Misappropriation Theory

Nonpublic Information

Interestingly, the Misappropriation Theory began with a failure. Vincent F. Chiarella, a low-level employee at a financial printing house, was able to discern information relevant to company mergers and sales. He made investments based on the information he discovered and was convicted of securities fraud for trading on inside information. He won an appeal to the Supreme Court in 1980, with the justices ruling that he was not guilty because, not being affiliated with the company, he had no duty to other investors.

In a dissenting opinion, Chief Justice Warren E. Burger said Chiarella violated an obligation to his employer to keep its clients' secrets and had “misappropriated,” or stolen, valuable nonpublic information. Within a year, the New York federal appeals court had upheld the conviction using the new Misappropriation Theory in a case involving securities trader James M. Newman. Newman's appeal to the Supreme Court went unheard.

In 1983, Anthony Materia, another low-level printing company employee, was convicted of inside trading in a civil suit brought by the Securities and Exchange Commission (SEC), under circumstances similar to those of Chiarella's case. A fiduciary duty to refrain from trading or providing information to others was found, in that doing those things would damage his employer's reputation and business. The court found that this duty was sufficient, even though the employer was not in any way involved with the securities that were bought or sold.

[Page 541]R. Foster Winans wrote a financial column in the Wall Street Journal which often affected the stock price of companies mentioned. In 1983 and 1984, Winans (and other brokers he told about the column contents) traded stocks in companies mentioned prior to the columns being published. He was fired from this action and for breaking conflictof-interest rules, and was convicted of securities fraud using the Misappropriation Theory. The mail and wire fraud convictions were upheld by the U.S. Supreme Court in November 1987. However, the court split evenly on the securities fraud conviction. Because of the even split, this case will not set legal precedent but did lead many to believe the SEC needed to produce a clearer definition of insider trading. There was no tie-break vote because the court had one vacancy at the time.

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