2nd Circuit Issues Must-Read Opinion Setting Out Standards for Insider Trading Liability
The U.S. Court of Appeals for the 2nd Circuit, in SEC v. Obus, recently revived an insider trading enforcement action by the Securities and Exchange Commission against a hedge-fund manager and other individuals. In doing so, the 2nd Circuit, starting on page 15 of its opinion, set forth a succinct summary of the law on insider trading, which provides a useful source for understanding the basics of tipper and tippee liability under section 10(b) of the Securities and Exchange Act of 1934.
As the Obus court explains, insider trading claims rest on one of two basic theories. Under the classical theory, a corporate insider is prohibited from trading shares of that corporation based on material non-public information in violation of the duty of trust and confidence insiders owe to shareholders. A second theory, grounded in misappropriation, targets persons who are not corporate insiders but to whom material non-public information has been entrusted in confidence and who breach a fiduciary duty to the source of the information to gain personal profit in the securities market. A person who has a fiduciary duty of trust and confidence to shareholders (classical theory) or to a source of confidential information (misappropriation theory) and is in receipt of material non-public information has a duty to abstain from trading or to disclose the information publicly. The bar against insider trading is not confined only to insiders or misappropriators who trade for their own account; it also reaches situations where the insider or misappropriator tips another person who then trades on that information—i.e., tipper and tippee liability. Before liability may attach, however, the tipper or tippee must know or be reckless in not knowing that the information that is the subject of the tip is non-public and is material for securities trading purposes.