Chiarella v. United States
445 U.S. 222 (1980)
Rule of Law:
Under Section 10(b) of the Securities Exchange Act of 1934, a duty to disclose material, nonpublic information arises from a relationship of trust and confidence between parties to a transaction; it does not arise from the mere possession of such information.
Facts:
- Vincent Chiarella was employed as a 'markup man' at Pandick Press, a financial printing company.
- Pandick Press was hired by several corporations to print announcements for upcoming confidential takeover bids.
- While handling the documents, which used false names to conceal the identities of the companies, Chiarella was able to deduce the names of the target companies.
- Without disclosing his knowledge of the impending takeovers, Chiarella purchased stock in the target companies.
- After the takeover bids were publicly announced, he sold the shares, realizing a profit of over $30,000.
- Chiarella had no prior relationship or dealings with the shareholders of the target companies from whom he purchased the stock; he was a stranger dealing through impersonal market transactions.
Procedural Posture:
- The Securities and Exchange Commission (SEC) investigated Chiarella's trading and he entered a consent decree, returning his profits.
- Chiarella was indicted in the U.S. District Court for the Southern District of New York on 17 counts of willfully violating Section 10(b) and Rule 10b-5.
- After his motion to dismiss the indictment was denied, a jury convicted Chiarella on all counts.
- Chiarella, as appellant, appealed to the U.S. Court of Appeals for the Second Circuit.
- The Court of Appeals affirmed the conviction, holding that anyone who regularly receives material nonpublic information has a duty to disclose it before trading.
- The U.S. Supreme Court granted certiorari to review the judgment of the Court of Appeals.
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Issue:
Does a person who is not a corporate insider violate Section 10(b) of the Securities Exchange Act of 1934 by failing to disclose material, nonpublic information before trading on it, when that person has no fiduciary or similar relationship of trust and confidence with the sellers of the securities?
Opinions:
Majority - Justice Powell
No, a person who is not a corporate insider and has no fiduciary relationship with the sellers does not violate Section 10(b) by failing to disclose material, nonpublic information before trading. Liability for nondisclosure under Section 10(b) is premised upon a duty to disclose, which arises from a specific relationship of trust and confidence between the parties to the transaction. Chiarella was not an insider of the target companies and had no prior dealings with the sellers of the stock; he was not their agent, fiduciary, or a person in whom they placed their trust. Therefore, he owed them no duty to disclose the information about the upcoming takeovers. The Court rejected the lower court's theory of a general duty between all market participants to ensure equal access to information, stating that 'not every instance of financial unfairness constitutes fraudulent activity under § 10(b).' The government's alternative theory, that Chiarella breached a duty to his employer and the acquiring corporations, was not submitted to the jury and thus could not be the basis for affirming the criminal conviction.
Dissenting - Chief Justice Burger
Yes, Chiarella's conviction should be affirmed. The general rule that parties to a transaction have no duty to disclose should give way when an informational advantage is obtained through unlawful means. A person who has misappropriated nonpublic information has an absolute duty to disclose that information or refrain from trading. This 'misappropriation theory' is a natural extension of § 10(b) and Rule 10b-5. The jury instructions, which referred to Chiarella's 'confidential position,' combined with the prosecutor's statements and Chiarella's own testimony, were sufficient to charge the jury on this theory. Any deficiency in the instructions was harmless error beyond a reasonable doubt.
Dissenting - Justice Blackmun
Yes, Chiarella's conviction should be affirmed, even without relying on a misappropriation theory. The Court's requirement of a special relationship is an unduly narrow interpretation of § 10(b). The rule should prohibit persons with access to confidential, material information that is not legally available to others from exploiting their 'structural informational advantage.' This principle is consistent with the common law's 'special facts' doctrine and the securities laws' purpose of ensuring fairness in impersonal markets. Chiarella had an informational advantage that was inherently unfair to those with whom he dealt, and his conduct lies at the heart of what the securities laws are intended to prohibit.
Concurring - Justice Stevens
No, the conviction cannot be affirmed on the theory presented to the jury. Chiarella owed no duty of disclosure to the sellers of the target company stock, and his conviction was based on the erroneous premise that he did. The Court correctly does not decide the second question of whether Chiarella's breach of duty to his employer and its customers (the acquiring companies) could give rise to criminal liability under Rule 10b-5. This decision does not approve of Chiarella's conduct but merely holds that his conviction cannot rest on a breach of a duty he did not owe.
Concurring - Justice Brennan
No, the conviction must be reversed, but the majority's legal reasoning is flawed. The applicable substantive law is the 'misappropriation theory' articulated by The Chief Justice: a person violates § 10(b) when he improperly converts nonpublic information and uses it to trade securities. However, this legal theory was not presented to the jury. The instructions improperly allowed the jury to convict based merely on a finding of failure to disclose. Because the conviction was not based on a proper legal instruction, it cannot be affirmed, and thus I concur in the judgment to reverse.
Analysis:
This landmark case established the 'classical theory' of insider trading, rejecting a broad 'parity-of-information' rule that would require anyone with nonpublic information to disclose it before trading. The Court grounded Section 10(b) liability for nondisclosure in the breach of a fiduciary duty owed to the counterparty of the trade. By holding that Chiarella owed no duty to the sellers of the target company's stock, the decision narrowed the potential scope of Rule 10b-5. However, by declining to rule on the government's alternative 'misappropriation' theory, the Court left open the possibility that an outsider could be liable for breaching a duty to the source of the information, a theory that would later be adopted by the Court in United States v. O'Hagan.
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