Insider Trading

Law and Legal Theories

The modern federal law of insider trading is complex. The law typically relied upon in most federal insider trading prosecutions is a general securities antifraud law, Section 10(b) of the Securities Exchange Act of 1934, and the Securities and Exchange Commission (SEC) Rule 10b-5 issued thereunder. Although the federal statute under which most insider trading prosecutions are brought dates to 1934, it was not until the 1960s that U.S. authorities began prosecuting insider trading claims in earnest. Rule 10b-5 prohibits “employ[ing] any device, scheme, or artifice to defraud,” or perpetrating acts which “operate as a fraud or deceit upon any person.”

In the shadow of this very general prohibition, several different theories of unlawful insider trading have been recognized by the courts. First, there is what is known as the “classical theory” of insider trading. Under this theory, as articulated in the U.S. Supreme Court case of Chiarella v. United States (1980), a person commits unlawful insider trading if that person purchases or sells [Page 515]securities in violation of a fiduciary duty to the shareholders of that corporation. Such a corporate insider is under an obligation either to disclose his information or to abstain from trading. Thus, when that person buys or sells shares for his own benefit while remaining silent, he has (in a sense) deceived the shareholders of the corporation.

A second theory of insider trading that has been recognized by courts is known as the “misappropriation” theory. Under the misappropriation theory, a fiduciary obligation to the investors with whom the insider trades is not required; instead, the insider trader need simply breach a fiduciary duty (or fiduciary-like relationship of trust and confidence) to a third party (e.g., the source of the relevant, material, nonpublic information). For example, a journalist who breaches a fiduciary obligation to his employer in order to trade on material nonpublic information regarding Company X might be subject to the insider trading prohibition, even though that journalist had no preexisting fiduciary duty to the shareholders of Company X.

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