United States v. O'Hagan
521 U.S. 642 (1997)
Rule of Law:
A person violates § 10(b) and Rule 10b-5 by misappropriating confidential information for securities trading in breach of a fiduciary duty owed to the source of that information. Additionally, the SEC does not exceed its rulemaking authority under § 14(e) by promulgating a rule that prohibits trading on nonpublic information related to a tender offer without requiring a breach of fiduciary duty, as this is a valid prophylactic measure.
Facts:
- James Herman O’Hagan was a partner at the law firm of Dorsey & Whitney.
- In July 1988, Dorsey & Whitney was retained as local counsel by Grand Metropolitan PLC (Grand Met) for a potential tender offer for the common stock of the Pillsbury Company.
- O'Hagan did not perform any work on the Grand Met representation but learned of the confidential plan.
- Beginning in August 1988, while his firm was still representing Grand Met, O'Hagan began purchasing large quantities of Pillsbury call options and common stock.
- In October 1988, Grand Met publicly announced its tender offer for Pillsbury, causing the price of Pillsbury stock to rise significantly.
- O'Hagan sold his Pillsbury securities and options, realizing a profit of more than $4.3 million from his trades.
Procedural Posture:
- The Securities and Exchange Commission (SEC) initiated an investigation into O’Hagan's transactions.
- A grand jury in the U.S. District Court for the District of Minnesota returned a 57-count indictment against O'Hagan.
- Following a trial, a jury convicted O'Hagan on all 57 counts, including securities fraud, mail fraud, and money laundering.
- O'Hagan, as appellant, appealed his convictions to the U.S. Court of Appeals for the Eighth Circuit.
- A divided panel of the Eighth Circuit reversed all of O’Hagan’s convictions, holding that § 10(b) liability cannot be based on the misappropriation theory and that Rule 14e-3(a) exceeds the SEC's rulemaking authority.
- The United States, as petitioner, was granted a writ of certiorari by the U.S. Supreme Court.
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Issue:
First, does a person who trades in securities for personal profit, using confidential information misappropriated in breach of a fiduciary duty to the source of the information, violate § 10(b) and Rule 10b-5? Second, did the SEC exceed its rulemaking authority under § 14(e) by adopting Rule 14e-3(a), which prohibits trading on undisclosed information in the tender offer setting even in the absence of a duty to disclose?
Opinions:
Majority - Justice Ginsburg
To the first question, yes. A person who trades securities for personal profit using confidential information misappropriated in breach of a fiduciary duty to the source of the information violates § 10(b) and Rule 10b-5. This 'misappropriation theory' satisfies the deception requirement of § 10(b) because a fiduciary who pretends loyalty to a principal while secretly converting the principal's information for personal gain is engaged in a deceptive device. The 'in connection with' requirement is met because the fraud is consummated not when the information is obtained, but when it is used to purchase or sell securities. This theory is complementary to the 'classical theory' and is designed to protect market integrity from abuses by outsiders who have access to confidential information but owe no duty to the shareholders of the corporation whose stock is traded. To the second question, no. The SEC did not exceed its rulemaking authority by adopting Rule 14e-3(a) without a fiduciary duty requirement. Section 14(e) authorizes the Commission not only to define fraudulent acts but also to 'prescribe means reasonably designed to prevent' them. Rule 14e-3(a) is a valid prophylactic measure because it provides a clear 'disclose or abstain from trading' rule in the tender offer context, where proving a breach of fiduciary duty can be difficult. Given the potential for abuse of confidential information concerning a tender offer, this rule is a means reasonably designed to prevent fraudulent trading.
Concurring-in-part-and-dissenting-in-part - Justice Scalia
I join the Court’s opinion on the § 14(e) and mail fraud issues, but I dissent from its holding regarding § 10(b). The principle of lenity, which requires ambiguity in criminal statutes to be resolved in favor of the defendant, dictates a narrower reading of § 10(b). The statutory language must be construed to require that the deception be practiced upon a party to the securities transaction, a requirement the misappropriation theory does not meet.
Concurring-in-part-and-dissenting-in-part - Justice Thomas
Regarding the first question, no. I dissent from the Court's adoption of the misappropriation theory. The theory fails to provide a coherent interpretation of § 10(b)'s 'in connection with' requirement. The government’s argument that misappropriated information is unique because its value is only realized through securities trading is incorrect; the information could be sold to a newspaper or to the target company. The majority’s attempt to salvage the theory by substituting 'ordinarily' for 'only' is an impermissible post hoc rationalization created by the Court, not the agency. Regarding the second question, yes. I dissent from the Court's holding on Rule 14e-3(a). The SEC did exceed its authority. The rule, on its face, purports to define fraud, not prevent it, and it defines it more broadly than our precedents allow. Furthermore, as a prophylactic measure, it is not 'reasonably designed' to prevent the underlying fraud of misappropriation because there is no special difficulty in proving a breach of duty in misappropriation cases. The rule is actually aimed at regulating non-fraudulent market unfairness, which is beyond the scope of § 14(e).
Analysis:
This landmark decision solidified the 'misappropriation theory' as a valid basis for insider trading liability under § 10(b), significantly expanding the government's enforcement power. It makes clear that liability is not limited to traditional corporate insiders but extends to any person who breaches a fiduciary duty by trading on confidential information, regardless of the source. The ruling also strongly affirmed the SEC's broad prophylactic rulemaking authority under the Williams Act, allowing the agency to regulate non-fraudulent conduct to prevent fraud in the tender offer context. This gives the SEC considerable latitude to adopt clear, bright-line rules to protect market integrity, even if those rules sweep more broadly than the underlying fraudulent conduct they are designed to prevent.
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