FACTS O’Hagan was a partner in the law firm of Dorsey & Whitney. In July 1988, Grand Metropolitan retained the firm to represent it in a tender offer for Pillsbury stock. O’Hagan did no work on this matter. In August, O’Hagan began purchasing Pillsbury stock options. He also purchased Pillsbury stock at $39. When the tender offer was announced, the price rose to $60. O’Hagan sold his options and stock, making a profit of $4.3 million. He used the profits to conceal his previous embezzlement of unrelated client trust funds. The SEC investigated. O’Hagan was convicted on securities fraud. The Eighth Circuit reversed, rejecting liability under Rule 10b-5 under the “misappropriation theory.” The Supreme Court granted certiorari. Section 10(b) proscribes (1) using any deceptive device (2) in connection with the purchase or sale of securities. It does not confine its coverage to deception of a purchaser or seller; rather, it reaches any deceptive device used “in connection with the purchase or sale of any security.” Justice Ginsburg * * * * * Under the “traditional” or “classical theory” of insider trading liability, Section 10(b) and Rule 10b-5 are violated when [an] insider trades in the securities of his corporation on the basis of material, nonpublic information. Trading on such information qualifies as a “deceptive device” . . . because “a relationship of trust [exists] between the shareholders [and the] insiders who have obtained confidential information by reason of their position with [the] corporation.” That relationship . . . “gives rise to a duty to disclose [or to abstain from trading]”. . . .The classical theory applies not only to officers, directors, and other permanent insiders . . ., but also to attorneys, accountants, consultants, and others who temporarily become fiduciaries of a corporation. The “misappropriation theory” holds that a person commits fraud “in connection with” a securities transaction . . . when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. Under this theory, a fiduciary’s undisclosed, self-serving use of a principal’s information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information. In lieu of premising liability on a fiduciary relationship between company insider and purchaser or seller of the company’s stock, the misappropriation theory premises liability on a fiduciary-turned-trader’s deception of those who entrusted him with access to confidential information. The two theories are complementary, each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities. . . . In this case, the indictment alleged that O’Hagan, in breach of a duty of trust . . . he owed to his law firm . . . and to its client . . . , traded on the basis of nonpublic information regarding the client’s tender offer . . . . This conduct, the Government charged, constituted a fraudulent device in connection with the purchase and sale of securities. . . . We agree . . . . We observe, first, that . . . deal in deception. A fiduciary who “[pretends] loyalty to the principal while secretly converting the principal’s information for personal gain” . . . defrauds the principal. * * * * * We turn next to the Section 10(b) requirement that the deceptive use of information be “in connection with the purchase or sale of [a] security.” This element is satisfied because the fiduciary’s fraud is consummated, not when the fiduciary gains the confidential information, but when, without disclosure to his principal, he uses the information to purchase or sell securities. . . . * * * * * The misappropriation theory . . . is also well-tuned to an animating purpose of the  Act: to insure honest securities markets and thereby promote investor confidence. Although informational disparity is inevitable in the securities markets, . . . [an] investor’s informational disadvantage vis-a-vis a . . . stems from contrivance, not luck; it is a disadvantage that cannot be overcome with research or skill. . . . [Reversed and remanded.] Questions 1. Are both insider trading theories needed to fulfill the 1934 Act’s desire to keep the markets “honest”? 2. Both insider trading theories depend heavily on fiduciary relationships. Contrast the parties in the fiduciary relationships under the “classical” and “misappropriation” theories. 3. Would it have made any difference if O’Hagan had established with his broker, long before this trading, a portfolio diversification plan such that, pursuant to the plan, the identical trading would have occurred?
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