-public information from its lawful possessor is regarded as a sufficient breach of fiduciary duty in connection with the purchase or sale of a security to justify liability under Rule 10b-5. Id. at 410. 39 In this case, Ferrero's tipping implicates both classical theory and misappropriation theory. Classical theory is implicated by the sales of Anacomp stock, because Ferrero was an insider of the corporation whose stocks were traded. Misappropriation theory is implicated by the purchases of Xidex stock because, although Ferrero was not an insider of that corporation, it was Ferrero's misappropriation of information from Anacomp concerning its upcoming tender offer for Xidex that led to this trading. 40 With this background in mind we turn to the principal challenge that Maio and Ladavac have raised to their convictions under Sec. 10(b), Rule 10b-5, and Sec. 17(a). Here, Maio and Ladavac argue that they had no fiduciary duty to Anacomp or Xidex where their failure to disclose material non-public information prior to trading in the stocks of those corporations would breach a fiduciary duty. Therefore, they insist they did not violate Sec. 10(b) and Rule 10b-5, or Sec. 17(a). In response, the SEC argues that Maio and Ladavac had a derivative duty not to trade in the stocks of Anacomp and Xidex because Ferrero breached his fiduciary duty to Anacomp when he misappropriated and gifted material non-public information to them and they knew that Ferrero's disclosure was improper. Thus, the issue presented is whether Maio and Ladavac had a derivative duty to Anacomp which they violated when they bought and sold stock in Anacomp and Xidex on the basis of information provided by Ferrero. 41