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Federal-based

This playlist is intended to be used as a “virtual” casebook for an introductory corporations class. This virtual casebook is an experiment using the H20 platform of Harvard's Berkman Center. This casebook can be printed and used in a hard copy form, or students can read and access the cases and materials online.

The materials in this casebook follow a format that is familiar to a student in any of my previous corporations classes. The materials start with an extended focus on the concepts of agency. Then we turn to the Delaware corporate code. While the various conceptual approaches to the corporate law are extremely interesting and important, it is critical that law students master the code. Consequently, after an introduction to the concepts of agency, we will focus on the Delaware code. Although we could study the Model code or the Massachusetts code, for most corporate lawyers, the Delaware corporate law will be central to their practice.

Beyond the code, Delaware has a very deep corporate common law. It is in the corporate common law that the courts have developed the law of corporate fiduciary duties. It is through fiduciary duties that the corporate law attempts to regulate the relationship between shareholders and the corporation, between managers and the corporation, as well as the relationships of controlling shareholders and minority shareholders.

Fiduciary duties are tested most often in the context of corporate takeovers. The corporate takeover materials in this casebook attempt to highlight the most important issues in takeover situations as well as the court's doctrinal efforts to mitigate the transaction costs that arise in these situations.

  • 1 Rule 10b-5

    § 240.10b-5 Employment of manipulative and deceptive devices.

    It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
    (a) To employ any device, scheme, or artifice to defraud,
    (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
    (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
    in connection with the purchase or sale of any security.
  • 2 Basic Inc. v. Levinson

    1
    485 U.S. 224 (1988)
    2
    BASIC INC. ET AL.
    v.
    LEVINSON ET AL.
    3
    No. 86-279.
    Supreme Court of United States.
    4
    Argued November 2, 1987
    5
    Decided March 7, 1988
    6
    CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT
    7

    [225] Joel W. Sternman argued the cause for petitioners. With him on the briefs were H. Stephen Madsen, Norman S. Jeavons, William W. Golub, Ambrose Doskow, Arnold I. Roth, and Katherine M. Blakeley.

    8

    [226] Wayne A. Cross argued the cause for respondents. With him on the brief were David S. Elkind and Lee A. Pickard.[*]

    9

    Solicitor General Fried, Deputy Solicitor General Cohen, Jerrold J. Ganzfried, Daniel L. Goelzer, Paul Gonson, Jacob H. Stillman, Eric Summergrad, Katharine B. Gresham, and Max Berueffy filed a brief for the United States as amicus curiae.

    10
    JUSTICE BLACKMUN delivered the opinion of the Court.
    11

    This case requires us to apply the materiality requirement of § 10(b) of the Securities Exchange Act of 1934 (1934 Act), 48 Stat. 881, as amended, 15 U. S. C. § 78a et seq., and the Securities and Exchange Commission's Rule 10b-5, 17 CFR § 240.10b-5 (1987), promulgated thereunder, in the context of preliminary corporate merger discussions. We must also determine whether a person who traded a corporation's shares on a securities exchange after the issuance of a materially misleading statement by the corporation may invoke a rebuttable presumption that, in trading, he relied on the integrity of the price set by the market.

    12
    I
    13

    Prior to December 20, 1978, Basic Incorporated was a publicly traded company primarily engaged in the business of manufacturing chemical refractories for the steel industry. As early as 1965 or 1966, Combustion Engineering, Inc., a company producing mostly alumina-based refractories, expressed some interest in acquiring Basic, but was deterred from pursuing this inclination seriously because of antitrust concerns it then entertained. See App. 81-83. In 1976, however, regulatory action opened the way to a renewal of [227] Combustion's interest.[1] The "Strategic Plan," dated October 25, 1976, for Combustion's Industrial Products Group included the objective: "Acquire Basic Inc. $30 million." App. 337.

    14

    Beginning in September 1976, Combustion representatives had meetings and telephone conversations with Basic officers and directors, including petitioners here,[2] concerning the possibility of a merger.[3] During 1977 and 1978, Basic made three public statements denying that it was engaged in merger negotiations.[4] On December 18, 1978, Basic asked [228] the New York Stock Exchange to suspend trading in its shares and issued a release stating that it had been "approached" by another company concerning a merger. Id., at 413. On December 19, Basic's board endorsed Combustion's offer of $46 per share for its common stock, id., at 335, 414-416, and on the following day publicly announced its approval of Combustion's tender offer for all outstanding shares.

    15

    Respondents are former Basic shareholders who sold their stock after Basic's first public statement of October 21, 1977, and before the suspension of trading in December 1978. Respondents brought a class action against Basic and its directors, asserting that the defendants issued three false or misleading public statements and thereby were in violation of § 10(b) of the 1934 Act and of Rule 10b-5. Respondents alleged that they were injured by selling Basic shares at artificially depressed prices in a market affected by petitioners' misleading statements and in reliance thereon.

    16

    The District Court adopted a presumption of reliance by members of the plaintiff class upon petitioners' public statements that enabled the court to conclude that common questions of fact or law predominated over particular questions pertaining to individual plaintiffs. See Fed. Rule Civ. Proc. 23(b)(3). The District Court therefore certified respondents' class.[5] On the merits, however, the District Court granted [229] summary judgment for the defendants. It held that, as a matter of law, any misstatements were immaterial: there were no negotiations ongoing at the time of the first statement, and although negotiations were taking place when the second and third statements were issued, those negotiations were not "destined, with reasonable certainty, to become a merger agreement in principle." App. to Pet. for Cert. 103a.

    17

    The United States Court of Appeals for the Sixth Circuit affirmed the class certification, but reversed the District Court's summary judgment, and remanded the case. 786 F. 2d 741 (1986). The court reasoned that while petitioners were under no general duty to disclose their discussions with Combustion, any statement the company voluntarily released could not be " `so incomplete as to mislead.' " Id., at 746, quoting SEC v. Texas Gulf Sulphur Co., 401 F. 2d 833, 862 (CA2 1968) (en banc), cert. denied sub nom. Coates v. SEC, 394 U. S. 976 (1969). In the Court of Appeals' view, Basic's statements that no negotiations were taking place, and that it knew of no corporate developments to account for the heavy trading activity, were misleading. With respect to materiality, the court rejected the argument that preliminary merger discussions are immaterial as a matter of law, and held that "once a statement is made denying the existence of any discussions, even discussions that might not have been material in absence of the denial are material because they make the statement made untrue." 786 F. 2d, at 749.

    18

    The Court of Appeals joined a number of other Circuits in accepting the "fraud-on-the-market theory" to create a rebuttable presumption that respondents relied on petitioners' material [230] misrepresentations, noting that without the presumption it would be impractical to certify a class under Federal Rule of Civil Procedure 23(b)(3). See 786 F. 2d, at 750-751.

    19

    We granted certiorari, 479 U. S. 1083 (1987), to resolve the split, see Part III, infra, among the Courts of Appeals as to the standard of materiality applicable to preliminary merger discussions, and to determine whether the courts below properly applied a presumption of reliance in certifying the class, rather than requiring each class member to show direct reliance on Basic's statements.

    20
    II
    21

    The 1934 Act was designed to protect investors against manipulation of stock prices. See S. Rep. No. 792, 73d Cong., 2d Sess., 1-5 (1934). Underlying the adoption of extensive disclosure requirements was a legislative philosophy: "There cannot be honest markets without honest publicity. Manipulation and dishonest practices of the market place thrive upon mystery and secrecy." H. R. Rep. No. 1383, 73d Cong., 2d Sess., 11 (1934). This Court "repeatedly has described the `fundamental purpose' of the Act as implementing a `philosophy of full disclosure.' " Santa Fe Industries, Inc. v. Green, 430 U. S. 462, 477-478 (1977), quoting SEC v. Capital Gains Research Bureau, Inc., 375 U. S. 180, 186 (1963).

    22

    Pursuant to its authority under § 10(b) of the 1934 Act, 15 U. S. C. § 78j, the Securities and Exchange Commission promulgated Rule 10b-5.[6] Judicial interpretation and application, [231] legislative acquiescence, and the passage of time have removed any doubt that a private cause of action exists for a violation of § 10(b) and Rule 10b-5, and constitutes an essential tool for enforcement of the 1934 Act's requirements. See, e. g., Ernst & Ernst v. Hochfelder, 425 U. S. 185, 196 (1976); Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723, 730 (1975).

    23

    The Court previously has addressed various positive and common-law requirements for a violation of § 10(b) or of Rule 10b-5. See, e. g., Santa Fe Industries, Inc. v. Green, supra ("manipulative or deceptive" requirement of the statute); Blue Chip Stamps v. Manor Drug Stores, supra ("in connection with the purchase or sale" requirement of the Rule); Dirks v. SEC, 463 U. S. 646 (1983) (duty to disclose); Chiarella v. United States, 445 U. S. 222 (1980) (same); Ernst & Ernst v. Hochfelder, supra (scienter). See also Carpenter v. United States, 484 U. S. 19 (1987) (confidentiality). The Court also explicitly has defined a standard of materiality under the securities laws, see TSC Industries, Inc. v. Northway, Inc., 426 U. S. 438 (1976), concluding in the proxy-solicitation context that "[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." Id., at 449.[7] Acknowledging that certain information concerning corporate developments could well be of "dubious significance," id., at 448, the Court was careful not to set too low a standard of materiality; it was concerned that a minimal standard might bring an overabundance of information within its reach, and lead management "simply to bury the shareholders in an avalanche of trivial information — a result that is hardly conducive to informed decisionmaking." Id., at 448-449. It further explained that to fulfill the materiality requirement "there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the [232] reasonable investor as having significantly altered the `total mix' of information made available." Id., at 449. We now expressly adopt the TSC Industries standard of materiality for the § 10(b) and Rule 10b-5 context.[8]

    24
    III
    25

    The application of this materiality standard to preliminary merger discussions is not self-evident. Where the impact of the corporate development on the target's fortune is certain and clear, the TSC Industries materiality definition admits straightforward application. Where, on the other hand, the event is contingent or speculative in nature, it is difficult to ascertain whether the "reasonable investor" would have considered the omitted information significant at the time. Merger negotiations, because of the ever-present possibility that the contemplated transaction will not be effectuated, fall into the latter category.[9]

    26
    A
    27

    Petitioners urge upon us a Third Circuit test for resolving this difficulty.[10] See Brief for Petitioners 20-22. Under this [233] approach, preliminary merger discussions do not become material until "agreement-in-principle" as to the price and structure of the transaction has been reached between the would-be merger partners. See Greenfield v. Heublein, Inc., 742 F. 2d 751, 757 (CA3 1984), cert. denied, 469 U. S. 1215 (1985). By definition, then, information concerning any negotiations not yet at the agreement-in-principle stage could be withheld or even misrepresented without a violation of Rule 10b-5.

    28

    Three rationales have been offered in support of the "agreement-in-principle" test. The first derives from the concern expressed in TSC Industries that an investor not be overwhelmed by excessively detailed and trivial information, and focuses on the substantial risk that preliminary merger discussions may collapse: because such discussions are inherently tentative, disclosure of their existence itself could mislead investors and foster false optimism. See Greenfield v. Heublein, Inc., 742 F. 2d, at 756; Reiss v. Pan American World Airways, Inc., 711 F. 2d 11, 14 (CA2 1983). The other two justifications for the agreement-in-principle standard are based on management concerns: because the requirement of "agreement-in-principle" limits the scope of disclosure obligations, it helps preserve the confidentiality of merger discussions where earlier disclosure might prejudice the negotiations; and the test also provides a usable, bright-line rule for determining when disclosure must be made. See Greenfield v. Heublein, Inc., 742 F. 2d, at 757; Flamm [234] v. Eberstadt, 814 F. 2d 1169, 1176-1178 (CA7), cert. denied, 484 U. S. 853 (1987).

    29

    None of these policy-based rationales, however, purports to explain why drawing the line at agreement-in-principle reflects the significance of the information upon the investor's decision. The first rationale, and the only one connected to the concerns expressed in TSC Industries, stands soundly rejected, even by a Court of Appeals that otherwise has accepted the wisdom of the agreement-in-principle test. "It assumes that investors are nitwits, unable to appreciate — even when told — that mergers are risky propositions up until the closing." Flamm v. Eberstadt, 814 F. 2d, at 1175. Disclosure, and not paternalistic withholding of accurate information, is the policy chosen and expressed by Congress. We have recognized time and again, a "fundamental purpose" of the various Securities Acts, "was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry." SEC v. Capital Gains Research Bureau, Inc., 375 U. S., at 186. Accord, Affiliated Ute Citizens v. United States, 406 U. S. 128, 151 (1972); Santa Fe Industries, Inc. v. Green, 430 U. S., at 477. The role of the materiality requirement is not to "attribute to investors a child-like simplicity, and inability to grasp the probabilistic significance of negotiations," Flamm v. Eberstadt, 814 F. 2d, at 1175, but to filter out essentially useless information that a reasonable investor would not consider significant, even as part of a larger "mix" of factors to consider in making his investment decision. TSC Industries, Inc. v. Northway, Inc., 426 U. S., at 448-449.

    30

    The second rationale, the importance of secrecy during the early stages of merger discussions, also seems irrelevant to an assessment whether their existence is significant to the trading decision of a reasonable investor. To avoid a "bidding war" over its target, an acquiring firm often will insist that negotiations remain confidential, see, e. g., In re Carnation [235] Co., Exchange Act Release No. 22214, 33 S. E. C. Docket 1025 (1985), and at least one Court of Appeals has stated that "silence pending settlement of the price and structure of a deal is beneficial to most investors, most of the time." Flamm v. Eberstadt, 814 F. 2d, at 1177.[11]

    31

    We need not ascertain, however, whether secrecy necessarily maximizes shareholder wealth — although we note that the proposition is at least disputed as a matter of theory and empirical research[12] — for this case does not concern the timing of a disclosure; it concerns only its accuracy and completeness.[13] We face here the narrow question whether information concerning the existence and status of preliminary merger discussions is significant to the reasonable investor's trading decision. Arguments based on the premise that some disclosure would be "premature" in a sense are more properly considered under the rubric of an issuer's duty to disclose. The "secrecy" rationale is simply inapposite to the definition of materiality.

    32

    [236] The final justification offered in support of the agreement-in-principle test seems to be directed solely at the comfort of corporate managers. A bright-line rule indeed is easier to follow than a standard that requires the exercise of judgment in the light of all the circumstances. But ease of application alone is not an excuse for ignoring the purposes of the Securities Acts and Congress' policy decisions. Any approach that designates a single fact or occurrence as always determinative of an inherently fact-specific finding such as materiality, must necessarily be overinclusive or underinclusive. In TSC Industries this Court explained: "The determination [of materiality] requires delicate assessments of the inferences a `reasonable shareholder' would draw from a given set of facts and the significance of those inferences to him . . . ." 426 U. S., at 450. After much study, the Advisory Committee on Corporate Disclosure cautioned the SEC against administratively confining materiality to a rigid formula.[14] Courts also would do well to heed this advice.

    33

    We therefore find no valid justification for artificially excluding from the definition of materiality information concerning merger discussions, which would otherwise be considered significant to the trading decision of a reasonable investor, merely because agreement-in-principle as to price and structure has not yet been reached by the parties or their representatives.

    34
    B
    35

    [237] The Sixth Circuit explicitly rejected the agreement-in-principle test, as we do today, but in its place adopted a rule that, if taken literally, would be equally insensitive, in our view, to the distinction between materiality and the other elements of an action under Rule 10b-5:

    36
    "When a company whose stock is publicly traded makes a statement, as Basic did, that `no negotiations' are underway, and that the corporation knows of `no reason for the stock's activity,' and that `management is unaware of any present or pending corporate development that would result in the abnormally heavy trading activity,' information concerning ongoing acquisition discussions becomes material by virtue of the statement denying their existence. . . .
    37
    .....
    38
    ". . . In analyzing whether information regarding merger discussions is material such that it must be affirmatively disclosed to avoid a violation of Rule 10b-5, the discussions and their progress are the primary considerations. However, once a statement is made denying the existence of any discussions, even discussions that might not have been material in absence of the denial are material because they make the statement made untrue." 786 F. 2d, at 748-749 (emphasis in original).[15]
    39

    [238] This approach, however, fails to recognize that, in order to prevail on a Rule 10b-5 claim, a plaintiff must show that the statements were misleading as to a material fact. It is not enough that a statement is false or incomplete, if the misrepresented fact is otherwise insignificant.

    40
    C
    41

    Even before this Court's decision in TSC Industries, the Second Circuit had explained the role of the materiality requirement of Rule 10b-5, with respect to contingent or speculative information or events, in a manner that gave that term meaning that is independent of the other provisions of the Rule. Under such circumstances, materiality "will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity." SEC v. Texas Gulf Sulphur Co., 401 F. 2d, at 849. Interestingly, neither the Third Circuit decision adopting the agreement-in-principle test nor petitioners here take issue with this general standard. Rather, they suggest that with respect to preliminary merger discussions, there are good reasons to draw a line at agreement on price and structure.

    42

    In a subsequent decision, the late Judge Friendly, writing for a Second Circuit panel, applied the Texas Gulf Sulphur probability/magnitude approach in the specific context of preliminary merger negotiations. After acknowledging that materiality is something to be determined on the basis of the particular facts of each case, he stated:

    43
    "Since a merger in which it is bought out is the most important event that can occur in a small corporation's life, to wit, its death, we think that inside information, as regards a merger of this sort, can become material at an earlier stage than would be the case as regards lesser transactions — and this even though the mortality rate of mergers in such formative stages is doubtless high." SEC v. Geon Industries, Inc., 531 F. 2d 39, 47-48 (1976).
    44

    [239] We agree with that analysis.[16]

    45

    Whether merger discussions in any particular case are material therefore depends on the facts. Generally, in order to assess the probability that the event will occur, a factfinder will need to look to indicia of interest in the transaction at the highest corporate levels. Without attempting to catalog all such possible factors, we note by way of example that board resolutions, instructions to investment bankers, and actual negotiations between principals or their intermediaries may serve as indicia of interest. To assess the magnitude of the transaction to the issuer of the securities allegedly manipulated, a factfinder will need to consider such facts as the size of the two corporate entities and of the potential premiums over market value. No particular event or factor short of closing the transaction need be either necessary or sufficient by itself to render merger discussions material.[17]

    46

    [240] As we clarify today, materiality depends on the significance the reasonable investor would place on the withheld or misrepresented information.[18] The fact-specific inquiry we endorse here is consistent with the approach a number of courts have taken in assessing the materiality of merger negotiations.[19] Because the standard of materiality we have [241] adopted differs from that used by both courts below, we remand the case for reconsideration of the question whether a grant of summary judgment is appropriate on this record.[20]

    47
    IV
    48
    A
    49

    We turn to the question of reliance and the fraud-on-the-market theory. Succinctly put:

    50
    "The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company's stock is determined by the available material information regarding the company and its business. . . . Misleading statements will therefore [242] defraud purchasers of stock even if the purchasers do not directly rely on the misstatements. . . . The causal connection between the defendants' fraud and the plaintiffs' purchase of stock in such a case is no less significant than in a case of direct reliance on misrepresentations." Peil v. Speiser, 806 F. 2d 1154, 1160-1161 (CA3 1986).
    51

    Our task, of course, is not to assess the general validity of the theory, but to consider whether it was proper for the courts below to apply a rebuttable presumption of reliance, supported in part by the fraud-on-the-market theory. Cf. the comments of the dissent, post, at 252-255.

    52

    This case required resolution of several common questions of law and fact concerning the falsity or misleading nature of the three public statements made by Basic, the presence or absence of scienter, and the materiality of the misrepresentations, if any. In their amended complaint, the named plaintiffs alleged that in reliance on Basic's statements they sold their shares of Basic stock in the depressed market created by petitioners. See Amended Complaint in No. C79-1220 (ND Ohio), ¶¶ 27, 29, 35, 40; see also id., ¶ 33 (alleging effect on market price of Basic's statements). Requiring proof of individualized reliance from each member of the proposed plaintiff class effectively would have prevented respondents from proceeding with a class action, since individual issues then would have overwhelmed the common ones. The District Court found that the presumption of reliance created by the fraud-on-the-market theory provided "a practical resolution to the problem of balancing the substantive requirement of proof of reliance in securities cases against the procedural requisites of [Federal Rule of Civil Procedure] 23." The District Court thus concluded that with reference to each public statement and its impact upon the open market for Basic shares, common questions predominated over individual questions, as required by Federal Rules of Civil Procedure 23(a)(2) and (b)(3).

    53

    [243] Petitioners and their amici complain that the fraud-on-the-market theory effectively eliminates the requirement that a plaintiff asserting a claim under Rule 10b-5 prove reliance. They note that reliance is and long has been an element of common-law fraud, see, e. g., Restatement (Second) of Torts § 525 (1977); W. Keeton, D. Dobbs, R. Keeton, & D. Owen, Prosser and Keeton on Law of Torts § 108 (5th ed. 1984), and argue that because the analogous express right of action includes a reliance requirement, see, e. g., § 18(a) of the 1934 Act, as amended, 15 U. S. C. § 78r(a), so too must an action implied under § 10(b).

    54

    We agree that reliance is an element of a Rule 10b-5 cause of action. See Ernst & Ernst v. Hochfelder, 425 U. S., at 206 (quoting Senate Report). Reliance provides the requisite causal connection between a defendant's misrepresentation and a plaintiff's injury. See, e. g., Wilson v. Comtech Telecommunications Corp., 648 F. 2d 88, 92 (CA2 1981); List v. Fashion Park, Inc., 340 F. 2d 457, 462 (CA2), cert. denied sub nom. List v. Lerner, 382 U. S. 811 (1965). There is, however, more than one way to demonstrate the causal connection. Indeed, we previously have dispensed with a requirement of positive proof of reliance, where a duty to disclose material information had been breached, concluding that the necessary nexus between the plaintiffs' injury and the defendant's wrongful conduct had been established. See Affiliated Ute Citizens v. United States, 406 U. S., at 153-154. Similarly, we did not require proof that material omissions or misstatements in a proxy statement decisively affected voting, because the proxy solicitation itself, rather than the defect in the solicitation materials, served as an essential link in the transaction. See Mills v. Electric Auto-Lite Co., 396 U. S. 375, 384-385 (1970).

    55

    The modern securities markets, literally involving millions of shares changing hands daily, differ from the face-to-face [244] transactions contemplated by early fraud cases,[21] and our understanding of Rule 10b-5's reliance requirement must encompass these differences.[22]

    56
    "In face-to-face transactions, the inquiry into an investor's reliance upon information is into the subjective pricing of that information by that investor. With the presence of a market, the market is interposed between seller and buyer and, ideally, transmits information to the investor in the processed form of a market price. Thus the market is performing a substantial part of the valuation process performed by the investor in a face-to-face transaction. The market is acting as the unpaid agent of the investor, informing him that given all the information available to it, the value of the stock is worth the market price." In re LTV Securities Litigation, 88 F. R. D. 134, 143 (ND Tex. 1980).
    57

    Accord, e. g., Peil v. Speiser, 806 F. 2d, at 1161 ("In an open and developed market, the dissemination of material misrepresentations or withholding of material information typically affects the price of the stock, and purchasers generally rely on the price of the stock as a reflection of its value"); Blackie [245] v. Barrack, 524 F. 2d 891, 908 (CA9 1975) ("[T]he same causal nexus can be adequately established indirectly, by proof of materiality coupled with the common sense that a stock purchaser does not ordinarily seek to purchase a loss in the form of artificially inflated stock"), cert. denied, 429 U. S. 816 (1976).

    58
    B
    59

    Presumptions typically serve to assist courts in managing circumstances in which direct proof, for one reason or another, is rendered difficult. See, e. g., 1 D. Louisell & C. Mueller, Federal Evidence 541-542 (1977). The courts below accepted a presumption, created by the fraud-on-the-market theory and subject to rebuttal by petitioners, that persons who had traded Basic shares had done so in reliance on the integrity of the price set by the market, but because of petitioners' material misrepresentations that price had been fraudulently depressed. Requiring a plaintiff to show a speculative state of facts, i. e., how he would have acted if omitted material information had been disclosed, see Affiliated Ute Citizens v. United States, 406 U. S., at 153-154, or if the misrepresentation had not been made, see Sharp v. Coopers & Lybrand, 649 F. 2d 175, 188 (CA3 1981), cert. denied, 455 U. S. 938 (1982), would place an unnecessarily unrealistic evidentiary burden on the Rule 10b-5 plaintiff who has traded on an impersonal market. Cf. Mills v. Electric Auto-Lite Co., 396 U. S., at 385.

    60

    Arising out of considerations of fairness, public policy, and probability, as well as judicial economy, presumptions are also useful devices for allocating the burdens of proof between parties. See E. Cleary, McCormick on Evidence 968-969 (3d ed. 1984); see also Fed. Rule Evid. 301 and Advisory Committee Notes, 28 U. S. C. App., p. 685. The presumption of reliance employed in this case is consistent with, and, by facilitating Rule 10b-5 litigation, supports, the congressional policy embodied in the 1934 Act. In drafting that Act, [246] Congress expressly relied on the premise that securities markets are affected by information, and enacted legislation to facilitate an investor's reliance on the integrity of those markets:

    61
    "No investor, no speculator, can safely buy and sell securities upon the exchanges without having an intelligent basis for forming his judgment as to the value of the securities he buys or sells. The idea of a free and open public market is built upon the theory that competing judgments of buyers and sellers as to the fair price of a security brings [sic] about a situation where the market price reflects as nearly as possible a just price. Just as artificial manipulation tends to upset the true function of an open market, so the hiding and secreting of important information obstructs the operation of the markets as indices of real value." H. R. Rep. No. 1383, at 11.
    62

    See Lipton v. Documation, Inc., 734 F. 2d 740, 748 (CA11 1984), cert. denied, 469 U. S. 1132 (1985).[23]

    63

    The presumption is also supported by common sense and probability. Recent empirical studies have tended to confirm Congress' premise that the market price of shares traded on well-developed markets reflects all publicly available information, and, hence, any material misrepresentations.[24] It has been noted that "it is hard to imagine that [247] there ever is a buyer or seller who does not rely on market integrity. Who would knowingly roll the dice in a crooked crap game?" Schlanger v. Four-Phase Systems Inc., 555 F. Supp. 535, 538 (SDNY 1982). Indeed, nearly every court that has considered the proposition has concluded that where materially misleading statements have been disseminated into an impersonal, well-developed market for securities, the reliance of individual plaintiffs on the integrity of the market price may be presumed.[25] Commentators generally have applauded the adoption of one variation or another of the fraud-on-the-market theory.[26] An investor who buys or sells stock at the price set by the market does so in reliance on the integrity of that price. Because most publicly available information is reflected in market price, an investor's reliance on any public material misrepresentations, therefore, may be presumed for purposes of a Rule 10b-5 action.

    64
    C
    65

    [248] The Court of Appeals found that petitioners "made public, material misrepresentations and [respondents] sold Basic stock in an impersonal, efficient market. Thus the class, as defined by the district court, has established the threshold facts for proving their loss." 786 F. 2d, at 751.[27] The court acknowledged that petitioners may rebut proof of the elements giving rise to the presumption, or show that the misrepresentation in fact did not lead to a distortion of price or that an individual plaintiff traded or would have traded despite his knowing the statement was false. Id., at 750, n. 6.

    66

    Any showing that severs the link between the alleged misrepresentation and either the price received (or paid) by the plaintiff, or his decision to trade at a fair market price, will be sufficient to rebut the presumption of reliance. For example, if petitioners could show that the "market makers" were privy to the truth about the merger discussions here with Combustion, and thus that the market price would not have been affected by their misrepresentation, the causal connection could be broken: the basis for finding that the fraud had been transmitted through market price would be gone.[28] Similarly, if, despite petitioners' allegedly fraudulent attempt [249] to manipulate market price, news of the merger discussions credibly entered the market and dissipated the effects of the misstatements, those who traded Basic shares after the corrective statements would have no direct or indirect connection with the fraud.[29] Petitioners also could rebut the presumption of reliance as to plaintiffs who would have divested themselves of their Basic shares without relying on the integrity of the market. For example, a plaintiff who believed that Basic's statements were false and that Basic was indeed engaged in merger discussions, and who consequently believed that Basic stock was artificially underpriced, but sold his shares nevertheless because of other unrelated concerns, e. g., potential antitrust problems, or political pressures to divest from shares of certain businesses, could not be said to have relied on the integrity of a price he knew had been manipulated.

    67
    V
    68

    In summary:

    69

    1. We specifically adopt, for the § 10(b) and Rule 10b-5 context, the standard of materiality set forth in TSC Industries, Inc. v. Northway, Inc., 426 U. S., at 449.

    70

    2. We reject "agreement-in-principle as to price and structure" as the bright-line rule for materiality.

    71

    3. We also reject the proposition that "information becomes material by virtue of a public statement denying it."

    72

    [250] 4. Materiality in the merger context depends on the probability that the transaction will be consummated, and its significance to the issuer of the securities. Materiality depends on the facts and thus is to be determined on a case-by-case basis.

    73

    5. It is not inappropriate to apply a presumption of reliance supported by the fraud-on-the-market theory.

    74

    6. That presumption, however, is rebuttable.

    75

    7. The District Court's certification of the class here was appropriate when made but is subject on remand to such adjustment, if any, as developing circumstances demand.

    76

    The judgment of the Court of Appeals is vacated, and the case is remanded to that court for further proceedings consistent with this opinion.

    77

    It is so ordered.

    78

    THE CHIEF JUSTICE, JUSTICE SCALIA, and JUSTICE KENNEDY took no part in the consideration or decision of this case.

    79
    JUSTICE WHITE, with whom JUSTICE O'CONNOR joins, concurring in part and dissenting in part.
    80

    I join Parts I-III of the Court's opinion, as I agree that the standard of materiality we set forth in TSC Industries, Inc. v. Northway, Inc., 426 U. S. 438, 449 (1976), should be applied to actions under § 10(b) and Rule 10b-5. But I dissent from the remainder of the Court's holding because I do not agree that the "fraud-on-the-market" theory should be applied in this case.

    81
    I
    82

    Even when compared to the relatively youthful private cause-of-action under § 10(b), see Kardon v. National Gypsum Co., 69 F. Supp. 512 (ED Pa. 1946), the fraud-on-the-market theory is a mere babe.[1] Yet today, the Court embraces [251] this theory with the sweeping confidence usually reserved for more mature legal doctrines. In so doing, I fear that the Court's decision may have many adverse, unintended effects as it is applied and interpreted in the years to come.

    83
    A
    84

    At the outset, I note that there are portions of the Court's fraud-on-the-market holding with which I am in agreement. Most importantly, the Court rejects the version of that theory, heretofore adopted by some courts,[2] which equates "causation" with "reliance," and permits recovery by a plaintiff who claims merely to have been harmed by a material misrepresentation which altered a market price, notwithstanding proof that the plaintiff did not in any way rely on that price. Ante, at 248. I agree with the Court that if Rule 10b-5's reliance requirement is to be left with any content at all, the fraud-on-the-market presumption must be capable of being rebutted by a showing that a plaintiff did not "rely" on the market price. For example, a plaintiff who decides, months in advance of an alleged misrepresentation, to purchase a stock; one who buys or sells a stock for reasons unrelated to its price; one who actually sells a stock "short" days before the misrepresentation is made — surely none of these people can state a valid claim under Rule 10b-5. Yet, some federal courts have allowed such claims to stand under one variety or another of the fraud-on-the-market theory.[3]

    85

    [252] Happily, the majority puts to rest the prospect of recovery under such circumstances. A nonrebuttable presumption of reliance — or even worse, allowing recovery in the face of "affirmative evidence of nonreliance," Zweig v. Hearst Corp., 594 F. 2d 1261, 1272 (CA9 1979) (Ely, J., dissenting) — would effectively convert Rule 10b-5 into "a scheme of investor's insurance." Shores v. Sklar, 647 F. 2d 462, 469, n. 5 (CA5 1981) (en banc), cert. denied, 459 U. S. 1102 (1983). There is no support in the Securities Exchange Act, the Rule, or our cases for such a result.

    86
    B
    87

    But even as the Court attempts to limit the fraud-on-the-market theory it endorses today, the pitfalls in its approach are revealed by previous uses by the lower courts of the broader versions of the theory. Confusion and contradiction in court rulings are inevitable when traditional legal analysis is replaced with economic theorization by the federal courts.

    88

    [253] In general, the case law developed in this Court with respect to § 10(b) and Rule 10b-5 has been based on doctrines with which we, as judges, are familiar: common-law doctrines of fraud and deceit. See, e. g., Santa Fe Industries, Inc. v. Green, 430 U. S. 462, 471-477 (1977). Even when we have extended civil liability under Rule 10b-5 to a broader reach than the common law had previously permitted, see ante, at 244, n. 22, we have retained familiar legal principles as our guideposts. See, e. g., Herman & MacLean v. Huddleston, 459 U. S. 375, 389-390 (1983). The federal courts have proved adept at developing an evolving jurisprudence of Rule 10b-5 in such a manner. But with no staff economists, no experts schooled in the "efficient-capital-market hypothesis," no ability to test the validity of empirical market studies, we are not well equipped to embrace novel constructions of a statute based on contemporary microeconomic theory.[4]

    89

    The "wrong turns" in those Court of Appeals and District Court fraud-on-the-market decisions which the Court implicitly rejects as going too far should be ample illustration of the dangers when economic theories replace legal rules as the basis for recovery. Yet the Court today ventures into this area beyond its expertise, beyond — by its own admission — the confines of our previous fraud cases. See ante, at 243-244. Even if I agreed with the Court that "modern securities [254] markets . . . involving millions of shares changing hands daily" require that the "understanding of Rule 10b-5's reliance requirement" be changed, ibid., I prefer that such changes come from Congress in amending § 10(b). The Congress, with its superior resources and expertise, is far better equipped than the federal courts for the task of determining how modern economic theory and global financial markets require that established legal notions of fraud be modified. In choosing to make these decisions itself, the Court, I fear, embarks on a course that it does not genuinely understand, giving rise to consequences it cannot foresee.[5]

    90

    For while the economists' theories which underpin the fraud-on-the-market presumption may have the appeal of mathematical exactitude and scientific certainty, they are — in the end — nothing more than theories which may or may not prove accurate upon further consideration. Even the most earnest advocates of economic analysis of the law recognize this. See, e. g., Easterbrook, Afterword: Knowledge and Answers, 85 Colum. L. Rev. 1117, 1118 (1985). Thus, while the majority states that, for purposes of reaching its result it need only make modest assumptions about the way in which "market professionals generally" do their jobs, and how the conduct of market professionals affects stock prices, ante, at 246, n. 23, I doubt that we are in much of a position [255] to assess which theories aptly describe the functioning of the securities industry.

    91

    Consequently, I cannot join the Court in its effort to reconfigure the securities laws, based on recent economic theories, to better fit what it perceives to be the new realities of financial markets. I would leave this task to others more equipped for the job than we.

    92
    C
    93

    At the bottom of the Court's conclusion that the fraud-on-the-market theory sustains a presumption of reliance is the assumption that individuals rely "on the integrity of the market price" when buying or selling stock in "impersonal, well-developed market[s] for securities." Ante, at 247. Even if I was prepared to accept (as a matter of common sense or general understanding) the assumption that most persons buying or selling stock do so in response to the market price, the fraud-on-the-market theory goes further. For in adopting a "presumption of reliance," the Court also assumes that buyers and sellers rely — not just on the market price — but on the "integrity" of that price. It is this aspect of the fraud-on-the-market hypothesis which most mystifies me.

    94

    To define the term "integrity of the market price," the majority quotes approvingly from cases which suggest that investors are entitled to " `rely on the price of a stock as a reflection of its value.' " Ante, at 244 (quoting Peil v. Speiser, 806 F. 2d 1154, 1161 (CA3 1986)). But the meaning of this phrase eludes me, for it implicitly suggests that stocks have some "true value" that is measurable by a standard other than their market price. While the scholastics of medieval times professed a means to make such a valuation of a commodity's "worth,"[6] I doubt that the federal courts of our day are similarly equipped.

    95

    [256] Even if securities had some "value" — knowable and distinct from the market price of a stock — investors do not always share the Court's presumption that a stock's price is a "reflection of [this] value." Indeed, "many investors purchase or sell stock because they believe the price inaccurately reflects the corporation's worth." See Black, Fraud on the Market: A Criticism of Dispensing with Reliance Requirements in Certain Open Market Transactions, 62 N. C. L. Rev. 435, 455 (1984) (emphasis added). If investors really believed that stock prices reflected a stock's "value," many sellers would never sell, and many buyers never buy (given the time and cost associated with executing a stock transaction). As we recognized just a few years ago: "[I]nvestors act on inevitably incomplete or inaccurate information, [consequently] there are always winners and losers; but those who have `lost' have not necessarily been defrauded." Dirks v. SEC, 463 U. S. 646, 667, n. 27 (1983). Yet today, the Court allows investors to recover who can show little more than that they sold stock at a lower price than what might have been.[7]

    96

    I do not propose that the law retreat from the many protections that § 10(b) and Rule 10b-5, as interpreted in our prior cases, provide to investors. But any extension of these laws, to approach something closer to an investor insurance [257] scheme, should come from Congress, and not from the courts.

    97
    II
    98

    Congress has not passed on the fraud-on-the-market theory the Court embraces today. That is reason enough for us to abstain from doing so. But it is even more troubling that, to the extent that any view of Congress on this question can be inferred indirectly, it is contrary to the result the majority reaches.

    99
    A
    100

    In the past, the scant legislative history of § 10(b) has led us to look at Congress' intent in adopting other portions of the Securities Exchange Act when we endeavor to discern the limits of private causes of action under Rule 10b-5. See, e. g., Ernst & Ernst v. Hochfelder, 425 U. S. 185, 204-206 (1976). A similar undertaking here reveals that Congress flatly rejected a proposition analogous to the fraud-on-the-market theory in adopting a civil liability provision of the 1934 Act.

    101

    Section 18 of the Act expressly provides for civil liability for certain misleading statements concerning securities. See 15 U. S. C. § 78r(a). When the predecessor of this section was first being considered by Congress, the initial draft of the provision allowed recovery by any plaintiff "who shall have purchased or sold a security the price of which may have been affected by such [misleading] statement." See S. 2693, 73d Cong., 2d Sess., § 17(a) (1934). Thus, as initially drafted, the precursor to the express civil liability provision of the 1934 Act would have permitted suits by plaintiffs based solely on the fact that the price of the securities they bought or sold was affected by a misrepresentation: a theory closely akin to the Court's holding today.

    102

    Yet this provision was roundly criticized in congressional hearings on the proposed Securities Exchange Act, because it failed to include a more substantial "reliance" requirement.[8] [258] Subsequent drafts modified the original proposal, and included an express reliance requirement in the final version of the Act. In congressional debates over the redrafted version of this bill, the then-Chairman of the House Committee, Representative Sam Rayburn, explained that the "bill as originally written was very much challenged on the ground that reliance should be required. This objection has been met." 78 Cong. Rec. 7701 (1934). Moreover, in a previous case concerning the scope of § 10(b) and Rule 10b-5, we quoted approvingly from the legislative history of this revised provision, which emphasized the presence of a strict reliance requirement as a prerequisite for recovery. See Ernst & Ernst v. Hochfelder, supra, at 206 (citing S. Rep. No. 792, 73d Cong., 2d Sess., 12-13 (1934)).

    103

    Congress thus anticipated meaningful proof of "reliance" before civil recovery can be had under the Securities Exchange Act. The majority's adoption of the fraud-on-the-market theory effectively eviscerates the reliance rule in actions brought under Rule 10b-5, and negates congressional intent to the contrary expressed during adoption of the 1934 Act.

    104
    B
    105

    A second congressional policy that the majority's opinion ignores is the strong preference the securities laws display for widespread public disclosure and distribution to investors of material information concerning securities. This congressionally adopted policy is expressed in the numerous and varied disclosure requirements found in the federal securities [259] law scheme. See, e. g., 15 U. S. C. §§ 78m, 78o(d) (1982 ed. and Supp. IV).

    106

    Yet observers in this field have acknowledged that the fraud-on-the-market theory is at odds with the federal policy favoring disclosure. See, e. g., Black, 62 N. C. L. Rev., at 457-459. The conflict between Congress' preference for disclosure and the fraud-on-the-market theory was well expressed by a jurist who rejected the latter in order to give force to the former:

    107
    "[D]isclosure . . . is crucial to the way in which the federal securities laws function. . . . [T]he federal securities laws are intended to put investors into a position from which they can help themselves by relying upon disclosures that others are obligated to make. This system is not furthered by allowing monetary recovery to those who refuse to look out for themselves. If we say that a plaintiff may recover in some circumstances even though he did not read and rely on the defendants' public disclosures, then no one need pay attention to those disclosures and the method employed by Congress to achieve the objective of the 1934 Act is defeated." Shores v. Sklar, 647 F. 2d, at 483 (Randall, J., dissenting).
    108

    It is no surprise, then, that some of the same voices calling for acceptance of the fraud-on-the-market theory also favor dismantling the federal scheme which mandates disclosure. But to the extent that the federal courts must make a choice between preserving effective disclosure and trumpeting the new fraud-on-the-market hypothesis, I think Congress has spoken clearly — favoring the current prodisclosure policy. We should limit our role in interpreting § 10(b) and Rule 10b-5 to one of giving effect to such policy decisions by Congress.

    109
    III
    110

    Finally, the particular facts of this case make it an exceedingly poor candidate for the Court's fraud-on-the-market theory, [260] and illustrate the illogic achieved by that theory's application in many cases.

    111

    Respondents here are a class of sellers who sold Basic stock between October 1977 and December 1978, a 14-month period. At the time the class period began, Basic's stock was trading at $20 a share (at the time, an all-time high); the last members of the class to sell their Basic stock got a price of just over $30 a share. App. 363, 423. It is indisputable that virtually every member of the class made money from his or her sale of Basic stock.

    112

    The oddities of applying the fraud-on-the-market theory in this case are manifest. First, there are the facts that the plaintiffs are sellers and the class period is so lengthy — both are virtually without precedent in prior fraud-on-the-market cases.[9] For reasons I discuss in the margin, I think these two facts render this case less apt to application of the fraud-on-the-market hypothesis.

    113

    Second, there is the fact that in this case, there is no evidence that petitioner Basic's officials made the troublesome misstatements for the purpose of manipulating stock prices, or with any intent to engage in underhanded trading of Basic stock. Indeed, during the class period, petitioners do not [261] appear to have purchased or sold any Basic stock whatsoever. App. to Pet. for Cert. 27a. I agree with amicus who argues that "[i]mposition of damages liability under Rule 10b-5 makes little sense . . . where a defendant is neither a purchaser nor a seller of securities." See Brief for American Corporate Counsel Association as Amicus Curiae 13. In fact, in previous cases, we had recognized that Rule 10b-5 is concerned primarily with cases where the fraud is committed by one trading the security at issue. See, e. g., Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723, 736, n. 8 (1975). And it is difficult to square liability in this case with § 10(b)'s express provision that it prohibits fraud "in connection with the purchase or sale of any security." See 15 U. S. C. § 78j(b) (emphasis added).

    114

    Third, there are the peculiarities of what kinds of investors will be able to recover in this case. As I read the District Court's class certification order, App. to Pet. for Cert. 123a-126a; ante, at 228-229, n. 5, there are potentially many persons who did not purchase Basic stock until after the first false statement (October 1977), but who nonetheless will be able to recover under the Court's fraud-on-the-market theory. Thus, it is possible that a person who heard the first corporate misstatement and disbelieved it — i. e., someone who purchased Basic stock thinking that petitioners' statement was false — may still be included in the plaintiff-class on remand. How a person who undertook such a speculative stock-investing strategy — and made $10 a share doing so (if he bought on October 22, 1977, and sold on December 15, 1978) — can say that he was "defrauded" by virtue of his reliance on the "integrity" of the market price is beyond me.[10] [262] And such speculators may not be uncommon, at least in this case. See App. to Pet. for Cert. 125a.

    115

    Indeed, the facts of this case lead a casual observer to the almost inescapable conclusion that many of those who bought or sold Basic stock during the period in question flatly disbelieved the statements which are alleged to have been "materially misleading." Despite three statements denying that merger negotiations were underway, Basic stock hit record-high after record-high during the 14-month class period. It seems quite possible that, like Casca's knowing disbelief of Caesar's "thrice refusal" of the Crown,[11] clever investors were skeptical of petitioners' three denials that merger talks were going on. Yet such investors, the saviest of the savvy, will be able to recover under the Court's opinion, as long as they now claim that they believed in the "integrity of the market price" when they sold their stock (between September and December 1978).[12] Thus, persons who bought after hearing and relying on the falsity of petitioners' statements may be able to prevail and recover money damages on remand.

    116

    And who will pay the judgments won in such actions? I suspect that all too often the majority's rule will "lead to large judgments, payable in the last analysis by innocent investors, for the benefit of speculators and their lawyers." Cf. SEC v. Texas Gulf Sulphur Co., 401 F. 2d 833, 867 (CA2 1968) (en banc) (Friendly, J., concurring), cert. denied, 394 U. S. 976 (1969). This Court and others have previously recognized that "inexorably broadening . . . the class of plaintiff[s] who may sue in this area of the law will ultimately result in more harm than good." Blue Chip Stamps v. Manor Drug Stores, supra, at 747-748. See also Ernst & Ernst v. Hochfelder, 425 U. S., at 214; Ultramares Corp. v. Touche, [263] 255 N. Y. 170, 179-180, 174 N. E. 441, 444-445 (1931) (Cardozo, C. J.). Yet such a bitter harvest is likely to be the reaped from the seeds sewn by the Court's decision today.

    117
    IV
    118

    In sum, I think the Court's embracement of the fraud-on-the-market theory represents a departure in securities law that we are ill suited to commence — and even less equipped to control as it proceeds. As a result, I must respectfully dissent.

    119

    ----------

    120

    [*] Briefs of amici curiae urging reversal were filed for the American Corporate Counsel Association by Stephen M. Shapiro, Andrew L. Frey, Kenneth S. Geller, Daniel Harris, and Mark I. Levy; for Arthur Andersen & Co. et al. by Victor M. Earle III, Carl D. Liggio, Donald Dreyfus, Harris J. Amhowitz, Kenneth H. Lang, Richard H. Murray, Leonard P. Novello, and Eldon Olson; and for the American Institute of Certified Public Accountants by Louis A. Craco.

    121

    [1] In what are known as the Kaiser-Lavino proceedings, the Federal Trade Commission took the position in 1976 that basic or chemical refractories were in a market separate from nonbasic or acidic or alumina refractories; this would remove the antitrust barrier to a merger between Basic and Combustion's refractories subsidiary. On October 12, 1978, the Initial Decision of the Administrative law Judge confirmed that position. See In re Kaiser Aluminum & Chemical Corp., 93 F. T. C. 764, 771, 809-810 (1979). See also the opinion of the Court of Appeals in this case, 786 F. 2d 741, 745 (CA6 1986).

    122

    [2] In addition to Basic itself, petitioners are individuals who had been members of its board of directors prior to 1979: Anthony M. Caito, Samuel Eels, Jr., John A. Gelbach, Harley C. Lee, Max Muller, H. Chapman Rose, Edmund G. Sylvester, and John C. Wilson, Jr. Another former director, Mathew J. Ludwig, was a party to the proceedings below but died on July 17, 1986, and is not a petitioner here. See Brief for Petitioners ii.

    123

    [3] In light of our disposition of this case, any further characterization of these discussions must await application, on remand, of the materiality standard adopted today.

    124

    [4] On October 21, 1977, after heavy trading and a new high in Basic stock, the following news item appeared in the Cleveland Plain Dealer:

    125

    "[Basic] President Max Muller said the company knew no reason for the stock's activity and that no negotiations were under way with any company for a merger. He said Flintkote recently denied Wall Street rumors that it would make a tender offer of $25 a share for control of the Cleveland-based maker of refractories for the steel industry." App. 363.

    126

    On September 25, 1978, in reply to an inquiry from the New York Stock Exchange, Basic issued a release concerning increased activity in its stock and stated that

    127

    "management is unaware of any present or pending company development that would result in the abnormally heavy trading activity and price fluctuation in company shares that have been experienced in the past few days." Id., at 401.

    128

    On November 6, 1978, Basic issued to its shareholders a "Nine Months Report 1978." This Report stated:

    129

    "With regard to the stock market activity in the Company's shares we remain unaware of any present or pending developments which would account for the high volume of trading and price fluctuations in recent months." Id., at 403.

    130

    [5] Respondents initially sought to represent all those who sold Basic shares between October 1, 1976, and December 20, 1978. See Amended Complaint in No. C79-1220 (ND Ohio), ¶ 5. The District Court, however, recognized a class period extending only from October 21, 1977, the date of the first public statement, rather than from the date negotiations allegedly commenced. In its certification decision, as subsequently amended, the District Court also excluded from the class those who had purchased Basic shares after the October 1977 statement but sold them before the September 1978 statement, App. to Pet. for Cert. 123a-124a, and those who sold their shares after the close of the market on Friday, December 15, 1978. Id., at 137a.

    131

    [6] In relevant part, Rule 10b-5 provides:

    132

    "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

    .....

    "(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading . . . ,

    .....

    "in connection with the purchase or sale of any security."

    133

    [7] TSC Industries arose under § 14(a), as amended, of the 1934 Act, 15 U. S. C. § 78n(a), and Rule 14a-9, 17 CFR § 240.14a-9 (1975).

    134

    [8] This application of the § 14(a) definition of materiality to § 10(b) and Rule 10b-5 is not disputed. See Brief for Petitioners 17, n. 12; Brief for Respondents 30, n. 10; Brief for SEC as Amicus Curiae 8, n. 4. See also McGrath v. Zenith Radio Corp., 651 F. 2d 458, 466, n. 4 (CA7), cert. denied, 454 U. S. 835 (1981), and Goldberg v. Meridor, 567 F. 2d 209, 218-219 (CA2 1977), cert. denied, 434 U. S. 1069 (1978).

    135

    [9] We do not address here any other kinds of contingent or speculative information, such as earnings forecasts or projections. See generally Hiler, The SEC and the Courts' Approach to Disclosure of Earnings Projections, Asset Appraisals, and Other Soft Information: Old Problems, Changing Views, 46 Md. L. Rev. 1114 (1987).

    136

    [10] See Staffin v. Greenberg, 672 F. 2d 1196, 1207 (CA3 1982) (defining duty to disclose existence of ongoing merger negotiations as triggered when agreement-in-principle is reached); Greenfield v. Heublein, Inc., 742 F. 2d 751 (CA3 1984) (applying agreement-in-principle test to materiality inquiry), cert. denied, 469 U. S. 1215 (1985). Citing Staffin, the United States Court of Appeals for the Second Circuit has rejected a claim that defendant was under an obligation to disclose various events related to merger negotiations. Reiss v. Pan American World Airways, Inc., 711 F. 2d 11, 13-14 (1983). The Seventh Circuit recently endorsed the agreement-in-principle test of materiality. See Flamm v. Eberstadt, 814 F. 2d 1169, 1174-1179 (describing agreement-in-principle as an agreement on price and structure), cert. denied, 484 U. S. 853 (1987). In some of these cases it is unclear whether the court based its decision on a finding that no duty arose to reveal the existence of negotiations, or whether it concluded that the negotiations were immaterial under an interpretation of the opinion in TSC Industries, Inc. v. Northway, Inc., 426 U. S. 438 (1976).

    137

    [11] Reasoning backwards from a goal of economic efficiency, that Court of Appeals stated: "Rule 10b-5 is about fraud, after all, and it is not fraudulent to conduct business in a way that makes investors better off . . . ." 814 F. 2d, at 1177.

    138

    [12] See, e. g., Brown, Corporate Secrecy, the Federal Securities Laws, and the Disclosure of Ongoing Negotiations, 36 Cath. U. L. Rev. 93, 145-155 (1986); Bebchuk, The Case for Facilitating Competing Tender Offers, 95 Harv. L. Rev. 1028 (1982); Flamm v. Eberstadt, 814 F. 2d, at 1177, n. 2 (citing scholarly debate). See also In re Carnation Co., Exchange Act Release No. 22214, 33 S. E. C. Docket 1025, 1030 (1985) ("The importance of accurate and complete issuer disclosure to the integrity of the securities markets cannot be overemphasized. To the extent that investors cannot rely upon the accuracy and completeness of issuer statements, they will be less likely to invest, thereby reducing the liquidity of the securities markets to the detriment of investors and issuers alike").

    139

    [13] See SEC v. Texas Gulf Sulphur Co., 401 F. 2d 833, 862 (CA2 1968) (en banc) ("Rule 10b-5 is violated whenever assertions are made, as here, in a manner reasonably calculated to influence the investing public . . . if such assertions are false or misleading or are so incomplete as to mislead . . ."), cert. denied sub nom. Coates v. SEC, 394 U. S. 976 (1969).

    140

    [14] "Although the Committee believes that ideally it would be desirable to have absolute certainty in the application of the materiality concept, it is its view that such a goal is illusory and unrealistic. The materiality concept is judgmental in nature and it is not possible to translate this into a numerical formula. The Committee's advice to the [SEC] is to avoid this quest for certainty and to continue consideration of materiality on a case-by-case basis as disclosure problems are identified." House Committee on Interstate and Foreign Commerce, Report of the Advisory Committee on Corporate Disclosure to the Securities and Exchange Commission, 95th Cong., 1st Sess., 327 (Comm. Print 1977).

    141

    [15] Subsequently, the Sixth Circuit denied a petition for rehearing en banc in this case. App. to Pet. for Cert. 144a. Concurring separately, Judge Wellford, one of the original panel members, then explained that he did not read the panel's opinion to create a "conclusive presumption of materiality for any undisclosed information claimed to render inaccurate statements denying the existence of alleged preliminary merger discussions." Id., at 145a. In his view, the decision merely reversed the District Court's judgment, which had been based on the agreement-in-principle standard. Ibid.

    142

    [16] The SEC in the present case endorses the highly fact-dependent probability/magnitude balancing approach of Texas Gulf Sulphur. It explains: "The possibility of a merger may have an immediate importance to investors in the company's securities even if no merger ultimately takes place." Brief for SEC as Amicus Curiae 10. The SEC's insights are helpful, and we accord them due deference. See TSC Industries, Inc. v. Northway, Inc., 426 U. S., at 449, n. 10.

    143

    [17] To be actionable, of course, a statement must also be misleading. Silence, absent a duty to disclose, is not misleading under Rule 10b-5. "No comment" statements are generally the functional equivalent of silence. See In re Carnation Co., Exchange Act Release No. 22214, 33 S. E. C. Docket 1025 (1985). See also New York Stock Exchange Listed Company Manual § 202.01, reprinted in 3 CCH Fed. Sec. L. Rep. ¶ 23,515 (1987) (premature public announcement may properly be delayed for valid business purpose and where adequate security can be maintained); American Stock Exchange Company Guide §§ 401-405, reprinted in 3 CCH Fed. Sec. L. Rep. ¶¶ 23,124A-23, 124E (1985) (similar provisions).

    144

    It has been suggested that given current market practices, a "no comment" statement is tantamount to an admission that merger discussions are underway. See Flamm v. Eberstadt, 814 F. 2d, at 1178. That may well hold true to the extent that issuers adopt a policy of truthfully denying merger rumors when no discussions are underway, and of issuing "no comment" statements when they are in the midst of negotiations. There are, of course, other statement policies firms could adopt; we need not now advise issuers as to what kind of practice to follow, within the range permitted by law. Perhaps more importantly, we think that creating an exception to a regulatory scheme founded on a prodisclosure legislative philosophy, because complying with the regulation might be "bad for business," is a role for Congress, not this Court. See also id., at 1182 (opinion concurring in judgment and concurring in part).

    145

    [18] We find no authority in the statute, the legislative history, or our previous decisions for varying the standard of materiality depending on who brings the action or whether insiders are alleged to have profited. See, e. g., Pavlidis v. New England Patriots Football Club, Inc., 737 F. 2d 1227, 1231 (CA1 1984) ("A fact does not become more material to the shareholder's decision because it is withheld by an insider, or because the insider might profit by withholding it"); cf. Aaron v. SEC, 446 U. S. 680, 691 (1980) ("[S]cienter is an element of a violation of § 10(b) and Rule 10b-5, regardless of the identity of the plaintiff or the nature of the relief sought").

    146

    We recognize that trading (and profit making) by insiders can serve as an indication of materiality, see SEC v. Texas Gulf Sulphur Co., 401 F. 2d, at 851; General Portland, Inc. v. LaFarge Coppee S. A., [1982-1983] CCH Fed. Sec. L. Rep. ¶ 99,148, p. 95,544 (ND Tex. 1981). We are not prepared to agree, however, that "[i]n cases of the disclosure of inside information to a favored few, determination of materiality has a different aspect than when the issue is, for example, an inaccuracy in a publicly disseminated press release." SEC v. Geon Industries, Inc., 531 F. 2d 39, 48 (CA2 1976). Devising two different standards of materiality, one for situations where insiders have traded in abrogation of their duty to disclose or abstain (or for that matter when any disclosure duty has been breached), and another covering affirmative misrepresentations by those under no duty to disclose (but under the ever-present duty not to mislead), would effectively collapse the materiality requirement into the analysis of defendant's disclosure duties.

    147

    [19] See, e. g., SEC v. Shapiro, 494 F. 2d 1301, 1306-1307 (CA2 1974) (in light of projected very substantial increase in earnings per share, negotiations material, although merger still less than probable); Holmes v. Bateson, 583 F. 2d 542, 558 (CA1 1978) (merger negotiations material although they had not yet reached point of discussing terms); SEC v. Gaspar, [1984-1985] CCH Fed. Sec. L. Rep. ¶ 92,004, pp. 90,977-90,978 (SDNY 1985) (merger negotiations material although they did not proceed to actual tender offer); Dungan v. Colt Industries, Inc., 532 F. Supp. 832, 837 (ND Ill. 1982) (fact that defendants were seriously exploring the sale of their company was material); American General Ins. Co. v. Equitable General Corp., 493 F. Supp. 721, 744-745 (ED Va. 1980) (merger negotiations material four months before agreement-in-principle reached). Cf. Susquehanna Corp. v. Pan American Sulphur Co., 423 F. 2d 1075, 1084-1085 (CA5 1970) (holding immaterial "unilateral offer to negotiate" never acknowledged by target and repudiated two days later); Berman v. Gerber Products Co., 454 F. Supp. 1310, 1316, 1318 (WD Mich. 1978) (mere "overtures" immaterial).

    148

    [20] The Sixth Circuit rejected the District Court's narrow reading of Basic's "no developments" statement, see n. 4, supra, which focused on whether petitioners knew of any reason for the activity in Basic stock, that is, whether petitioners were aware of leaks concerning ongoing discussions. 786 F. 2d, at 747. See also Comment, Disclosure of Preliminary Merger Negotiations Under Rule 10b-5, 62 Wash. L. Rev. 81, 82-84 (1987) (noting prevalence of leaks and studies demonstrating that substantial trading activity immediately preceding merger announcements is the "rule, not the exception"). We accept the Court of Appeals' reading of the statement as the more natural one, emphasizing management's knowledge of developments (as opposed to leaks) that would explain unusual trading activity. See id., at 92-93; see also SEC v. Texas Gulf Sulphur Co., 401 F. 2d, at 862-863.

    149

    [21] W. Keeton, D. Dobbs, R. Keeton, & D. Owen, Prosser and Keeton on Law of Torts 726 (5th ed. 1984) ("The reasons for the separate development of [the tort action for misrepresentation and nondisclosure], and for its peculiar limitations, are in part historical, and in part connected with the fact that in the great majority of the cases which have come before the courts the misrepresentations have been made in the course of a bargaining transaction between the parties. Consequently the action has been colored to a considerable extent by the ethics of bargaining between distrustful adversaries") (footnote omitted).

    150

    [22] Actions under Rule 10b-5 are distinct from common-law deceit and misrepresentation claims, see Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723, 744-745 (1975), and are in part designed to add to the protections provided investors by the common law, see Herman & MacLean v. Huddleston, 459 U. S. 375, 388-389 (1983).

    151

    [23] Contrary to the dissent's suggestion, the incentive for investors to "pay attention" to issuers' disclosures comes from their motivation to make a profit, not their attempt to preserve a cause of action under Rule 10b-5. Facilitating an investor's reliance on the market, consistently with Congress' expectations, hardly calls for "dismantling the federal scheme which mandates disclosure." See post, at 259.

    152

    [24] See In re LTV Securities Litigation, 88 F. R. D. 134, 144 (ND Tex. 1980) (citing studies); Fischel, Use of Modern Finance Theory in Securities Fraud Cases Involving Actively Traded Securities, 38 Bus. Law. 1, 4, n. 9 (1982) (citing literature on efficient-capital-market theory); Dennis, Materiality and the Efficient Capital Market Model: A Recipe for the Total Mix. 25 Wm. & Mary L. Rev. 373, 374-381, and n. 1 (1984). We need not determine by adjudication what economists and social scientists have debated through the use of sophisticated statistical analysis and the application of economic theory. For purposes of accepting the presumption of reliance in this case, we need only believe that market professionals generally consider most publicly announced material statements about companies, thereby affecting stock market prices.

    153

    [25] See, e. g., Peil v. Speiser, 806 F. 2d 1154, 1161 (CA3 1986); Harris v. Union Electric Co., 787 F. 2d 355, 367, and n. 9 (CA8), cert. denied, 479 U. S. 823 (1986); Lipton v. Documation, Inc., 734 F. 2d 740 (CA11 1984), cert. denied, 469 U. S. 1132 (1985); T. J. Raney & Sons, Inc. v. Fort Cobb, Oklahoma Irrigation Fuel Authority, 717 F. 2d 1330, 1332-1333 (CA10 1983), cert. denied sub nom. Linde, Thomson, Fairchild, Langworthy, Kohn & Van Dyke v. T. J. Raney & Sons, Inc., 465 U. S. 1026 (1984); Panzirer v. Wolf, 663 F. 2d 365, 367-368 (CA2 1981), vacated and remanded sub nom. Price Waterhouse v. Panzirer, 459 U. S. 1027 (1982); Ross v. A. H. Robins Co., 607 F. 2d 545, 553 (CA2 1979), cert. denied, 446 U. S. 946 (1980); Blackie v. Barrack, 524 F. 2d 891, 905-908 (CA9 1975), cert. denied, 429 U. S. 816 (1976).

    154

    [26] See, e. g., Black, Fraud on the Market: A Criticism of Dispensing with Reliance Requirements in Certain Open Market Transactions, 62 N. C. L. Rev. 435 (1984); Note, The Fraud-on-the-Market Theory, 95 Harv. L. Rev. 1143 (1982); Note, Fraud on the Market: An Emerging Theory of Recovery Under SEC Rule 10b-5, 50 Geo. Wash. L. Rev. 627 (1982).

    155

    [27] The Court of Appeals held that in order to invoke the presumption, a plaintiff must allege and prove: (1) that the defendant made public misrepresentations; (2) that the misrepresentations were material; (3) that the shares were traded on an efficient market; (4) that the misrepresentations would induce a reasonable, relying investor to misjudge the value of the shares; and (5) that the plaintiff traded the shares between the time the misrepresentations were made and the time the truth was revealed. See 786 F. 2d, at 750.

    156

    Given today's decision regarding the definition of materiality as to preliminary merger discussions, elements (2) and (4) may collapse into one.

    157

    [28] By accepting this rebuttable presumption, we do not intend conclusively to adopt any particular theory of how quickly and completely publicly available information is reflected in market price. Furthermore, our decision today is not to be interpreted as addressing the proper measure of damages in litigation of this kind.

    158

    [29] We note there may be a certain incongruity between the assumption that Basic shares are traded on a well-developed, efficient, and information-hungry market, and the allegation that such a market could remain misinformed, and its valuation of Basic shares depressed, for 14 months, on the basis of the three public statements. Proof of that sort is a matter for trial, throughout which the District Court retains the authority to amend the certification order as may be appropriate. See Fed. Rules Civ. Proc. 23(c)(1) and (c)(4). See 7B C. Wright, A. Miller, & M. Kane, Federal Practice and Procedure 128-132 (1986). Thus, we see no need to engage in the kind of factual analysis the dissent suggests that manifests the "oddities" of applying a rebuttable presumption of reliance in this case. See post, at 259-263.

    159

    ----------

    160

    [1] The earliest Court of Appeals case adopting this theory cited by the Court is Blackie v. Barrack, 524 F. 2d 891 (CA9 1975), cert. denied, 429 U. S. 816 (1976). Moreover, widespread acceptance of the fraud-on-the-market theory in the Courts of Appeals cannot be placed any earlier than five or six years ago. See ante, at 246-247, n. 24; Brief for Securities and Exchange Commission as Amicus Curiae 21, n. 24.

    161

    [2] See, e. g., Zweig v. Hearst Corp., 594 F. 2d 1261, 1268-1271 (CA9 1979); Arthur Young & Co. v. United States District Court, 549 F. 2d 686, 694-695 (CA9), cert. denied, 434 U. S. 829 (1977); Pellman v. Cinerama, Inc., 89 F. R. D. 386, 388 (SDNY 1981).

    162

    [3] Cases illustrating these factual situations are, respectively, Zweig v. Hearst Corp., supra, at 1271 (Ely, J., dissenting); Abrams v. Johns-Manville Corp., [1981-1982] CCH Fed. Sec. L. Rep. ¶ 98,348, p. 92,157 (SDNY 1981); Fausett v. American Resources Management Corp., 542 F. Supp. 1234, 1238-1239 (Utah 1982).

    163

    The Abrams decision illustrates the particular pliability of the fraud-on-the-market presumption. In Abrams, the plaintiff represented a class of purchasers of defendant's stock who were allegedly misled by defendant's misrepresentations in annual reports. But in a deposition taken shortly after the plaintiff filed suit, she testified that she had bought defendant's stock primarily because she thought that favorable changes in the Federal Tax Code would boost sales of its product (insulation).

    164

    Two years later, after the defendant moved for summary judgment based on the plaintiff's failure to prove reliance on the alleged misrepresentations, the plaintiff resuscitated her case by executing an affidavit which stated that she "certainly [had] assumed that the market price of Johns-Manville stock was an accurate reflection of the worth of the company" and would not have paid the then-going price if she had known otherwise. Abrams, supra, at 92,157. Based on this affidavit, the District Court permitted the plaintiff to proceed on her fraud-on-the-market theory.

    165

    Thus, Abrams demonstrates how easily a post hoc statement will enable a plaintiff to bring a fraud-on-the-market action — even in the rare case where a plaintiff is frank or foolhardy enough to admit initially that a factor other than price led her to the decision to purchase a particular stock.

    166

    [4] This view was put well by two commentators who wrote a few years ago:

    167

    "Of all recent developments in financial economics, the efficient capital market hypothesis (`ECMH') has achieved the widest acceptance by the legal culture. . . .

    "Yet the legal culture's remarkably rapid and broad acceptance of an economic concept that did not exist twenty years ago is not matched by an equivalent degree of understanding." Gilson & Kraakman, The Mechanisms of Market Efficiency, 70 Va. L. Rev. 549, 549-550 (1984) (footnotes omitted; emphasis added).

    168

    While the fraud-on-the-market theory has gained even broader acceptance since 1984, I doubt that it has achieved any greater understanding.

    169

    [5] For example, Judge Posner in his Economic Analysis of Law § 15.8, pp. 423-424 (3d ed. 1986), submits that the fraud-on-the-market theory produces the "economically correct result" in Rule 10b-5 cases but observes that the question of damages under the theory is quite problematic. Not withstanding the fact that "[a]t first blush it might seem obvious," the proper calculation of damages when the fraud-on-the-market theory is applied must rest on several "assumptions" about "social costs" which are "difficult to quantify." Ibid. Of course, answers to the question of the proper measure of damages in a fraud-on-the-market case are essential for proper implementation of the fraud-on-the-market presumption. Not surprisingly, the difficult damages question is one the Court expressly declines to address today. Ante, at 248, n. 27.

    170

    [6] See E. Salin, Just Price, 8 Encyclopaedia of Social Sciences 504-506 (1932); see also R. de Roover, Economic Thought: Ancient and Medieval Thought, 4 International Encyclopedia of Social Sciences 433-435 (1968).

    171

    [7] This is what the Court's rule boils down to in practical terms. For while, in theory, the Court allows for rebuttal of its "presumption of reliance" — a proviso with which I agree, see supra, at 251 — in practice the Court must realize, as other courts applying the fraud-on-the-market theory have, that such rebuttal is virtually impossible in all but the most extraordinary case. See Blackie v. Barrack, 524 F. 2d, at 906-907, n. 22; In re LTV Securities Litigation, 88 F. R. D. 134, 143, n. 4 (ND Tex. 1980).

    172

    Consequently, while the Court considers it significant that the fraud-on-the-market presumption it endorses is a rebuttable one, ante, at 242, 248, the majority's implicit rejection of the "pure causation" fraud-on-the-market theory rings hollow. In most cases, the Court's theory will operate just as the causation theory would, creating a nonrebuttable presumption of "reliance" in future Rule 10b-5 actions.

    173

    [8] See Stock Exchange Practices, Hearings on S. Res. 84, 56, and 97 before the Senate Committee on Banking and Currency, 73d Cong., 2d Sess., pt. 15, p. 6638 (1934) (statement of Richard Whitney, President of the New York Stock Exchange); Stock Exchange Regulation, Hearing on H. R. 7852 and 8720, before the House Committee on Interstate and Foreign Commerce, 73d Cong., 2d Sess., 226 (1934) (statement of Richard Whitney).

    174

    [9] None of the Court of Appeals cases the Court cites as endorsing the fraud-on-the-market theory, ante, at 246-247, n. 24, involved seller-plaintiffs. Rather, all of these cases were brought by purchasers who bought securities in a short period following some material misstatement (or similar act) by an issuer, which was alleged to have falsely inflated a stock's price.

    175

    Even if the fraud-on-the-market theory provides a permissible link between such a misstatement and a decision to purchase a security shortly thereafter, surely that link is far more attenuated between misstatements made in October 1977, and a decision to sell a stock the following September, 11 months later. The fact that the plaintiff-class is one of sellers, and that the class period so long, distinguish this case from any other cited in the Court's opinion, and make it an even poorer candidate for the fraud-on-the-market presumption. Cf., e. g., Schlanger v. Four-Phase Systems Inc., 555 F. Supp. 535 (SDNY 1982) (permitting class of sellers to use fraud-on-the-market theory where the class period was eight days long).

    176

    [10] The Court recognizes that a person who sold his Basic shares believing petitioners' statements to be false may not be entitled to recovery. Ante, at 249. Yet it seems just as clear to me that one who bought Basic stock under this same belief — hoping to profit from the uncertainty over Basic's merger plans — should not be permitted to recover either.

    177

    [11] See W. Shakespeare, Julius Caesar, Act I, Scene II.

    178

    [12] The ease with which such a post hoc claim of "reliance on the integrity of the market price" can be made, and gain acceptance by a trial court, is illustrated by Abrams v. Johns-Manville Corp., discussed in n. 3, supra.

  • 3 Tipper/Tippee Liability

    This playlist is intended to be used as a “virtual” casebook for an introductory corporations class. This virtual casebook is an experiment using the H20 platform of Harvard's Berkman Center. This casebook can be printed and used in a hard copy form, or students can read and access the cases and materials online.

    The materials in this casebook follow a format that is familiar to a student in any of my previous corporations classes. The materials start with an extended focus on the concepts of agency. Then we turn to the Delaware corporate code. While the various conceptual approaches to the corporate law are extremely interesting and important, it is critical that law students master the code. Consequently, after an introduction to the concepts of agency, we will focus on the Delaware code. Although we could study the Model code or the Massachusetts code, for most corporate lawyers, the Delaware corporate law will be central to their practice.

    Beyond the code, Delaware has a very deep corporate common law. It is in the corporate common law that the courts have developed the law of corporate fiduciary duties. It is through fiduciary duties that the corporate law attempts to regulate the relationship between shareholders and the corporation, between managers and the corporation, as well as the relationships of controlling shareholders and minority shareholders.

    Fiduciary duties are tested most often in the context of corporate takeovers. The corporate takeover materials in this casebook attempt to highlight the most important issues in takeover situations as well as the court's doctrinal efforts to mitigate the transaction costs that arise in these situations.

    • 3.1 Dirks v. SEC

      Tipper/Tippee liability

      1
      463 U.S. 646 (1983)
      2
      DIRKS
      v.
      SECURITIES AND EXCHANGE COMMISSION
      3
      No. 82-276.
      Supreme Court of United States.
      4
      Argued March 21, 1983
      5
      Decided July 1, 1983
      6

      CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE DISTRICT OF COLUMBIA CIRCUIT

      7

      [648] David Bonderman argued the cause for petitioner. With him on the briefs were Lawrence A. Schneider and Eric Summergrad.

      8

      Paul Gonson argued the cause for respondent. With him on the brief were Daniel L. Goelzer, Jacob H. Stillman, and Whitney Adams.[*]

      9

      Edward H. Fleischman, Richard E. Nathan, Martin P. Unger, and William J. Fitzpatrick filed a brief for the Securities Industry Association as amicus curiae.

      10
      JUSTICE POWELL delivered the opinion of the Court.
      11

      Petitioner Raymond Dirks received material nonpublic information from "insiders" of a corporation with which he had no connection. He disclosed this information to investors who relied on it in trading in the shares of the corporation. The question is whether Dirks violated the antifraud provisions of the federal securities laws by this disclosure.

      12
      I
      13

      In 1973, Dirks was an officer of a New York broker-dealer firm who specialized in providing investment analysis of insurance company securities to institutional investors.[1] On [649] March 6, Dirks received information from Ronald Secrist, a former officer of Equity Funding of America. Secrist alleged that the assets of Equity Funding, a diversified corporation primarily engaged in selling life insurance and mutual funds, were vastly overstated as the result of fraudulent corporate practices. Secrist also stated that various regulatory agencies had failed to act on similar charges made by Equity Funding employees. He urged Dirks to verify the fraud and disclose it publicly.

      14

      Dirks decided to investigate the allegations. He visited Equity Funding's headquarters in Los Angeles and interviewed several officers and employees of the corporation. The senior management denied any wrongdoing, but certain corporation employees corroborated the charges of fraud. Neither Dirks nor his firm owned or traded any Equity Funding stock, but throughout his investigation he openly discussed the information he had obtained with a number of clients and investors. Some of these persons sold their holdings of Equity Funding securities, including five investment advisers who liquidated holdings of more than $16 million.[2]

      15

      While Dirks was in Los Angeles, he was in touch regularly with William Blundell, the Wall Street Journal's Los Angeles bureau chief. Dirks urged Blundell to write a story on the fraud allegations. Blundell did not believe, however, that such a massive fraud could go undetected and declined to [650] write the story. He feared that publishing such damaging hearsay might be libelous.

      16

      During the 2-week period in which Dirks pursued his investigation and spread word of Secrist's charges, the price of Equity Funding stock fell from $26 per share to less than $15 per share. This led the New York Stock Exchange to halt trading on March 27. Shortly thereafter California insurance authorities impounded Equity Funding's records and uncovered evidence of the fraud. Only then did the Securities and Exchange Commission (SEC) file a complaint against Equity Funding[3] and only then, on April 2, did the Wall Street Journal publish a front-page story based largely on information assembled by Dirks. Equity Funding immediately went into receivership.[4]

      17

      The SEC began an investigation into Dirks' role in the exposure of the fraud. After a hearing by an Administrative Law Judge, the SEC found that Dirks had aided and abetted violations of § 17(a) of the Securities Act of 1933, 48 Stat. 84, as amended, 15 U. S. C. § 77q(a),[5] § 10(b) of the Securities [651] Exchange Act of 1934, 48 Stat. 891, 15 U. S. C. § 78j(b),[6] and SEC Rule 10b-5, 17 CFR § 240.10b-5 (1983),[7] by repeating the allegations of fraud to members of the investment community who later sold their Equity Funding stock. The SEC concluded: "Where `tippees' — regardless of their motivation or occupation — come into possession of material `corporate information that they know is confidential and know or should know came from a corporate insider,' they must either publicly disclose that information or refrain from trading." 21 S. E. C. Docket 1401, 1407 (1981) (footnote omitted) (quoting Chiarella v. United States, 445 U. S. 222, 230, n. 12 (1980)). Recognizing, however, that Dirks "played an important role in bringing [Equity Funding's] massive fraud [652] to light," 21 S. E. C. Docket, at 1412,[8] the SEC only censured him.[9]

      18

      Dirks sought review in the Court of Appeals for the District of Columbia Circuit. The court entered judgment against Dirks "for the reasons stated by the Commission in its opinion." App. to Pet. for Cert. C-2. Judge Wright, a member of the panel, subsequently issued an opinion. Judge Robb concurred in the result and Judge Tamm dissented; neither filed a separate opinion. Judge Wright believed that "the obligations of corporate fiduciaries pass to all those to whom they disclose their information before it has been disseminated to the public at large." 220 U. S. App. D. C. 309, 324, 681 F. 2d 824, 839 (1982). Alternatively, Judge Wright concluded that, as an employee of a broker-dealer, Dirks had violated "obligations to the SEC and to the public completely independent of any obligations he acquired" as a result of receiving the information. Id., at 325, 681 F. 2d, at 840.

      19

      In view of the importance to the SEC and to the securities industry of the question presented by this case, we granted a writ of certiorari. 459 U. S. 1014 (1982). We now reverse.

      20
      [653] II
      21

      In the seminal case of In re Cady, Roberts & Co., 40 S. E. C. 907 (1961), the SEC recognized that the common law in some jurisdictions imposes on "corporate `insiders,' particularly officers, directors, or controlling stockholders" an "affirmative duty of disclosure . . . when dealing in securities." Id., at 911, and n. 13.[10] The SEC found that not only did breach of this common-law duty also establish the elements of a Rule 10b-5 violation,[11] but that individuals other than corporate insiders could be obligated either to disclose material nonpublic information[12] before trading or to abstain from trading altogether. Id., at 912. In Chiarella, we accepted the two elements set out in Cady, Roberts for establishing a Rule 10b-5 violation: "(i) the existence of a relationship affording access to inside information intended to be available only for a corporate purpose, and (ii) the unfairness of allowing a corporate insider to take advantage of that information [654] by trading without disclosure." 445 U. S., at 227. In examining whether Chiarella had an obligation to disclose or abstain, the Court found that there is no general duty to disclose before trading on material nonpublic information,[13] and held that "a duty to disclose under § 10(b) does not arise from the mere possession of nonpublic market information." Id., at 235. Such a duty arises rather from the existence of a fiduciary relationship. See id., at 227-235.

      22

      Not "all breaches of fiduciary duty in connection with a securities transaction," however, come within the ambit of Rule 10b-5. Santa Fe Industries, Inc. v. Green, 430 U. S. 462, 472 (1977). There must also be "manipulation or deception." Id., at 473. In an inside-trading case this fraud derives from the "inherent unfairness involved where one takes advantage" of "information intended to be available only for a corporate purpose and not for the personal benefit of anyone." In re Merrill Lynch, Pierce, Fenner & Smith, Inc., 43 S. E. C. 933, 936 (1968). Thus, an insider will be liable under Rule 10b-5 for inside trading only where he fails to disclose material nonpublic information before trading on it and thus makes "secret profits." Cady, Roberts, supra, at 916, n. 31.

      23
      III
      24

      We were explicit in Chiarella in saying that there can be no duty to disclose where the person who has traded on inside information "was not [the corporation's] agent, . . . was not a fiduciary, [or] was not a person in whom the sellers [of the securities] had placed their trust and confidence." 445 U. S., at 232. Not to require such a fiduciary relationship, we recognized, would "depar[t] radically from the established doctrine that duty arises from a specific relationship between [655] two parties" and would amount to "recognizing a general duty between all participants in market transactions to forgo actions based on material, nonpublic information." Id., at 232, 233. This requirement of a specific relationship between the shareholders and the individual trading on inside information has created analytical difficulties for the SEC and courts in policing tippees who trade on inside information. Unlike insiders who have independent fiduciary duties to both the corporation and its shareholders, the typical tippee has no such relationships.[14] In view of this absence, it has been unclear how a tippee acquires the Cady, Roberts duty to refrain from trading on inside information.

      25
      A
      26

      The SEC's position, as stated in its opinion in this case, is that a tippee "inherits" the Cady, Roberts obligation to shareholders whenever he receives inside information from an insider:

      27
      "In tipping potential traders, Dirks breached a duty which he had assumed as a result of knowingly receiving [656] confidential information from [Equity Funding] insiders. Tippees such as Dirks who receive non-public, material information from insiders become `subject to the same duty as [the] insiders.' Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc. [495 F. 2d 228, 237 (CA2 1974) (quoting Ross v. Licht, 263 F. Supp. 395, 410 (SDNY 1967))]. Such a tippee breaches the fiduciary duty which he assumes from the insider when the tippee knowingly transmits the information to someone who will probably trade on the basis thereof. . . . Presumably, Dirks' informants were entitled to disclose the [Equity Funding] fraud in order to bring it to light and its perpetrators to justice. However, Dirks — standing in their shoes — committed a breach of the fiduciary duty which he had assumed in dealing with them, when he passed the information on to traders." 21 S. E. C. Docket, at 1410, n. 42.
      28

      This view differs little from the view that we rejected as inconsistent with congressional intent in Chiarella. In that case, the Court of Appeals agreed with the SEC and affirmed Chiarella's conviction, holding that "[a]nyone — corporate insider or not — who regularly receives material nonpublic information may not use that information to trade in securities without incurring an affirmative duty to disclose." United States v. Chiarella, 588 F. 2d 1358, 1365 (CA2 1978) (emphasis in original). Here, the SEC maintains that anyone who knowingly receives nonpublic material information from an insider has a fiduciary duty to disclose before trading.[15]

      29

      [657] In effect, the SEC's theory of tippee liability in both cases appears rooted in the idea that the antifraud provisions require equal information among all traders. This conflicts with the principle set forth in Chiarella that only some persons, under some circumstances, will be barred from trading while in possession of material nonpublic information.[16] Judge Wright correctly read our opinion in Chiarella as repudiating any notion that all traders must enjoy equal information before trading: "[T]he `information' theory is rejected. Because the disclose-or-refrain duty is extraordinary, it attaches only when a party has legal obligations other than a mere duty to comply with the general antifraud proscriptions in the federal securities laws." 220 U. S. App. D. C., at 322, 681 F. 2d, at 837. See Chiarella, 445 U. S., at 235, n. 20. We reaffirm today that "[a] duty [to disclose] [658] arises from the relationship between parties . . . and not merely from one's ability to acquire information because of his position in the market." Id., at 231-232, n. 14.

      30

      Imposing a duty to disclose or abstain solely because a person knowingly receives material nonpublic information from an insider and trades on it could have an inhibiting influence on the role of market analysts, which the SEC itself recognizes is necessary to the preservation of a healthy market.[17] It is commonplace for analysts to "ferret out and analyze information," 21 S. E. C. Docket, at 1406,[18] and this often is done by meeting with and questioning corporate officers and others who are insiders. And information that the analysts [659] obtain normally may be the basis for judgments as to the market worth of a corporation's securities. The analyst's judgment in this respect is made available in market letters or otherwise to clients of the firm. It is the nature of this type of information, and indeed of the markets themselves, that such information cannot be made simultaneously available to all of the corporation's stockholders or the public generally.

      31
      B
      32

      The conclusion that recipients of inside information do not invariably acquire a duty to disclose or abstain does not mean that such tippees always are free to trade on the information. The need for a ban on some tippee trading is clear. Not only are insiders forbidden by their fiduciary relationship from personally using undisclosed corporate information to their advantage, but they also may not give such information to an outsider for the same improper purpose of exploiting the information for their personal gain. See 15 U. S. C. § 78t(b) (making it unlawful to do indirectly "by means of any other person" any act made unlawful by the federal securities laws). Similarly, the transactions of those who knowingly participate with the fiduciary in such a breach are "as forbidden" as transactions "on behalf of the trustee himself." Mosser v. Darrow, 341 U. S. 267, 272 (1951). See Jackson v. Smith, 254 U. S. 586, 589 (1921); Jackson v. Ludeling, 21 Wall. 616, 631-632 (1874). As the Court explained in Mosser, a contrary rule "would open up opportunities for devious dealings in the name of others that the trustee could not conduct in his own." 341 U. S., at 271. See SEC v. Texas Gulf Sulphur Co., 446 F. 2d 1301, 1308 (CA2), cert. denied, 404 U. S. 1005 (1971). Thus, the tippee's duty to disclose or abstain is derivative from that of the insider's duty. See Tr. of Oral Arg. 38. Cf. Chiarella, 445 U. S., at 246, n. 1 (BLACKMUN, J., dissenting). As we noted in Chiarella, "[t]he tippee's obligation has been viewed as arising from his role as a participant after the fact in the insider's breach of a fiduciary duty." Id., at 230, n. 12.

      33

      [660] Thus, some tippees must assume an insider's duty to the shareholders not because they receive inside information, but rather because it has been made available to them improperly.[19] And for Rule 10b-5 purposes, the insider's disclosure is improper only where it would violate his Cady, Roberts duty. Thus, a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach.[20] As Commissioner Smith perceptively observed [661] in In re Investors Management Co., 44 S. E. C. 633 (1971): "[T]ippee responsibility must be related back to insider responsibility by a necessary finding that the tippee knew the information was given to him in breach of a duty by a person having a special relationship to the issuer not to disclose the information . . . ." Id., at 651 (concurring in result). Tipping thus properly is viewed only as a means of indirectly violating the Cady, Roberts disclose-or-abstain rule.[21]

      34
      C
      35

      In determining whether a tippee is under an obligation to disclose or abstain, it thus is necessary to determine whether the insider's "tip" constituted a breach of the insider's fiduciary duty. All disclosures of confidential corporate information [662] are not inconsistent with the duty insiders owe to shareholders. In contrast to the extraordinary facts of this case, the more typical situation in which there will be a question whether disclosure violates the insider's Cady, Roberts duty is when insiders disclose information to analysts. See n. 16, supra. In some situations, the insider will act consistently with his fiduciary duty to shareholders, and yet release of the information may affect the market. For example, it may not be clear — either to the corporate insider or to the recipient analyst — whether the information will be viewed as material nonpublic information. Corporate officials may mistakenly think the information already has been disclosed or that it is not material enough to affect the market. Whether disclosure is a breach of duty therefore depends in large part on the purpose of the disclosure. This standard was identified by the SEC itself in Cady, Roberts: a purpose of the securities laws was to eliminate "use of inside information for personal advantage." 40 S. E. C., at 912, n. 15. See n. 10, supra. Thus, the test is whether the insider personally will benefit, directly or indirectly, from his disclosure. Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider, there is no derivative breach.[22] As Commissioner Smith stated in Investors Management Co.: "It is important in this type of [663] case to focus on policing insiders and what they do . . . rather than on policing information per se and its possession. . . ." 44 S. E. C., at 648 (concurring in result).

      36

      The SEC argues that, if inside-trading liability does not exist when the information is transmitted for a proper purpose but is used for trading, it would be a rare situation when the parties could not fabricate some ostensibly legitimate business justification for transmitting the information. We think the SEC is unduly concerned. In determining whether the insider's purpose in making a particular disclosure is fraudulent, the SEC and the courts are not required to read the parties' minds. Scienter in some cases is relevant in determining whether the tipper has violated his Cady, Roberts duty.[23] But to determine whether the disclosure itself "deceive[s], manipulate[s], or defraud[s]" shareholders, Aaron v. SEC, 446 U. S. 680, 686 (1980), the initial inquiry is whether there has been a breach of duty by the insider. This requires courts to focus on objective criteria, i. e., whether the insider receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings. Cf. 40 S. E. C., at 912, n. 15; Brudney, Insiders, Outsiders, and Informational Advantages Under the Federal Securities [664] Laws, 93 Harv. L. Rev. 322, 348 (1979) ("The theory . . . is that the insider, by giving the information out selectively, is in effect selling the information to its recipient for cash, reciprocal information, or other things of value for himself. . ."). There are objective facts and circumstances that often justify such an inference. For example, there may be a relationship between the insider and the recipient that suggests a quid pro quo from the latter, or an intention to benefit the particular recipient. The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of the profits to the recipient.

      37

      Determining whether an insider personally benefits from a particular disclosure, a question of fact, will not always be easy for courts. But it is essential, we think, to have a guiding principle for those whose daily activities must be limited and instructed by the SEC's inside-trading rules, and we believe that there must be a breach of the insider's fiduciary duty before the tippee inherits the duty to disclose or abstain. In contrast, the rule adopted by the SEC in this case would have no limiting principle.[24] 

      38
      [665] IV
      39

      Under the inside-trading and tipping rules set forth above, we find that there was no actionable violation by Dirks.[25] It is undisputed that Dirks himself was a stranger to Equity Funding, with no pre-existing fiduciary duty to its shareholders.[26] He took no action, directly or indirectly, that induced the shareholders or officers of Equity Funding to repose trust or confidence in him. There was no expectation by Dirks' sources that he would keep their information in confidence. Nor did Dirks misappropriate or illegally obtain the information about Equity Funding. Unless the insiders breached their Cady, Roberts duty to shareholders in disclosing the nonpublic information to Dirks, he breached no duty when he passed it on to investors as well as to the Wall Street Journal.

      40

      [666] It is clear that neither Secrist nor the other Equity Funding employees violated their Cady, Roberts duty to the corporation's shareholders by providing information to Dirks.[27] [667] The tippers received no monetary or personal benefit for revealing Equity Funding's secrets, nor was their purpose to make a gift of valuable information to Dirks. As the facts of this case clearly indicate, the tippers were motivated by a desire to expose the fraud. See supra, at 648-649. In the absence of a breach of duty to shareholders by the insiders, there was no derivative breach by Dirks. See n. 20, supra. Dirks therefore could not have been "a participant after the fact in [an] insider's breach of a fiduciary duty." Chiarella, 445 U. S., at 230, n. 12.

      41
      V
      42

      We conclude that Dirks, in the circumstances of this case, had no duty to abstain from use of the inside information that he obtained. The judgment of the Court of Appeals therefore is

      43

      Reversed.

      44
      JUSTICE BLACKMUN, with whom JUSTICE BRENNAN and JUSTICE MARSHALL join, dissenting.
      45

      The Court today takes still another step to limit the protections provided investors by § 10(b) of the Securities Exchange [668] Act of 1934.[1] See Chiarella v. United States, 445 U. S. 222, 246 (1980) (dissenting opinion). The device employed in this case engrafts a special motivational requirement on the fiduciary duty doctrine. This innovation excuses a knowing and intentional violation of an insider's duty to shareholders if the insider does not act from a motive of personal gain. Even on the extraordinary facts of this case, such an innovation is not justified.

      46
      I
      47

      As the Court recognizes, ante, at 658, n. 18, the facts here are unusual. After a meeting with Ronald Secrist, a former Equity Funding employee, on March 7, 1973, App. 226, petitioner Raymond Dirks found himself in possession of material nonpublic information of massive fraud within the company.[2] In the Court's words, "[h]e uncovered . . . startling information that required no analysis or exercise of judgment as to [669] its market relevance." Ibid. In disclosing that information to Dirks, Secrist intended that Dirks would disseminate the information to his clients, those clients would unload their Equity Funding securities on the market, and the price would fall precipitously, thereby triggering a reaction from the authorities. App. 16, 25, 27.

      48

      Dirks complied with his informant's wishes. Instead of reporting that information to the Securities and Exchange Commission (SEC or Commission) or to other regulatory agencies, Dirks began to disseminate the information to his clients and undertook his own investigation.[3] One of his first steps was to direct his associates at Delafield Childs to draw up a list of Delafield clients holding Equity Funding securities. On March 12, eight days before Dirks flew to Los Angeles to investigate Secrist's story, he reported the full allegations to Boston Company Institutional Investors, Inc., which on March 15 and 16 sold approximately $1.2 million of Equity securities.[4] See id., at 199. As he gathered more [670] information, he selectively disclosed it to his clients. To those holding Equity Funding securities he gave the "hard" story — all the allegations; others received the "soft" story — a recitation of vague factors that might reflect adversely on Equity Funding's management. See id., at 211, n. 24.

      49

      Dirks' attempts to disseminate the information to nonclients were feeble, at best. On March 12, he left a message for Herbert Lawson, the San Francisco bureau chief of The Wall Street Journal. Not until March 19 and 20 did he call Lawson again, and outline the situation. William Blundell, a Journal investigative reporter based in Los Angeles, got in touch with Dirks about his March 20 telephone call. On March 21, Dirks met with Blundell in Los Angeles. Blundell began his own investigation, relying in part on Dirks' contacts, and on March 23 telephoned Stanley Sporkin, the SEC's Deputy Director of Enforcement. On March 26, the next business day, Sporkin and his staff interviewed Blundell and asked to see Dirks the following morning. Trading was halted by the New York Stock Exchange at about the same time Dirks was talking to Los Angeles SEC personnel. The next day, March 28, the SEC suspended trading in Equity Funding securities. By that time, Dirks' clients had unloaded close to $15 million of Equity Funding stock and the price had plummeted from $26 to $15. The effect of Dirks' selective dissemination of Secrist's information was that Dirks' clients were able to shift the losses that were inevitable due to the Equity Funding fraud from themselves to uninformed market participants.

      50
      II
      51
      A
      52

      No one questions that Secrist himself could not trade on his inside information to the disadvantage of uninformed shareholders and purchasers of Equity Funding securities. See Brief for United States as Amicus Curiae 19, n. 12. Unlike the printer in Chiarella, Secrist stood in a fiduciary relationship [671] with these shareholders. As the Court states, ante, at 653, corporate insiders have an affirmative duty of disclosure when trading with shareholders of the corporation. See Chiarella, 445 U. S., at 227. This duty extends as well to purchasers of the corporation's securities. Id., at 227, n. 8, citing Gratz v. Claughton, 187 F. 2d 46, 49 (CA2), cert. denied, 341 U. S. 920 (1951).

      53

      The Court also acknowledges that Secrist could not do by proxy what he was prohibited from doing personally. Ante, at 659; Mosser v. Darrow, 341 U. S. 267, 272 (1951). But this is precisely what Secrist did. Secrist used Dirks to disseminate information to Dirks' clients, who in turn dumped stock on unknowing purchasers. Secrist thus intended Dirks to injure the purchasers of Equity Funding securities to whom Secrist had a duty to disclose. Accepting the Court's view of tippee liability,[5] it appears that Dirks' knowledge of this breach makes him liable as a participant in the breach after the fact. Ante, at 659, 667; Chiarella, 445 U. S., at 230, n. 12.

      54
      B
      55

      The Court holds, however, that Dirks is not liable because Secrist did not violate his duty; according to the Court, this is so because Secrist did not have the improper purpose of personal gain. Ante, at 662-663, 666-667. In so doing, the Court imposes a new, subjective limitation on the scope of the duty owed by insiders to shareholders. The novelty of this limitation is reflected in the Court's lack of support for it.[6]

      56

      [672] The insider's duty is owed directly to the corporation's shareholders.[7] See Langevoort, Insider Trading and the Fiduciary Principle: A Post-Chiarella Restatement, 70 Calif. L. Rev. 1, 5 (1982); 3A W. Fletcher, Cyclopedia of the Law of Private Corporations § 1168.2, pp. 288-289 (rev. ed. 1975). As Chiarella recognized, it is based on the relationship of trust and confidence between the insider and the shareholder. 445 U. S., at 228. That relationship assures the shareholder that the insider may not take actions that will harm him unfairly.[8] The affirmative duty of disclosure protects [673] against this injury. See Pepper v. Litton, 308 U. S. 295, 307, n. 15 (1939); Strong v. Repide, 213 U. S. 419, 431-434 (1909); see also Chiarella, 445 U. S., at 228, n. 10; cf. Pepper, 308 U. S., at 307 (fiduciary obligation to corporation exists for corporation's protection).

      57
      C
      58

      The fact that the insider himself does not benefit from the breach does not eradicate the shareholder's injury.[9] Cf. Restatement (Second) of Trusts § 205, Comments c and d (1959) (trustee liable for acts causing diminution of value of trust); 3 [674] A. Scott, Law of Trusts § 205, p. 1665 (3d ed. 1967) (trustee liable for any losses to trust caused by his breach). It makes no difference to the shareholder whether the corporate insider gained or intended to gain personally from the transaction; the shareholder still has lost because of the insider's misuse of nonpublic information. The duty is addressed not to the insider's motives,[10] but to his actions and their consequences on the shareholder. Personal gain is not an element of the breach of this duty.[11]

      59

      [675] This conclusion is borne out by the Court's decision in Mosser v. Darrow, 341 U. S. 267 (1951). There, the Court faced an analogous situation: a reorganization trustee engaged two employee-promoters of subsidiaries of the companies being reorganized to provide services that the trustee considered to be essential to the successful operation of the trust. In order to secure their services, the trustee expressly agreed with the employees that they could continue to trade in the securities of the subsidiaries. The employees then turned their inside position into substantial profits at the expense both of the trust and of other holders of the companies' securities.

      60

      The Court acknowledged that the trustee neither intended to nor did in actual fact benefit from this arrangement; his motives were completely selfless and devoted to the companies. Id., at 275. The Court, nevertheless, found the trustee liable to the estate for the activities of the employees he authorized.[12] The Court described the trustee's defalcation as "a willful and deliberate setting up of an interest in employees adverse to that of the trust." Id., at 272. The breach did not depend on the trustee's personal gain, and his motives in violating his duty were irrelevant; like Secrist, the trustee intended that others would abuse the inside information for their personal gain. Cf. Dodge v. Ford Motor Co., 204 Mich. 459, 506-509, 170 N. W. 668, 684-685 (1919) (Henry Ford's philanthropic motives did not permit him to [676] set Ford Motor Company dividend policies to benefit public at expense of shareholders).

      61

      As Mosser demonstrates, the breach consists in taking action disadvantageous to the person to whom one owes a duty. In this case, Secrist owed a duty to purchasers of Equity Funding shares. The Court's addition of the bad-purpose element to a breach-of-fiduciary-duty claim is flatly inconsistent with the principle of Mosser. I do not join this limitation of the scope of an insider's fiduciary duty to shareholders.[13]

      62
      III
      63

      The improper-purpose requirement not only has no basis in law, but it also rests implicitly on a policy that I cannot accept. The Court justifies Secrist's and Dirks' action because the general benefit derived from the violation of Secrist's duty to shareholders outweighed the harm caused to those [677] shareholders, see Heller, Chiarella, SEC Rule 14e-3 and Dirks: "Fairness" versus Economic Theory, 37 Bus. Lawyer 517, 550 (1982); Easterbrook, Insider Trading, Secret Agents, Evidentiary Privileges, and the Production of Information, 1981 S. Ct. Rev. 309, 338 — in other words, because the end justified the means. Under this view, the benefit conferred on society by Secrist's and Dirks' activities may be paid for with the losses caused to shareholders trading with Dirks' clients.[14]

      64

      Although Secrist's general motive to expose the Equity Funding fraud was laudable, the means he chose were not. Moreover, even assuming that Dirks played a substantial role in exposing the fraud,[15] he and his clients should not profit from the information they obtained from Secrist. Misprision of a felony long has been against public policy. Branzburg v. Hayes, 408 U. S. 665, 696-697 (1972); see 18 U. S. C. § 4. A person cannot condition his transmission of information of a crime on a financial award. As a citizen, Dirks had at least an ethical obligation to report the information to the proper authorities. See ante, at 661, n. 21. The Court's holding is deficient in policy terms not because it fails to create a legal [678] norm out of that ethical norm, see ibid., but because it actually rewards Dirks for his aiding and abetting.

      65

      Dirks and Secrist were under a duty to disclose the information or to refrain from trading on it.[16] I agree that disclosure in this case would have been difficult. Ibid. I also recognize that the SEC seemingly has been less than helpful in its view of the nature of disclosure necessary to satisfy the disclose-or-refrain duty. The Commission tells persons with inside information that they cannot trade on that information unless they disclose; it refuses, however, to tell them how to disclose.[17] See In re Faberge, Inc., 45 S. E. C. 249, 256 (1973) (disclosure requires public release through public media designed to reach investing public generally). This seems to be a less than sensible policy, which it is incumbent on the Commission to correct. The Court, however, has no authority to remedy the problem by opening a hole in the congressionally mandated prohibition on insider trading, thus rewarding such trading.

      66
      IV
      67

      In my view, Secrist violated his duty to Equity Funding shareholders by transmitting material nonpublic information [679] to Dirks with the intention that Dirks would cause his clients to trade on that information. Dirks, therefore, was under a duty to make the information publicly available or to refrain from actions that he knew would lead to trading. Because Dirks caused his clients to trade, he violated § 10(b) and Rule 10b-5. Any other result is a disservice to this country's attempt to provide fair and efficient capital markets. I dissent.

      68

      ----------

      69

      [*] Solicitor General Lee, Assistant Attorney General Jensen, Stephen M. Shapiro, Deputy Assistant Attorney General Olsen, David A. Strauss, and Geoffrey S. Stewart filed a brief for the United States as amicus curiae urging reversal.

      70

      [1] The facts stated here are taken from more detailed statements set forth by the Administrative Law Judge, App. 176-180, 225-247; the opinion of the Securities and Exchange Commission, 21 S. E. C. Docket 1401, 1402-1406 (1981); and the opinion of Judge Wright in the Court of Appeals, 220 U. S. App. D. C. 309, 314-318, 681 F. 2d 824, 829-833 (1982).

      71

      [2] Dirks received from his firm a salary plus a commission for securities transactions above a certain amount that his clients directed through his firm. See 21 S. E. C. Docket, at 1402, n. 3. But "[i]t is not clear how many of those with whom Dirks spoke promised to direct some brokerage business through [Dirks' firm] to compensate Dirks, or how many actually did so." 220 U. S. App. D. C., at 316, 681 F. 2d, at 831. The Boston Company Institutional Investors, Inc., promised Dirks about $25,000 in commissions, but it is unclear whether Boston actually generated any brokerage business for his firm. See App. 199, 204-205; 21 S. E. C. Docket, at 1404, n. 10; 220 U. S. App. D. C., at 316, n. 5, 681 F. 2d, at 831, n. 5.

      72

      [3] As early as 1971, the SEC had received allegations of fraudulent accounting practices at Equity Funding. Moreover, on March 9, 1973, an official of the California Insurance Department informed the SEC's regional office in Los Angeles of Secrist's charges of fraud. Dirks himself voluntarily presented his information at the SEC's regional office beginning on March 27.

      73

      [4] A federal grand jury in Los Angeles subsequently returned a 105-count indictment against 22 persons, including many of Equity Funding's officers and directors. All defendants were found guilty of one or more counts, either by a plea of guilty or a conviction after trial. See Brief for Petitioner 15; App. 149-153.

      74

      [5] Section 17(a), as set forth in 15 U. S. C. § 77q(a), provides:

      75

      "It shall be unlawful for any person in the offer or sale of any securities by the use of any means or instruments of transportation or communication in interstate commerce or by the use of the mails, directly or indirectly —

      "(1) to employ any device, scheme, or artifice to defraud, or

      "(2) to obtain money or property by means of any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

      "(3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser."

      76

      [6] Section 10(b) provides:

      77

      "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange —

      .....

      "(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors."

      78

      [7] Rule 10b-5 provides:

      79

      "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

      "(a) To employ any device, scheme, or artifice to defraud,

      "(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

      "(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security."

      80

      [8] JUSTICE BLACKMUN's dissenting opinion minimizes the role Dirks played in making public the Equity Funding fraud. See post, at 670 and 677, n. 15. The dissent would rewrite the history of Dirks' extensive investigative efforts. See, e. g., 21 S. E. C. Docket, at 1412 ("It is clear that Dirks played an important role in bringing [Equity Funding's] massive fraud to light, and it is also true that he reported the fraud allegation to [Equity Funding's] auditors and sought to have the information published in the Wall Street Journal"); 220 U. S. App. D. C., at 314, 681 F. 2d, at 829 (Wright, J.) ("Largely thanks to Dirks one of the most infamous frauds in recent memory was uncovered and exposed, while the record shows that the SEC repeatedly missed opportunities to investigate Equity Funding").

      81

      [9] Section 15 of the Securities Exchange Act, 15 U. S. C. § 78o(b)(4)(E), provides that the SEC may impose certain sanctions, including censure, on any person associated with a registered broker-dealer who has "willfully aided [or] abetted" any violation of the federal securities laws. See 15 U. S. C. § 78ff(a) (1976 ed., Supp. V) (providing criminal penalties).

      82

      [10] The duty that insiders owe to the corporation's shareholders not to trade on inside information differs from the common-law duty that officers and directors also have to the corporation itself not to mismanage corporate assets, of which confidential information is one. See 3 W. Fletcher, Cyclopedia of the Law of Private Corporations §§ 848, 900 (rev. ed. 1975 and Supp. 1982); 3A id., §§ 1168.1, 1168.2 (rev. ed. 1975). In holding that breaches of this duty to shareholders violated the Securities Exchange Act, the Cady, Roberts Commission recognized, and we agree, that "[a] significant purpose of the Exchange Act was to eliminate the idea that use of inside information for personal advantage was a normal emolument of corporate office." See 40 S. E. C., at 912, n. 15.

      83

      [11] Rule 10b-5 is generally the most inclusive of the three provisions on which the SEC rested its decision in this case, and we will refer to it when we note the statutory basis for the SEC's inside-trading rules.

      84

      [12] The SEC views the disclosure duty as requiring more than disclosure to purchasers or sellers: "Proper and adequate disclosure of significant corporate developments can only be effected by a public release through the appropriate public media, designed to achieve a broad dissemination to the investing public generally and without favoring any special person or group." In re Faberge, Inc., 45 S. E. C. 249, 256 (1973).

      85

      [13] See 445 U. S., at 233; id., at 237 (STEVENS, J., concurring); id., at 238-239 (BRENNAN, J., concurring in judgment); id., at 239-240 (BURGER, C. J., dissenting). Cf. id., at 252, n. 2 (BLACKMUN, J., dissenting) (recognizing that there is no obligation to disclose material nonpublic information obtained through the exercise of "diligence or acumen" and "honest means," as opposed to "stealth").

      86

      [14] Under certain circumstances, such as where corporate information is revealed legitimately to an underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders may become fiduciaries of the shareholders. The basis for recognizing this fiduciary duty is not simply that such persons acquired nonpublic corporate information, but rather that they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes. See SEC v. Monarch Fund, 608 F. 2d 938, 942 (CA2 1979); In re Investors Management Co., 44 S. E. C. 633, 645 (1971); In re Van Alstyne, Noel & Co., 43 S. E. C. 1080, 1084-1085 (1969); In re Merrill Lynch, Pierce, Fenner & Smith, Inc., 43 S. E. C. 933, 937 (1968); Cady, Roberts, 40 S. E. C., at 912. When such a person breaches his fiduciary relationship, he may be treated more properly as a tipper than a tippee. See Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F. 2d 228, 237 (CA2 1974) (investment banker had access to material information when working on a proposed public offering for the corporation). For such a duty to be imposed, however, the corporation must expect the outsider to keep the disclosed nonpublic information confidential, and the relationship at least must imply such a duty.

      87

      [15] Apparently, the SEC believes this case differs from Chiarella in that Dirks' receipt of inside information from Secrist, an insider, carried Secrist's duties with it, while Chiarella received the information without the direct involvement of an insider and thus inherited no duty to disclose or abstain. The SEC fails to explain, however, why the receipt of nonpublic information from an insider automatically carries with it the fiduciary duty of the insider. As we emphasized in Chiarella, mere possession of nonpublic information does not give rise to a duty to disclose or abstain; only a specific relationship does that. And we do not believe that the mere receipt of information from an insider creates such a special relationship between the tippee and the corporation's shareholders.

      88

      Apparently recognizing the weakness of its argument in light of Chiarella, the SEC attempts to distinguish that case factually as involving not "inside" information, but rather "market" information, i. e., "information originating outside the company and usually about the supply and demand for the company's securities." Brief for Respondent 22. This Court drew no such distinction in Chiarella and, as THE CHIEF JUSTICE noted, "[i]t is clear that § 10(b) and Rule 10b-5 by their terms and by their history make no such distinction." 445 U. S., at 241, n. 1 (dissenting opinion). See ALI, Federal Securities Code § 1603, Comment (2)(j) (Prop. Off. Draft 1978).

      89

      [16] In Chiarella, we noted that formulation of an absolute equal information rule "should not be undertaken absent some explicit evidence of congressional intent." 445 U. S., at 233. Rather than adopting such a radical view of securities trading, Congress has expressly exempted many market professionals from the general statutory prohibition set forth in § 11(a)(1) of the Securities Exchange Act, 15 U. S. C. § 78k(a)(1), against members of a national securities exchange trading for their own account. See id., at 233, n. 16. We observed in Chiarella that "[t]he exception is based upon Congress' recognition that [market professionals] contribute to a fair and orderly marketplace at the same time they exploit the informational advantage that comes from their possession of [nonpublic information]." Ibid.

      90

      [17] The SEC expressly recognized that "[t]he value to the entire market of [analysts'] efforts cannot be gainsaid; market efficiency in pricing is significantly enhanced by [their] initiatives to ferret out and analyze information, and thus the analyst's work redounds to the benefit of all investors." 21 S. E. C. Docket, at 1406. The SEC asserts that analysts remain free to obtain from management corporate information for purposes of "filling in the `interstices in analysis'. . . ." Brief for Respondent 42 (quoting Investors Management Co., 44 S. E. C., at 646). But this rule is inherently imprecise, and imprecision prevents parties from ordering their actions in accord with legal requirements. Unless the parties have some guidance as to where the line is between permissible and impermissible disclosures and uses, neither corporate insiders nor analysts can be sure when the line is crossed. Cf. Adler v. Klawans, 267 F. 2d 840, 845 (CA2 1959) (Burger, J., sitting by designation).

      91

      [18] On its facts, this case is the unusual one. Dirks is an analyst in a broker-dealer firm, and he did interview management in the course of his investigation. He uncovered, however, startling information that required no analysis or exercise of judgment as to its market relevance. Nonetheless, the principle at issue here extends beyond these facts. The SEC's rule — applicable without regard to any breach by an insider — could have serious ramifications on reporting by analysts of investment views.

      92

      Despite the unusualness of Dirks' "find," the central role that he played in uncovering the fraud at Equity Funding, and that analysts in general can play in revealing information that corporations may have reason to withhold from the public, is an important one. Dirks' careful investigation brought to light a massive fraud at the corporation. And until the Equity Funding fraud was exposed, the information in the trading market was grossly inaccurate. But for Dirks' efforts, the fraud might well have gone undetected longer. See n. 8, supra.

      93

      [19] The SEC itself has recognized that tippee liability properly is imposed only in circumstances where the tippee knows, or has reason to know, that the insider has disclosed improperly inside corporate information. In Investors Management Co., supra, the SEC stated that one element of tippee liability is that the tippee knew or had reason to know that the information "was non-public and had been obtained improperly by selective revelation or otherwise." 44 S. E. C., at 641 (emphasis added). Commissioner Smith read this test to mean that a tippee can be held liable only if he received information in breach of an insider's duty not to disclose it. Id., at 650 (concurring in result).

      94

      [20] Professor Loss has linked tippee liability to the concept in the law of restitution that " `[w]here a fiduciary in violation of his duty to the beneficiary communicates confidential information to a third person, the third person, if he had notice of the violation of duty, holds upon a constructive trust for the beneficiary any profit which he makes through the use of such information.' " 3 L. Loss, Securities Regulation 1451 (2d ed. 1961) (quoting Restatement of Restitution § 201(2) (1937)). Other authorities likewise have expressed the view that tippee liability exists only where there has been a breach of trust by an insider of which the tippee had knowledge. See, e. g., Ross v. Licht, 263 F. Supp. 395, 410 (SDNY 1967); A. Jacobs, The Impact of Rule 10b-5, § 167, p. 7-4 (rev. ed. 1980) ("[T]he better view is that a tipper must know or have reason to know the information is nonpublic and was improperly obtained"); Fleischer, Mundheim, & Murphy, An Initial Inquiry Into the Responsibility to Disclose Market Information, 121 U. Pa. L. Rev. 798, 818, n. 76 (1973) ("The extension of rule 10b-5 restrictions to tippees of corporate insiders can best be justified on the theory that they are participating in the insider's breach of his fiduciary duty"). Cf. Restatement (Second) of Agency § 312, Comment c (1958) ("A person who, with notice that an agent is thereby violating his duty to his principal, receives confidential information from the agent, may be [deemed] . . . a constructive trustee").

      95

      [21] We do not suggest that knowingly trading on inside information is ever "socially desirable or even that it is devoid of moral considerations." Dooley, Enforcement of Insider Trading Restrictions, 66 Va. L. Rev. 1, 55 (1980). Nor do we imply an absence of responsibility to disclose promptly indications of illegal actions by a corporation to the proper authorities — typically the SEC and exchange authorities in cases involving securities. Depending on the circumstances, and even where permitted by law, one's trading on material nonpublic information is behavior that may fall below ethical standards of conduct. But in a statutory area of the law such as securities regulation, where legal principles of general application must be applied, there may be "significant distinctions between actual legal obligations and ethical ideals." SEC, Report of Special Study of Securities Markets, H. R. Doc. No. 95, 88th Cong., 1st Sess., pt. 1, pp. 237-238 (1963). The SEC recognizes this. At oral argument, the following exchange took place:

      96

      "QUESTION: So, it would not have satisfied his obligation under the law to go to the SEC first?

      "[SEC's counsel]: That is correct. That an insider has to observe what has come to be known as the abstain or disclosure rule. Either the information has to be disclosed to the market if it is inside information . . . or the insider must abstain." Tr. of Oral Arg. 27.

      97

      Thus, it is clear that Rule 10b-5 does not impose any obligation simply to tell the SEC about the fraud before trading.

      98

      [22] An example of a case turning on the court's determination that the disclosure did not impose any fiduciary duties on the recipient of the inside information is Walton v. Morgan Stanley & Co., 623 F. 2d 796 (CA2 1980). There, the defendant investment banking firm, representing one of its own corporate clients, investigated another corporation that was a possible target of a takeover bid by its client. In the course of negotiations the investment banking firm was given, on a confidential basis, unpublished material information. Subsequently, after the proposed takeover was abandoned, the firm was charged with relying on the information when it traded in the target corporation's stock. For purposes of the decision, it was assumed that the firm knew the information was confidential, but that it had been received in arm's-length negotiations. See id., at 798. In the absence of any fiduciary relationship, the Court of Appeals found no basis for imposing tippee liability on the investment firm. See id., at 799.

      99

      [23] Scienter — "a mental state embracing intent to deceive, manipulate, or defraud," Ernst & Ernst v. Hochfelder, 425 U. S. 185, 193-194, n. 12 (1976) — is an independent element of a Rule 10b-5 violation. See Aaron v. SEC, 446 U. S. 680, 695 (1980). Contrary to the dissent's suggestion, see post, at 674, n. 10, motivation is not irrelevant to the issue of scienter. It is not enough that an insider's conduct results in harm to investors; rather, a violation may be found only where there is "intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities." Ernst & Ernst v. Hochfelder, supra, at 199. The issue in this case, however, is not whether Secrist or Dirks acted with scienter, but rather whether there was any deceptive or fraudulent conduct at all, i. e., whether Secrist's disclosure constituted a breach of his fiduciary duty and thereby caused injury to shareholders. See n. 27, infra. Only if there was such a breach did Dirks, a tippee, acquire a fiduciary duty to disclose or abstain.

      100

      [24] Without legal limitations, market participants are forced to rely on the reasonableness of the SEC's litigation strategy, but that can be hazardous, as the facts of this case make plain. Following the SEC's filing of the Texas Gulf Sulphur action, Commissioner (and later Chairman) Budge spoke of the various implications of applying Rule 10b-5 in inside-trading cases:

      101

      "Turning to the realm of possible defendants in the present and potential civil actions, the Commission certainly does not contemplate suing every person who may have come across inside information. In the Texas Gulf action neither tippees nor persons in the vast rank and file of employees have been named as defendants. In my view, the Commission in future cases normally should not join rank and file employees or persons outside the company such as an analyst or reporter who learns of inside information." Speech of Hamer Budge to the New York Regional Group of the American Society of Corporate Secretaries, Inc. (Nov. 18, 1965), reprinted in The Texas Gulf Sulphur Case — What It Is and What It Isn't, The Corporate Secretary, No. 127, p. 6 (Dec. 17, 1965) (emphasis added).

      102

      [25] Dirks contends that he was not a "tippee" because the information he received constituted unverified allegations of fraud that were denied by management and were not "material facts" under the securities laws that required disclosure before trading. He also argues that the information he received was not truly "inside" information, i. e., intended for a confidential corporate purpose, but was merely evidence of a crime. The Solicitor General agrees. See Brief for United States as Amicus Curiae 22. We need not decide, however, whether the information constituted "material facts," or whether information concerning corporate crime is properly characterized as "inside information." For purposes of deciding this case, we assume the correctness of the SEC's findings, accepted by the Court of Appeals, that petitioner was a tippee of material inside information.

      103

      [26] Judge Wright found that Dirks acquired a fiduciary duty by virtue of his position as an employee of a broker-dealer. See 220 U. S. App. D. C., at 325-327, 681 F. 2d, at 840-842. The SEC, however, did not consider Judge Wright's novel theory in its decision, nor did it present that theory to the Court of Appeals. The SEC also has not argued Judge Wright's theory in this Court. See Brief for Respondent 21, n. 27. The merits of such a duty are therefore not before the Court. See SEC v. Chenery Corp., 332 U. S. 194, 196-197 (1947).

      104

      [27] In this Court, the SEC appears to contend that an insider invariably violates a fiduciary duty to the corporation's shareholders by transmitting nonpublic corporate information to an outsider when he has reason to believe that the outsider may use it to the disadvantage of the shareholders. "Thus, regardless of any ultimate motive to bring to public attention the derelictions at Equity Funding, Secrist breached his duty to Equity Funding shareholders." Brief for Respondent 31. This perceived "duty" differs markedly from the one that the SEC identified in Cady, Roberts and that has been the basis for federal tippee-trading rules to date. In fact, the SEC did not charge Secrist with any wrongdoing, and we do not understand the SEC to have relied on any theory of a breach of duty by Secrist in finding that Dirks breached his duty to Equity Funding's shareholders. See App. 250 (decision of Administrative Law Judge) ("One who knows himself to be a beneficiary of non-public, selectively disclosed inside information must fully disclose or refrain from trading"); Record, SEC's Reply to Notice of Supplemental Authority before the SEC 4 ("If Secrist was acting properly, Dirks inherited a duty to [Equity Funding]'s shareholders to refrain from improper private use of the information"); Brief for SEC in No. 81-1243 (CADC), pp. 47-50; id., at 51 ("[K]nowing possession of inside information by any person imposes a duty to abstain or disclose"); id., at 52-54; id., at 55 ("[T]his obligation arises not from the manner in which such information is acquired . . ."); 220 U. S. App. D. C., at 322-323, 681 F. 2d, at 837-838 (Wright, J.).

      105

      The dissent argues that "Secrist violated his duty to Equity Funding shareholders by transmitting material nonpublic information to Dirks with the intention that Dirks would cause his clients to trade on that information. Post, at 678-679. By perceiving a breach of fiduciary duty whenever inside information is intentionally disclosed to securities traders, the dissenting opinion effectively would achieve the same result as the SEC's theory below, i. e., mere possession of inside information while trading would be viewed as a Rule 10b-5 violation. But Chiarella made it explicitly clear that there is no general duty to forgo market transactions "based on material, nonpublic information." 445 U. S., at 233. Such a duty would "depar[t] radically from the established doctrine that duty arises from a specific relationship between two parties." Ibid. See supra, at 654-655.

      106

      Moreover, to constitute a violation of Rule 10b-5, there must be fraud. See Ernst & Ernst v. Hochfelder, 425 U. S., at 199 (statutory words "manipulative," "device," and "contrivance . . . connot[e] intentional or willful conduct designed to deceive or defraud investors by controlling or artificially affecting the price of securities") (emphasis added). There is no evidence that Secrist's disclosure was intended to or did in fact "deceive or defraud" anyone. Secrist certainly intended to convey relevant information that management was unlawfully concealing, and — so far as the record shows — he believed that persuading Dirks to investigate was the best way to disclose the fraud. Other efforts had proved fruitless. Under any objective standard, Secrist received no direct or indirect personal benefit from the disclosure.

      107

      The dissenting opinion focuses on shareholder "losses," "injury," and "damages," but in many cases there may be no clear causal connection between inside trading and outsiders' losses. In one sense, as market values fluctuate and investors act on inevitably incomplete or incorrect information, there always are winners and losers; but those who have "lost" have not necessarily been defrauded. On the other hand, inside trading for personal gain is fraudulent, and is a violation of the federal securities laws. See Dooley, supra n. 21, at 39-41, 70. Thus, there is little legal significance to the dissent's argument that Secrist and Dirks created new "victims" by disclosing the information to persons who traded. In fact, they prevented the fraud from continuing and victimizing many more investors.

      108

      ---------

      109

      [1] See, e. g., Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723 (1975); Ernst & Ernst v. Hochfelder, 425 U. S. 185 (1976); Piper v. ChrisCraft Industries, Inc., 430 U. S. 1 (1977); Chiarella v. United States, 445 U. S. 222 (1980); Aaron v. SEC, 446 U. S. 680 (1980). This trend frustrates the congressional intent that the securities laws be interpreted flexibly to protect investors, see Affiliated Ute Citizens v. United States, 406 U. S. 128, 151 (1972); SEC v. Capital Gains Research Bureau, Inc., 375 U. S. 180, 186 (1963), and to regulate deceptive practices "detrimental to the interests of the investor," S. Rep. No. 792, 73d Cong., 2d Sess., 18 (1934); see H. R. Rep. No. 1383, 73d Cong., 2d Sess., 10 (1934). Moreover, the Court continues to refuse to accord to SEC administrative decisions the deference it normally gives to an agency's interpretation of its own statute. See, e. g., Blum v. Bacon, 457 U. S. 132 (1982).

      110

      [2] Unknown to Dirks, Secrist also told story to New York insurance regulators the same day. App. 23. They immediately assured themselves that Equity Funding's New York subsidiary had sufficient assets to cover its outstanding policies and then passed on the information to California regulators who in turn informed Illinois regulators. Illinois investigators, later joined by California officials, conducted a surprise audit of Equity Funding's Illinois subsidiary, id., at 87-88, to find $22 million of the subsidiary's assets missing. On March 30, these authorities seized control of the Illinois subsidiary. Id., at 271.

      111

      [3] In the same administrative proceeding at issue here, the Administrative Law Judge (ALJ) found that Dirks' clients — five institutional investment advisers — violated § 17(a) of the Securities Act of 1933, 15 U. S. C. § 77q(a), § 10(b) of the Securities Exchange Act of 1934, 15 U. S. C. § 78j(b), and Rule 10b-5, 17 CFR § 240.10b-5 (1983), by trading on Dirks' tips. App. 297. All the clients were censured, except Dreyfus Corporation. The ALJ found that Dreyfus had made significant efforts to disclose the information to Goldman, Sachs, the purchaser of its securities. Id., at 299, 301. None of Dirks' clients appealed these determinations. App. to Pet. for Cert. B-2, n. 1.

      112

      [4] The Court's implicit suggestion that Dirks did not gain by this selective dissemination of advice, ante, at 649, n. 2, is inaccurate. The ALJ found that because of Dirks' information, Boston Company Institutional Investors, Inc., directed business to Delafield Childs that generated approximately $25,000 in commissions. App. 199, 204-205. While it is true that the exact economic benefit gained by Delafield Childs due to Dirks' activities is unknowable because of the structure of compensation in the securities market, there can be no doubt that Delafield and Dirks gained both monetary rewards and enhanced reputations for "looking after" their clients.

      113

      [5] I interpret the Court's opinion to impose liability on tippees like Dirks when the tippee knows or has reason to know that the information is material and nonpublic and was obtained through a breach of duty by selective revelation or otherwise. See In re Investors Management Co., 44 S. E. C. 633, 641 (1971).

      114

      [6] The Court cites only a footnote in an SEC decision and Professor Brudney to support its rule. Ante, at 663-664. The footnote, however, merely identifies one result the securities laws are intended to prevent. It does not define the nature of the duty itself. See n. 9, infra. Professor Brudney's quoted statement appears in the context of his assertion that the duty of insiders to disclose prior to trading with shareholders is in large part a mechanism to correct the information available to noninsiders. Professor Brudney simply recognizes that the most common motive for breaching this duty is personal gain; he does not state, however, that the duty prevents only personal aggrandizement. Insiders, Outsiders, and Informational Advantages Under the Federal Securities Laws, 93 Harv. L. Rev. 322, 345-348 (1979). Surely, the Court does not now adopt Professor Brudney's access-to-information theory, a close cousin to the equality-of-information theory it accuses the SEC of harboring. See ante, at 655-658.

      115

      [7] The Court correctly distinguishes this duty from the duty of an insider to the corporation not to mismanage corporate affairs or to misappropriate corporate assets. Ante, at 653, n. 10. That duty also can be breached when the insider trades in corporate securities on the basis of inside information. Although a shareholder suing in the name of the corporation can recover for the corporation damages for any injury the insider causes by the breach of this distinct duty, Diamond v. Oreamuno, 24 N. Y. 2d 494, 498, 248 N. E. 2d 910, 912 (1969); see Thomas v. Roblin Industries, Inc., 520 F. 2d 1393, 1397 (CA3 1975), insider trading generally does not injure the corporation itself. See Langevoort, Insider Trading and the Fiduciary Principle: A Post-Chiarella Restatement, 70 Calif. L. Rev. 1, 2, n. 5, 28, n. 111 (1982).

      116

      [8] As it did in Chiarella, 445 U. S., at 226-229, the Court adopts the Cady, Roberts formulation of the duty. Ante, at 653-654.

      117

      "Analytically, the obligation rests on two principal elements; first, the existence of a relationship giving access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the personal benefit of anyone, and second, the inherent unfairness involved where a party takes advantage of such information knowing it is unavailable to those with whom he is dealing." In re Cady, Roberts & Co., 40 S. E. C. 907, 912 (1961) (footnote omitted).

      118

      The first element — on which Chiarella's holding rests — establishes the type of relationship that must exist between the parties before a duty to disclose is present. The second — not addressed by Chiarella — identifies the harm that the duty protects against: the inherent unfairness to the shareholder caused when an insider trades with him on the basis of undisclosed inside information.

      119

      [9] Without doubt, breaches of the insider's duty occur most often when an insider seeks personal aggrandizement at the expense of shareholders. Because of this, descriptions of the duty to disclose are often coupled with statements that the duty prevents unjust enrichment. See, e. g., In re Cady, Roberts & Co., 40 S. E. C., at 912, n. 15; Langevoort, 70 Calif. L. Rev., at 19. Private gain is certainly a strong motivation for breaching the duty.

      120

      It is, however, not an element of the breach of this duty. The reference to personal gain in Cady, Roberts for example, is appended to the first element underlying the duty which requires that an insider have a special relationship to corporate information that he cannot appropriate for his own benefit. See n. 8, supra. It does not limit the second element which addresses the injury to the shareholder and is at issue here. See ibid. In fact, Cady, Roberts describes the duty more precisely in a later footnote: "In the circumstances, [the insider's] relationship to his customers was such that he would have a duty not to take a position adverse to them, not to take secret profits at their expense, not to misrepresent facts to them, and in general to place their interests ahead of his own." 40 S. E. C., at 916, n. 31. This statement makes clear that enrichment of the insider himself is simply one of the results the duty attempts to prevent.

      121

      [10] Of course, an insider is not liable in a Rule 10b-5 administrative action unless he has the requisite scienter. Aaron v. SEC, 446 U. S., at 691. He must know that his conduct violates or intend that it violate his duty. Secrist obviously knew and intended that Dirks would cause trading on the inside information and that Equity Funding shareholders would be harmed. The scienter requirement addresses the intent necessary to support liability; it does not address the motives behind the intent.

      122

      [11] The Court seems concerned that this case bears on insiders' contacts with analysts for valid corporate reasons. Ante, at 658-659. It also fears that insiders may not be able to determine whether the information transmitted is material or nonpublic. Ante, at 661-662. When the disclosure is to an investment banker or some other adviser, however, there is normally no breach because the insider does not have scienter: he does not intend that the inside information be used for trading purposes to the disadvantage of shareholders. Moreover, if the insider in good faith does not believe that the information is material or nonpublic, he also lacks the necessary scienter. Ernst & Ernst v. Hochfelder, 425 U. S., at 197. In fact, the scienter requirement functions in part to protect good-faith errors of this type. Id., at 211, n. 31.

      123

      Should the adviser receiving the information use it to trade, it may breach a separate contractual or other duty to the corporation not to misuse the information. Absent such an arrangement, however, the adviser is not barred by Rule 10b-5 from trading on that information if it believes that the insider has not breached any duty to his shareholders. See Walton v. Morgan Stanley & Co., 623 F. 2d 796, 798-799 (CA2 1980).

      124

      The situation here, of course, is radically different. Ante, at 658, n. 18 (Dirks received information requiring no analysis "as to its market relevance"). Secrist divulged the information for the precise purpose of causing Dirks' clients to trade on it. I fail to understand how imposing liability on Dirks will affect legitimate insider-analyst contacts.

      125

      [12] The duty involved in Mosser was the duty to the corporation in trust not to misappropriate its assets. This duty, of course, differs from the duty to shareholders involved in this case. See n. 7, supra. Trustees are also subject to a higher standard of care than scienter. 3 A. Scott, Law of Trusts § 201, p. 1650 (3d ed. 1967). In addition, strict trustees are bound not to trade in securities at all. See Langevoort, 70 Calif. L. Rev., at 2, n. 5. These differences, however, are irrelevant to the principle of Mosser that the motive of personal gain is not essential to a trustee's liability. In Mosser, as here, personal gain accrued to the tippees. See 341 U. S., at 273.

      126

      [13] Although I disagree in principle with the Court's requirement of an improper motive, I also note that the requirement adds to the administrative and judicial burden in Rule 10b-5 cases. Assuming the validity of the requirement, the SEC's approach — a violation occurs when the insider knows that the tippee will trade with the information, Brief for Respondent 31 — can be seen as a presumption that the insider gains from the tipping. The Court now requires a case-by-case determination, thus prohibiting such a presumption.

      127

      The Court acknowledges the burdens and difficulties of this approach, but asserts that a principle is needed to guide market participants. Ante, at 664. I fail to see how the Court's rule has any practical advantage over the SEC's presumption. The Court's approach is particularly difficult to administer when the insider is not directly enriched monetarily by the trading he induces. For example, the Court does not explain why the benefit Secrist obtained — the good feeling of exposing a fraud and his enhanced reputation — is any different from the benefit to an insider who gives the information as a gift to a friend or relative. Under the Court's somewhat cynical view, gifts involve personal gain. See ibid. Secrist surely gave Dirks a gift of the commissions Dirks made on the deal in order to induce him to disseminate the information. The distinction between pure altruism and self-interest has puzzled philosophers for centuries; there is no reason to believe that courts and administrative law judges will have an easier time with it.

      128

      [14] This position seems little different from the theory that insider trading should be permitted because it brings relevant information to the market. See H. Manne, Insider Trading and the Stock Market 59-76, 111-146 (1966); Manne, Insider Trading and the Law Professors, 23 Vand. L. Rev. 547, 565-576 (1970). The Court also seems to embrace a variant of that extreme theory, which postulates that insider trading causes no harm at all to those who purchase from the insider. Ante, at 666-667, n. 27. Both the theory and its variant sit at the opposite end of the theoretical spectrum from the much maligned equality-of-information theory, and never have been adopted by Congress or ratified by this Court. See Langevoort, 70 Calif. L. Rev., at 1, and n. 1. The theory rejects the existence of any enforceable principle of fairness between market participants.

      129

      [15] The Court uncritically accepts Dirks' own view of his role in uncovering the Equity Funding fraud. See ante, at 658, n. 18. It ignores the fact that Secrist gave the same information at the same time to state insurance regulators, who proceeded to expose massive fraud in a major Equity Funding subsidiary. The fraud surfaced before Dirks ever spoke to the SEC.

      130

      [16] Secrist did pass on his information to regulatory authorities. His good but misguided motive may be the reason the SEC did not join him in the administrative proceedings against Dirks and his clients. The fact that the SEC, in an exercise of prosecutorial discretion, did not charge Secrist under Rule 10b-5 says nothing about the applicable law. Cf. ante, at 665, n. 25 (suggesting otherwise). Nor does the fact that the SEC took an unsupportable legal position in proceedings below indicate that neither Secrist nor Dirks is liable under any theory. Cf. ibid. (same).

      131

      [17] At oral argument, the SEC's view was that Dirks' obligation to disclose would not be satisfied by reporting the information to the SEC. Tr. of Oral Arg. 27, quoted ante, at 661, n. 21. This position is in apparent conflict with the statement in its brief that speaks favorably of a safe harbor rule under which an investor satisfies his obligation to disclose by reporting the information to the Commission and then waiting a set period before trading. Brief for Respondent 43-44. The SEC, however, has neither proposed nor adopted a rule to this effect, and thus persons such as Dirks have no real option other than to refrain from trading.

    • 3.2 SEC. v. Switzer

      What are the limits of tippee liability?

      1
      590 F.Supp. 756 (1984)
      2
      SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
      v.
      Barry L. SWITZER; Lee Allan Smith; Sedwyn T. Kennedy; Harold D. Deem; Harold D. Hodges; Robert E. Amyx; and Robert M. Hoover, Jr., Defendants.
      3
      Civ. A. No. Civ-83-225-Sf.
      United States District Court, W.D. Oklahoma.
      4
      July 2, 1984.
      5

      [757] T. Christopher Browne, Nancy E. McGinley, S.E.C., Fort Worth, Tex., for plaintiff.

      6

      Robert G. Grove, Grove & Grove, David Machanic, Michael Minnis, Pierson, Ball & Dowd, Harry A. Woods, Jr., Crowe & Dunlevy, Oklahoma City, Okl., Frederick T. Spindel, Washington, D.C., Daniel S. Greenfeld, Seyfarth, Shaw, Fairweather & Geraldson, New York City, for defendants.

      7
      MEMORANDUM AND ORDER
      8
      SAFFELS, District Judge, Sitting by Designation.
      9

      This action brought by the Securities and Exchange Commission [hereinafter SEC] was tried to the court on March 19-22, 1984. It involved allegations of violations of Section 10(b) of the Securities Exchange Act of 1934 and violations of Commission Rule 10b-5. On the basis of the following findings of fact and conclusions of law, the court shall enter judgment on behalf of the defendants.

      10
      Findings of Fact
      11

      The following findings of fact have been stipulated to by all parties and accepted by the court and are set forth as follows.

      12

      1. The SEC, pursuant to the authority granted to it by Sections 10(b), 16(a) and 23(a) of the Securities Exchange Act of 1934 [15 U.S.C. 78j(b), 78p(a) and 78w(a)] has promulgated Rules 10b-5, 16a-1 and [758] 16a-8 [17 C.F.R. 240.10b-5, 240.16a-1 and 240.16a-8], which have been in effect at all times mentioned in the complaint.

      13

      2. This court has jurisdiction over this action pursuant to Section 27 of the Securities Exchange Act [15 U.S.C. 78aa].

      14

      3. The SEC brings this action pursuant to Sections 21(d) and 21(e) of the Securities Exchange Act [15 U.S.C. 78u(d) and 78u(e)].

      15

      4. The defendants, directly or indirectly, made use of the means and instrumentalities of interstate commerce and of the mails in connection with the transactions, acts, practices and courses of business alleged in the complaint.

      16

      5. Certain of the transactions, acts, practices and courses of business alleged in the complaint as violations of, and aiding and abetting violations of, the Securities Exchange Act have occurred in the Western District of Oklahoma; and certain of the defendants can be found, inhabit or transact business in the Western District of Oklahoma.

      17

      6. Barry L. Switzer resides at 2811 Castlewood Drive, Norman, Oklahoma (73070). At all times mentioned in the complaint, Switzer was the head football coach at the University of Oklahoma in Norman, Oklahoma.

      18

      7. Lee Allan Smith resides at 6033 Riviera Drive, Oklahoma City, Oklahoma (73112). At all times mentioned in the complaint, Smith was General Manager of television station KTVY in Oklahoma City, Oklahoma.

      19

      8. Sedwyn T. Kennedy lives in the Oklahoma City, Oklahoma area. At all times mentioned in the complaint, Kennedy held an ownership interest in and operated restaurants located in the Oklahoma City, Oklahoma, area.

      20

      9. Harold D. Deem resides in Texas. Until 1975, he was involved in the restaurant business. At all times mentioned in the complaint, Deem managed his own investments, and he was a partner, along with Kennedy, in S & H Investments, an investment partnership.

      21

      10. Harold L. Hodges resides at 3215 Thornridge Road, Oklahoma City, Oklahoma (73120), and/or 2301 Grand Boulevard, Oklahoma City, Oklahoma (73116). At all times mentioned in the complaint, Hodges was the Owner and President of Core Oil and Gas, as well as the Owner and President of Bill Hodges Truck Company, both located in Oklahoma City, Oklahoma.

      22

      11. Robert E. Amyx resides at 3236 Rock Hollow, Oklahoma City, Oklahoma (74120). At all times mentioned in the complaint, Amyx was Vice President of Core Oil and Gas and Vice President of Bill Hodges Truck Company, and has been a partner, along with Hodges, in Hodges, Amyx, Cross and Hodges, an investment partnership.

      23

      12. Robert M. Hoover, Jr. resides at 7209 Waverly, Oklahoma City, Oklahoma (73120). At all times mentioned in the complaint, Hoover was Chairman of the Board of Directors of Oklahoma Energies Corporation, a publicly-traded company, located in Oklahoma City, Oklahoma.

      24

      13. Texas International Company [hereinafter TIC] is a Delaware corporation with principal offices located in Oklahoma City, Oklahoma. At all times mentioned in the complaint, TIC was engaged in, among other things, exploration for and development of oil and natural gas properties. At all times mentioned in the complaint, TIC's common stock was registered with the SEC pursuant to Section 12(b) of the Securities Exchange Act [15 U.S.C. 78l (b)] and was traded on the New York Stock Exchange, as well as other exchanges. On or about June 18, 1982, a wholly-owned subsidiary of TIC merged with Phoenix Resources Company [hereinafter Phoenix] and Phoenix became a wholly-owned subsidiary of TIC. At all times mentioned in the complaint prior to the merger, TIC owned in excess of fifty percent (50%) of the common stock of Phoenix, and, by reason of such ownership position, controlled Phoenix through election of three of the five members of the Phoenix Board of Directors.

      25

      [759] 14. Prior to the merger, Phoenix, the successor to King Resources Company, was a Maine corporation with principal offices located in Oklahoma City, Oklahoma. At all times mentioned in the complaint prior to the merger, Phoenix engaged in, among other things, exploration for and development of oil and natural gas properties. At all times mentioned in the complaint prior to the merger, Phoenix's common stock was registered with the SEC pursuant to Section 12(b) of the Securities Exchange Act [15 U.S.C. 78l (b)] and was traded in the Over-the-Counter securities market on the National Association of Securities Dealers Automated Quotation System.

      26

      15. On or about Monday, June 8, 1981, after discussions with defendant Deem, Kennedy purchased five thousand (5,000) shares of Phoenix at Forty-Two and 75/100 Dollars ($42.75) per share through the S & H Investments account; and on or about Tuesday, June 9, 1981, after further discussions with Deem, Kennedy purchased an additional one thousand (1,000) shares of Phoenix at Forty-Nine Dollars ($49) per share.

      27

      16. On or about Wednesday, June 10, and Friday, June 12, 1981, S & H Investments sold all six thousand (6,000) shares of Phoenix at prices between Sixty and 50/100 Dollars ($60.50) and Sixty-Eight and 50/100 Dollars ($68.50) per share; the pretax profits realized by and divided between Kennedy and Deem on the basis of this trading amounted to approximately One Hundred Eighteen Thousand Five Hundred Eighty-Seven Dollars ($118,587).

      28

      17. On or about Monday, June 8, and Tuesday, June 9, 1981, Hoover purchased sixteen thousand five hundred (16,500) shares of Phoenix at prices between Forty-Three Dollars ($43) and Forty-Eight and 50/100 Dollars ($48.50) per share.

      29

      18. On or about Wednesday, June 10, 1981, after the public announcement, Hoover sold all sixteen thousand five hundred (16,500) shares of Phoenix at prices between Fifty-Nine Dollars ($59) and Sixty-Three and 50/100 Dollars ($63.50) per share; the pre-tax profits realized on the basis of trading over this three-day period amounted to approximately Two Hundred Sixty-Seven Thousand Seven Hundred Twenty-Eight Dollars ($267,728); and the pre-tax profits paid to and divided by Switzer and Smith amounted to approximately One Hundred Ten Thousand Four Hundred Ninety-One Dollars ($110,491).

      30

      19. Hodges and Amyx agreed to purchase Phoenix stock through the Hodges, Amyx, Cross and Hodges investment partnership account.

      31

      20. On or about Monday, June 8, and Tuesday, June 9, 1981, Amyx, on behalf of the Hodges, Amyx, Cross and Hodges investment partnership, purchased thirteen thousand (13,000) shares of Phoenix at prices between Forty-Three and 50/100 Dollars ($43.50) and Forty-Eight and 50/100 Dollars ($48.50) per share.

      32

      21. On or about Wednesday, June 10, and Thursday, June 11, 1981, the Hodges, Amyx, Cross and Hodges investment partnership sold all thirteen thousand (13,000) shares of Phoenix at prices between Fifty-Nine Dollars ($59) and Sixty-Five Dollars ($65) per share; the pre-tax profits realized by the investment partnership on the basis of trading over a four-day period amounted to approximately Two Hundred Five Thousand Fifty-Five Dollars ($205,055); and the pre-tax profits from such trading paid to and divided by Switzer and Smith amounted to approximately Eighty-Five Thousand Three Hundred Ten Dollars ($85,310).

      33

      22. The volume and price at which Phoenix common stock traded during the period of June 1-12, 1981, were as follows:

      34
         DATE            VOLUME         PRICE (Bid)  June 1            8,800         $42-1/2       2            2,000         $42       3           10,600         $39-1/2       4            2,500         $39-1/2       5            6,800         $42       6  (Sat.)   ______         _______       7  (Sun.)   ______         _______       8           43,100         $44-1/2       9           31,800         $47-1/2       10         101,200         $61       11          63,800         $66-1/2       12          57,100         $69-1/4
      35

      [760] 23. The volume and price at which Phoenix common stock traded on July 31, 1981, was three hundred seventy-nine thousand (379,000) shares at Seventy-Nine and 7/8 Dollars ($79-7/8) bid.

      36

      The following additional facts are found by the court:

      37

      24. In or about May of 1981, Scott C. Newquist [hereinafter Newquist], a principal at Morgan Stanley, an investment banking firm, contacted G. Platt to discuss the prospect of obtaining TIC as a client. A meeting eventually was arranged between personnel of Morgan Stanley and personnel of TIC for June 4 or 5, 1981, at the Morgan Stanley offices in New York.

      38

      25. On or about June 4 or 5, 1981, G. Platt and Robert Gist [hereinafter Gist] met with Newquist and other Morgan Stanley personnel at the Morgan Stanley offices in New York City, New York. Newquist thought the meeting was going to concern various means available to TIC to alter the relationship between itself and Phoenix. At the meeting, however, G. Platt, in addition to discussing TIC's options, discussed Phoenix and inquired whether Morgan Stanley would be willing to be retained by Phoenix to evaluate, among other alternatives, the disposition of Phoenix or its assets. Newquist advised G. Platt that prior to accepting Phoenix as a client, Morgan Stanley would require a unanimous vote of the Phoenix Board of Directors, and further would have to conduct a "due diligence" inquiry, i.e., a familiarization with the affairs of the company. By the time G. Platt and Gist returned to Oklahoma City on June 5, 1981, they had decided to recommend to the Phoenix Board that Morgan Stanley be retained to undertake a study of the company and evaluate the prompt disposition of Phoenix or its assets.

      39

      26. In June of 1981, G. Platt was Chairman of the Board and the Chief Executive Officer of TIC and served as a Director on the Phoenix Board of Directors. Gist, in June of 1981, was President of Phoenix. G. Platt, in essence, controlled the Phoenix Board of Directors because he could fire any member except Arthur Lipper.

      40

      27. Although Lipper, the only independent director on the Board, had opposed mergers of Phoenix in the past, he had never opposed liquidation of Phoenix, provided the liquidation was at fair market value.

      41

      28. The Board of Directors of Phoenix met on June 9, 1981, and agreed to formally request Morgan Stanley to be retained. A phone call was then made to Morgan Stanley on June 9, 1981, and Morgan Stanley formally agreed to be retained by Phoenix, subject only to completion of its "due diligence" inquiry.

      42

      29. On June 10, 1981, Phoenix made a public announcement that its Board of Directors had determined to consider the prompt disposition of the company or its assets (liquidation) and had retained an unidentified investment banking firm, later publicly identified as Morgan Stanley, to conduct an evaluation of Phoenix. At the time of the public announcement, Morgan Stanley had not completed its "due diligence" examination of Phoenix, and the actual acceptance by Morgan Stanley was contingent upon completion of the "due diligence" examination.

      43

      30. From at least the time of the Platt-Newquist meeting on or about June 4 or 5, 1981, when G. Platt and Gist determined to pursue a possible liquidation of Phoenix, to at least the time of the public announcement on or about June 10, 1981, the proposal to liquidate Phoenix and retain an investment banking firm to evaluate that proposal was non-public information. Furthermore, such information was likely to affect the investment decision of a reasonably prudent investor, i.e., it was information which a reasonable investor would consider important in making his decision how to act because the pro-rata value of Phoenix assets could reasonably be expected to exceed the market price of its stock at the time of the public announcement. This made the information material.

      44

      31. During the days which followed the June 10, 1981, announcement, there were [761] no other market events to which the rise in Phoenix stock price could be attributed.

      45

      32. Barry Switzer is a well-recognized "celebrity" in Oklahoma and elsewhere. He has an interest in the oil and gas industry, as he is personally involved in various ventures within the industry.

      46

      33. Over the past several years, defendants Switzer, Kennedy, Deem, Smith, Hodges, Amyx and Hoover have acted together in varying combinations of persons (or in various groups of persons) in making investments. They have formed partnerships such as S & H Investments, Waverly Ltd., and Hodges, Amyx, Cross and Hodges, to assist them in their investment ventures. Often times, they trade on rumors or gossip they hear within the investing community. Profits and losses occurring as a result of stock investments made through these partnerships are shared by the members of the partnerships.

      47

      34. TIC had been considering various options for either consolidating or separating TIC and Phoenix for some time prior to its approaching Morgan Stanley on June 4 or 5, 1981. Rumors concerning these various options were circulating within the investing oil and gas community prior to June 4 or 5, 1981.

      48

      35. On June 6, 1981, four days prior to the public announcement concerning Phoenix, a state invitational secondary school track meet was held at John Jacobs Field on the University of Oklahoma campus. The track meet was a day long event. Several hundred spectators attended, including Barry Switzer, who arrived at the meet between 10:00 and 10:30 a.m. to watch his son compete, and George and Linda Platt, who arrived between 9:00 and 10:00 a.m. to watch their son compete. Soon after Switzer's arrival at the track meet, he and G. Platt recognized and greeted each other. Neither Switzer nor G. Platt knew that the other would be attending the meet.

      49

      36. G. Platt was a supporter of Oklahoma University football and had met Switzer at a few social engagements prior to June of 1981. TIC was a sponsor of Switzer's football show, "Play Back." G. Platt had had season tickets to the OU football games for approximately five years. G. Platt had obtained autographs from Switzer for G. Platt's minor children, and had had his secretary telephone Switzer to request that his season tickets be upgraded. Upgrading of tickets was extended as a courtesy by Switzer to many season ticket holders. On at least two occasions Switzer had phoned G. Platt requesting continued sponsorship by TIC of Switzer's football television program. These calls were made at the urging of Tom Goodgame, General Manager of the television station which then produced "Play Back." As of June 5, 1981, Switzer knew that G. Platt was Chairman of the Board of TIC and further knew that TIC was a substantial shareholder of Phoenix because Switzer was a stockholder in TIC and thereby knew Phoenix was a subsidiary.

      50

      37. Neither G. Platt nor his wife Linda are particularly impressed by Switzer. They view him as "just a nice fellow."

      51

      38. Upon first greeting each other at the track meet, G. Platt and Switzer exchanged pleasantries. Switzer then departed and continued on through the bleachers.

      52

      39. Throughout the course of the day, G. Platt and Linda Platt generally remained in one place in the bleachers. Switzer, however, throughout the day moved around a great deal, at times speaking with his son or other participants and their families, signing autographs and watching the different events on the field. While moving about, Switzer joined the Platts to visit with them about three to five times. During these visits Switzer and the Platts talked about their sons' participation in the meet, the oil and gas business, the economy, football and their respective personal investments.

      53

      40. G. Platt and Switzer did not have any conversations regarding Phoenix or Morgan Stanley, nor did they have any conversations regarding any mergers, acquisitions, take-overs or possible liquidations of Phoenix in which Morgan Stanley would play a part. G. Platt did not make [762] any stock recommendations to Switzer, nor did he intentionally communicate material, non-public corporate information to Switzer about Phoenix during their conversations at the track meet. The information that Switzer heard at the track meet about Phoenix was overheard and was not the result of an intentional disclosure by G. Platt.

      54

      41. Sometime in the afternoon, after his last conversation with G. Platt, Switzer laid down on a row of bleachers behind the Platts to sunbathe while waiting for his son's next event. While Switzer was sunbathing, he overheard G. Platt talking to his wife about his trip to New York the prior day. In that conversation, G. Platt mentioned Morgan Stanley and his desire to dispose of or liquidate Phoenix. G. Platt further talked about several companies bidding on Phoenix. Switzer also overheard that an announcement of a "possible" liquidation of Phoenix might occur the following Thursday. Switzer remained on the bleachers behind the Platts for approximately twenty minutes then got up and continued to move about.

      55

      42. At this time Switzer had no knowledge as to whether the information he had overheard was confidential.

      56

      43. G. Platt was not conscious of Switzer's presence on the bleachers behind him that day, nor that Switzer had overheard any conversation.

      57

      44. G. Platt had returned home late the previous day from his meetings in New York, and his wife was to leave town for an entire week on the following day. Having minor children, it is the Platts' common practice to try to arrange for G. Platt to be at home when his wife is out of town. The day of the track meet provided the Platts with an opportunity to discuss their respective plans for the up-coming week. During this discussion, G. Platt's prior business activities in New York and its resultant obligations and appointments were mentioned. In addition, when G. Platt appears distracted, it is not uncommon for his wife to inquire of him what is on his mind. On these occasions, he will talk to her about his problems, even though she does not have an understanding of nor interest in business matters. On the day of the track meet, Phoenix was weighing upon the mind of G. Platt, as it had been for the past several years, prompting G. Platt to talk to his wife about it.

      58

      45. On June 6, 1981, after the track meet, Switzer returned home and looked up the price of Phoenix in the paper. He then had dinner with Sedwyn Kennedy, a close friend of both his and defendant Lee Allan Smith. In the past, they had all made investments through their partnership, SKS. Switzer told Kennedy he had overheard a conversation about the possible liquidation of Phoenix and that it would probably occur or be announced the next Thursday. Switzer told him the source was a gentlemen who was an executive with TIC. Switzer did not tell Kennedy the man was G. Platt. Switzer and Kennedy are close friends and have known each other since 1966.

      59

      46. By the end of the evening, Switzer and Kennedy had each expressed an intention to purchase Phoenix stock.

      60

      47. On Sunday, June 7, 1981, Kennedy telephoned Deem, his partner in S&H Investments, to discuss the possible purchase of Phoenix stock. Kennedy told Deem that Barry Switzer had talked to him about Phoenix, but did not give him any other details. As a result, Kennedy and Deem agreed to purchase shares of Phoenix through their partnership, S&H Investments.

      61

      48. On or about Monday, June 8, 1981, Kennedy purchased five thousand (5,000) shares of Phoenix stock at Forty-Two and 75/100 Dollars ($42.75) per share through the S&H Investments account; and on or about Tuesday, June 9, 1981, after further discussions with Deem, Kennedy purchased an additional one thousand (1,000) shares of Phoenix at Forty-Nine Dollars ($49) per share. (See stipulated fact No. 15, supra.)

      62

      49. On Sunday, June 7, 1981, Switzer called Lee Allan Smith, a close friend with whom he had previously entered joint investments. [763] Switzer told Smith that he had been at a track meet on Saturday and had overheard some information regarding the possible liquidation or buy-out of Phoenix. Switzer attributed the information to "someone who should know," and said that he had overheard that Morgan Stanley was involved and that something could happen by Thursday of the following week. Switzer and Smith decided to approach Harold Hodges and Robert Hoover about providing the capital for buying some Phoenix stock with them because Smith and Switzer had insufficient available cash at that time to purchase a significant number of shares on their own. Hodges, Smith and Switzer were personal friends through participation in community and charitable activities in Oklahoma City. Hoover has known Smith for thirty years and has been a personal friend of both Smith and Switzer.

      63

      50. On Sunday, June 7, 1981, Switzer and Smith met with Hodges at the latter's offices. At this meeting, Switzer told Hodges that he had overheard some information that Phoenix stock was going to go up. Switzer did not state the source of the information, and Hodges did not inquire, because Switzer and Smith are good friends of his, and he often invests on information of this nature. During most of this meeting, Smith was occupied in making telephone calls on other matters in another area of the room.

      64

      51. At the conclusion of the meeting, it was agreed that Hodges would supply the capital and purchase the stock, and that any profits or losses would be split, fifty percent (50%) to Hodges and fifty percent (50%) to be divided between Smith and Switzer.

      65

      52. On Monday, June 8, 1981, Hodges told Robert Amyx that he had visited with Smith and Switzer the previous day and that they had told him they had heard a rumor that something favorable was going to happen regarding TIC or Phoenix, and instructed him to make stock purchases in both companies.

      66

      53. On Monday, June 8, and Tuesday, June 9, 1981, Robert Amyx, on behalf of the Hodges, Amyx, Cross and Hodges investment partnership, purchased thirteen thousand (13,000) shares of Phoenix, at prices between Forty-Three and 50/100 Dollars ($43.50) and Forty-Eight and 50/100 Dollars ($48.50) per share. (See stipulated fact No. 20, supra.)

      67

      54. Because Hodges did not know which company was going to have a stock price rise, he requested Amyx not only to purchase Phoenix stock, but also stock of TIC, through the Hodges, Amyx, Cross and Hodges investment partnership account.

      68

      55. At the same time that he made the Phoenix purchases, Amyx purchased twenty thousand (20,000) shares of TIC stock at Twenty-Seven Dollars ($27) and Twenty-Seven and 1/8 Dollars ($27-1/8) per share.

      69

      56. On Sunday, June 7, 1981, after their meeting with Hodges, Switzer and Smith met with Robert Hoover at his home, where he was having a party. Switzer and Smith arrived separately. Smith first discussed the matter with Hoover and did not mention where he had received the information. Switzer also told Hoover something was going to happen with Phoenix, but did not say from whom he had heard the information.

      70

      57. Hoover agreed to purchase Phoenix stock jointly with Smith and Switzer. Hoover advanced the capital and purchased the stock for his account, based on an understanding that any losses or profits would be split, fifty percent (50%) to Hoover, and the remaining fifty percent (50%) to be divided between Smith and Switzer.

      71

      58. Hoover purchased sixteen thousand (16,000) shares of Phoenix stock on or about Monday, June 8, or Tuesday, June 9, 1981. (See stipulated fact No. 17, supra.)

      72

      59. G. Platt did not learn of Switzer's purchase or sale of Phoenix stock, or of the conversation Switzer had overheard, until on or about March 10 or 11, 1982. On or about March 10 or 11, 1982, Switzer called G. Platt at Platt's condominium in Snow Mass, Colorado, and asked to meet with him because Switzer said something he had inadvertently done would affect Platt. At [764] the time Switzer was also staying in Snow Mass, Colorado. During this meeting, Switzer told G. Platt, for the first time, that Switzer had been sitting behind G. Platt and his wife at the track meet on June 6, 1981, and had overheard G. Platt's conversation with his wife regarding Phoenix, and that as a result of that overheard conversation, Switzer and other friends of his had subsequently purchased and sold Phoenix stock. G. Platt had heard as early as February of 1982 that Phoenix was under investigation by the SEC. After hearing the facts from Switzer, G. Platt told Switzer it was essential that they meet with Robert Gist as soon as G. Platt returned to Oklahoma City.

      73

      60. On or about March 22, 1982, G. Platt, Switzer and Gist met at TIC's offices and Switzer again related the facts he had told G. Platt on or about March 10 or 11, 1982.

      74

      61. G. Platt did not share in the profits made through the transactions in Phoenix stock by Switzer, Kennedy, Deem, Smith, Hodges, Amyx and Hoover, nor did he receive any other financial benefit as a result of those transactions.

      75

      62. G. Platt did not receive any direct or indirect pecuniary gain nor any reputational benefit likely to translate into future earnings due to Switzer's inadvertent receipt of the information regarding Phoenix.

      76

      63. G. Platt did not make any gift to Switzer at this time, nor has he ever made a gift to Switzer.

      77

      64. Neither Switzer, Kennedy, Smith, Deem, Hodges, Amyx nor Hoover has ever been employed by or been an officer or director of Phoenix or TIC, nor have any of these defendants ever had any business relationship with Phoenix or with G. Platt personally. None of these defendants is a relative or personal friend of G. Platt.

      78

      65. None of the defendants had a relationship of trust and confidence with Phoenix, its shareholders or G. Platt.

      79

      66. In June, 1981, neither Switzer, Smith, Kennedy, Deem, Hodges, Amyx nor Hoover had any information from any source as to whether there was in fact any prospective purchaser of the stock or assets of Phoenix, nor whether a liquidation of the company would actually take place.

      80

      67. Smith, Hodges, Amyx, Kennedy, Deem and Hoover did not know nor did they act in reckless disregard of circumstances through which they could have had a reason to believe that the information received by Switzer came from other than an overheard conversation. None of these defendants knew or acted in reckless disregard of circumstances through which they could have had a reason to believe that the information they received was disclosed by an insider of Phoenix for an improper purpose.

      81
      Conclusions of Law
      82

      Based upon the foregoing findings of fact, the court makes the following conclusions of law.

      83

      1. The information that defendants Switzer, Smith, Hodges, Amyx, Hoover, Kennedy and Deem received concerning Phoenix was material as of June 6, 1981, the date of the track meet. On that date, there was a substantial likelihood that, given all the circumstances, and contingencies involved, the information as received by Switzer and communicated to Kennedy, Smith, Hodges, Amyx, Hoover and Deem would have assumed actual significance in the deliberations of a reasonable shareholder. See TSC Industries Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 2132, 48 L.Ed.2d 757 (1976).

      84

      2. To constitute material information, the information need not necessarily relate to a past or existing condition or event. It may refer to a prospective event, even though the event may not occur, provided there appears to be a reasonable likelihood of its future occurrence. In situations where the event, if it should occur, could influence the stockholders' investment decision, the chance that it might well occur constitutes information that should be disclosed to the investor. See Securities and Exchange Commission v. Texas [765] International Co., 498 F.Supp. 1231 (N.D. Ill.1980); Sonesta International Hotels Corp. v. Willington Associates, 483 F.2d 247 (2nd Cir.1973). In both Sonesta and Texas International, facts which referred to prospective and contingent events were deemed material because there appeared to be a reasonable likelihood of the occurrence of the future events. The existence of the decision to evaluate the liquidation of Phoenix, coupled with the affirmative steps of hiring Morgan Stanley as an investment banker, although based upon some contingencies, constituted material information as of June 6, 1981, the date of the track meet.

      85

      3. It is undisputed that G. Platt was an insider in regard to both TIC and Phoenix as of June 6, 1981.

      86

      4. Switzer, Kennedy, Deem, Smith, Hodges, Amyx and Hoover were not insiders of Phoenix. None of them had any fiduciary duty to the stockholders of TIC or Phoenix by virtue of their positions. None of them were employed by Phoenix, nor did they have any position of trust or confidence with Phoenix. These defendants were strangers to Phoenix and had no preexisting fiduciary duties to the shareholders of Phoenix. In its recent opinion of Dirks v. Securities Exchange Commission, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983), the United States Supreme Court addressed tippee liability. The court pointed out that, unlike insiders who have independent fiduciary duties to both the corporation and its shareholders, the typical tippee has no such fiduciary relationship. In view of the absence of this fiduciary relationship, the court notes it has been unclear how a tippee acquires the Cady, Roberts duty to disclose or refrain from trading on inside information first stated in In re Cady, Roberts & Co., 40 S.E.C. 907 (1961). Although the SEC, in Dirks, urged the court to accept what has become known as the "information" theory, which in essence states that anyone knowingly receiving non-public, material information acquires an insider fiduciary duty to disclose or abstain from trading, the court rejected this theory as they had in Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980). The court in Dirks stated: "We reaffirm today that `[a] duty [to disclose] arises from the relationship between parties ... and not merely from one's ability to acquire information because of his position in the market.'" Dirks, 103 S.Ct. at 3263, quoting from Chiarella v. United States, 445 U.S. at 232-33, n. 14, 100 S.Ct. at 1116 n. 14. The court further stated in Dirks: "As we emphasized in Chiarella, mere possession of non-public information does not give rise to a duty to disclose or abstain; only a specific relationship does that. And we do not believe that the mere receipt of information from an insider creates such a special relationship between the tippee and the corporation's shareholders." 103 S.Ct. at 3262, n. 15.

      87

      6. Essentially, in Dirks the court found that the Cady, Roberts duty of a tippee "to disclose or abstain" is derivative from that of the insider's duty. The court stated:

      88
      ... [S]ome tippees must assume an insider's duty to the shareholders not because they receive inside information, but rather because it has been made available to them improperly. And for Rule 10b-5 purposes, the insider's disclosure is improper only where it would violate his Cady, Roberts duty. Thus, a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach. As Commissioner Smith perceptively observed in Investors Management Co.: `[T]ippee responsibility must be related back to insider responsibility by a necessary finding that the tippee knew the information was given to him in breach of a duty by a person having a special relationship to the issuer not to disclose the information .... `44 S.E.C., at 651 (concurring in the result). Tipping thus properly is viewed only as a means of indirectly violating [766] the Cady, Roberts disclose-or-abstain rule.
      89

      Dirks v. S.E.C., 103 S.Ct. at 3264. (Emphasis in original, footnotes omitted.)

      90

      7. Thus, only when a disclosure is made for an "improper purpose" will such a "tip" constitute a breach of an insider's duty, and only when there has been a breach of an insider's duty which the "tipee" knew or should have known constituted such a breach will there be "tippee" liability sufficient to constitute a violation of § 10(b) and Commission Rule 10b-5.

      91

      8. In Dirks, the court held that a disclosure is made for an "improper purpose" when an insider personally will benefit, directly or indirectly, from his disclosure. That court stated: "Absent some personal gain, there has been no breach of duty to stockholders. And absent a breach by the insider [to his stockholders], there is no derivative breach [by the tippee]. Dirks, 103 S.Ct. at 3265.

      92

      9. G. Platt did not breach a fiduciary duty to stockholders of Phoenix for purposes of Rule 10b-5 liability nor § 10(b) liability, when he disclosed to his wife at the track meet of June 6, 1981, that there was going to be a possible liquidation of Phoenix.

      93

      10. This information was given to Mrs. Platt by G. Platt for the purpose of informing her of his up-coming business schedule so that arrangements for child care could be made.

      94

      11. The information was inadvertently overheard by Switzer at the track meet.

      95

      12. Rule 10b-5 does not bar trading on the basis of information inadvertently revealed by an insider.

      96

      13. The information was not intentionally imparted to Switzer by G. Platt, nor was the disclosure made for an improper purpose.

      97

      14. G. Platt did not personally benefit, directly or indirectly, monetarily or otherwise from the inadvertent disclosure.

      98

      15. As noted above, Dirks set forth a two-prong test for purposes of determining whether a tippee has acquired a fiduciary duty. First, it must be shown that an insider breached a fiduciary duty to the shareholders by disclosing inside information; and, second, it must be shown that the tippee knew or should have known that there had been a breach by the insider. Dirks, 103 S.Ct. at 3264.

      99

      16. G. Platt did not breach a duty to the shareholders of Phoenix, and thus plaintiff failed to meet its burden of proof as to the first prong established in Dirks. Since G. Platt did not breach a fiduciary duty to Phoenix shareholders, Switzer did not acquire nor assume a fiduciary duty to Phoenix's shareholders, and because Switzer did not acquire a fiduciary duty to Phoenix shareholders, any information he passed on to defendants Smith, Hodges, Amyx, Hoover, Kennedy and Deem was not in violation of Rule 10b-5.

      100

      17. Since plaintiff did not meet its burden of proof as to the first prong of the two-prong Dirks test, i.e., it was not proved that G. Platt breached a fiduciary duty to the shareholders of Phoenix, tippee liability cannot result from G. Platt's inadvertent disclosure to Switzer.

      101

      18. Even if, however, plaintiff had met the first prong of the two-part test, i.e., had proven that G. Platt did disclose material non-public information to Switzer at the track meet in an improper manner, the court would still find no resulting tippee liability to Switzer, Smith, Hodges, Amyx, Hoover, Kennedy and Deem because the court concludes plaintiff failed to prove the second prong of the Dirks test as well. These defendants did not know, nor did they have reason to know, that the information they received was material, nonpublic information disseminated by a corporate insider for an improper purpose, and, thus, under Dirks, are not liable as tippees under Rule 10b-5.

      102

      19. Defendants Switzer, Smith, Hodges, Amyx, Hoover, Kennedy and Deem have not been shown to have a propensity to engage in additional violations of Rule 10b-5 in the future. Hence, a permanent [767] injunction may not be entered against these defendants.

      103

      20. The SEC is not entitled to disgorgement of profits calculated on a pre-income tax basis in connection with transactions which occurred during previous tax years.

      104

      The foregoing shall constitute the findings of fact and conclusions of law of this court. Any findings of fact which may be construed as conclusions of law shall so be construed; in like manner, any conclusions of law which may be construed as findings of fact shall so be construed.

      105

      On the basis of the above findings of fact and conclusions of law, the court orders judgment in favor of defendants.

      106

      The court now turns to the motion for attorneys' fees pursuant to the Equal Access to Justice Act [hereinafter EAJA], 28 U.S.C. 2412 (1980). Defendants Switzer, Smith, Hoover, Kennedy and Hart have petitioned this court for an award of attorneys' fees and costs authorized pursuant to the EAJA. Defendants Hodges and Amyx have petitioned the court for a similar award, but have brought the petition on behalf of their investment partnership.

      107

      Section 2412(d)(1)(A) of the Act provides that a court "shall" award an eligible[1] private prevailing party attorneys' fees and other litigation expenses unless some other statute specifically provides otherwise,[2] or "the court finds that the position of the United States was substantially justified or that special circumstances make an award unjust."[3]

      108

      The EAJA permits the government, when it loses a case, to avoid liability for attorneys' fees if it can demonstrate that its litigation position was "substantially justified." See Spencer v. NLRB, 712 F.2d 539 (D.C.Cir.1983); United States v. 2,116 Boxes of Boned Beef, 726 F.2d 1481 (10th Cir.1984). The government bears the burden of demonstrating that its position was "substantially justified." Spencer, supra, 712 F.2d at 557; S & H Riggers & Erectors, Inc. v. OSHRC, 672 F.2d 426 (5th Cir.1982).

      109

      To meet the substantial justification standard, the government need only demonstrate its litigation position was reasonable. In 2,116 Boxes, supra, the court held that the government need not establish its decision to litigate was based on a substantial probability of prevailing, but only need "show that there is a reasonable basis in truth for the facts alleged in the pleadings; that there exists a reasonable basis in law for the theory it propounds; and that the facts alleged will reasonably support the legal theory advanced." 726 F.2d at 1487. See also Dougherty v. Lehman, 711 F.2d 555 (3rd Cir.1983).

      110

      The court believes plaintiff's theory or position taken at litigation had a reasonable basis in law. Plaintiff asserted that violations under 10b-5 resulted when inside information was made available or "tipped" [768] to outsiders who then traded on the improperly obtained inside information when the tip was made by an insider in breach of his fiduciary duty to the corporate shareholders, and the "tippee knew or should have known of the breach." Dirks, 103 S.Ct. 3264 (1983).

      111

      The court further finds plaintiff's litigation position had a reasonable basis in fact. At trial, the SEC proceeded to set forth its case, based on circumstantial evidence, that the material, non-public information regarding the possible liquidation of Phoenix made available to Switzer on June 6, 1981, at a track meet in Norman, Oklahoma, had been passed to him in an improper manner by G. Platt, an insider at Phoenix. Although Switzer claimed he had overheard the information, and neither G. Platt nor his wife, Linda, recalled discussing Phoenix at the track meet that day, the SEC presented strong circumstantial evidence in support of its theory.

      112

      Although the court found the testimony of G. Platt and Switzer to be more credible and probative than the circumstantial evidence presented by the government, the court does not find that the circumstantial evidence was so devoid of legal or factual support that a fee award would be appropriate. Simply because G. Platt and Switzer did not admit they had engaged in an improper exchange of inside information does not mean the SEC could have no reasonable basis in fact for believing there had been improper conduct and bringing an action so that a determination of that issue could be made.

      113

      In view of the considerable circumstantial evidence presented by the SEC that the tip was intentional and not merely inadvertent, as claimed by defendants, the court finds the SEC's position to have been substantially justified, and on that basis the court denies the application of defendants Switzer, Smith, Hoover, Deem and Kennedy, as well as Hodges and Amyx,[4] for attorneys' fees pursuant to 28 U.S.C. 2412(d)(1)(A).

      114

      Defendant Hart has also filed an application for an award of attorneys' fees under the EAJA. Hart was dismissed from the case on a motion for summary judgment. Although he was dismissed at the summary judgment stage, the court finds the SEC's position in naming him in the lawsuit was substantially justified and had a reasonable basis in both law and fact, and therefore, the court denies defendant Hart's application for attorneys' fees under the EAJA as well.

      115
      JAMES HART'S MOTION FOR ENTRY OF JUDGMENT
      116

      Defendant Hart was granted summary judgment in an opinion and order filed on May 20, 1983. He has now moved the court for entry of judgment and further requests that the date of entry of judgment be the same as the date judgment is entered for the defendants who participated in the trial to the court. Defendant Hart's motion for entry of judgment is hereby granted. Further, the date of entry of judgment shall be the same as the date judgment is entered for defendants Switzer, Smith, Hoover, Amyx, Hodges, Kennedy and Deem.

      117

      IT IS BY THE COURT THEREFORE ORDERED, based on the earlier stated findings of fact and conclusions of law, that judgment is hereby entered in favor of defendants regarding the court trial which commenced March 19, 1984, and concluded March 22, 1984.

      118

      IT IS FURTHER ORDERED that the motions of defendants Switzer, Smith, Hoover and Hart for award of attorneys' fees and expenses are hereby denied.

      119

      IT IS FURTHER ORDERED that the motion for attorneys' fees brought on behalf of the Hodges, Amyx, Cross and Hodges partnership is hereby denied.

      120

      IT IS FURTHER ORDERED that the motion for attorneys' fees brought on behalf [769] of defendant Kennedy is hereby denied.

      121

      IT IS FURTHER ORDERED that defendant James Hart's motion for entry of judgment is hereby granted in accordance with the Memorandum and Order of May 20, 1983. IT IS FURTHER ORDERED that the date of entry of judgment shall be the same as the date judgment is entered for defendants Switzer, Smith, Hoover, Amyx, Hodges, Kennedy and Deem.

      122

      [1] The government claims Hodges and Amyx have not demonstrated their financial eligibility because they have brought their application on behalf of their investment partnership and not as individual defendants. Since the court finds that plaintiff's position was substantially justified, it is unnecessary to address the financial eligibility issue raised by the government as to defendants Hodges and Amyx.

      123

      [2] The EAJA provides that costs may be awarded "except as otherwise specifically provided by statute." 28 U.S.C. 2412(a). Section 27 of the Securities Exchange Act of 1934 specifically precludes any award of costs against the Commission. Section 27 states: "No costs shall be assessed for or against the Commission in any proceeding under this title brought by or against it...."

      124

      Accordingly, the court concludes that any request contained in these motions for costs must be denied because such award is specifically prohibited by Section 27 of the Securities Exchange Act of 1934.

      125

      [3] In relevant part, 28 U.S.C. 2412(d)(1)(A) provides:

      126

      [A] court shall award to a prevailing party other than the United States fees and other expenses ... incurred by that party in any civil action (other than cases sounding in tort) brought by or against the United States in any court having jurisdiction of that action, unless the court finds that the position of the United States was substantially justified or that special circumstances make an award unjust.

      127

      [4] Again, the court denies the application of defendants' Hodges and Amyx, brought by them through their investment partnership, for attorneys fees on the sole basis that the government's litigation position was substantially justified.

    • 3.3 U.S. v. Chestman

      There are many situations in which it might be unreasonable for the court to seek evidence of a breach of fiduciary duty. For example, where a spouse learns inside information and trades on it. The courts and SEC have adapted in response to those situations.

      1
      947 F.2d 551 (1991)
      2
      UNITED STATES of America, Appellee,
      v.
      Robert CHESTMAN, Defendant-Appellant.
      3
      No. 309, Docket 89-1276.
      United States Court of Appeals, Second Circuit.
      4
      Argued November 9, 1990.
      5
      Decided October 7, 1991.
      6

      [554] Elkan Abramowitz, New York City (Alan J. Brudner, Barbara L. Hartung, Alan P. Williamson, Morvillo, Abramowitz & Grand, New York City, of counsel), for appellant.

      7

      David E. Brodsky, Asst. U.S. Atty., S.D.N.Y. (Roger S. Hayes, Acting U.S. Atty. for S.D.N.Y., Gerard E. Lynch, Asst. U.S. Atty., S.D.N.Y., New York City, of counsel), for appellee.

      8

      Paul Gonson, Sol., S.E.C., Washington, D.C. (James R. Doty, Gen. Counsel, Jacob H. Stillman, Associate Gen. Counsel, Richard A. Kirby, Sr. Litigation Counsel, Brian Bellardo, Sr. Sp. Counsel, Randall W. Quinn, Rada L. Potts, S.E.C., Washington, D.C., of counsel), for amicus curiae S.E.C.

      9

      Before OAKES, Chief Judge, FEINBERG,[*] MESKILL, NEWMAN, KEARSE, CARDAMONE, WINTER, PRATT, MINER, ALTIMARI, MAHONEY and McLAUGHLIN, Circuit Judges.

      10
      ON REHEARING IN BANC
      11
      MESKILL, Circuit Judge, joined by CARDAMONE, PRATT, MINER and ALTIMARI, Circuit Judges:
      12

      In this rehearing in banc, we consider for the first time the validity of Rule 14e-3(a), 17 C.F.R. § 240.14e-3(a), which was promulgated by the Securities and Exchange Commission (SEC) under section 14(e) of the 1934 Act, 15 U.S.C. § 78n(e); we then reexamine two familiar landmarks of the securities fraud landscape, section 10(b) of the Securities Exchange Act of 1934 (1934 Act), 15 U.S.C. § 78j(b), and the mail fraud statute, 18 U.S.C. § 1341. The issues spring from the alleged insider trading of defendant Robert Chestman. A jury found Chestman guilty of thirty-one counts of insider trading and perjury: (1) ten counts of fraudulent trading in connection with a tender offer in violation of section 14(e), 18 U.S.C. § 2, and Rule 14e-3(a),[1] (2) ten counts of securities fraud in violation of section 10(b), 18 U.S.C. § 2, and 17 C.F.R. § 240.10b-5 (1988) (Rule 10b-5), (3) ten counts of mail fraud in violation of the mail fraud statute and 18 U.S.C. § 2, and (4) one count of perjury in violation of 18 U.S.C. § 1621. A panel of this Court reversed Chestman's convictions in their entirety. 903 F.2d 75 (2d Cir.1990).

      13

      On in banc reconsideration, we conclude that the Rule 14e-3(a) convictions should be affirmed and that the Rule 10b-5 and mail fraud convictions should be reversed. We vacate the panel's decision on all three issues. We did not rehear the appeal from the perjury conviction and, as a result, the panel's reversal of that conviction stands.

      14
      [555] BACKGROUND
      15

      Robert Chestman is a stockbroker. Keith Loeb first sought Chestman's services in 1982, when Loeb decided to consolidate his and his wife's holdings in Waldbaum, Inc. (Waldbaum), a publicly traded company that owned a large supermarket chain. During their initial meeting, Loeb told Chestman that his wife was a grand-daughter of Julia Waldbaum, a member of the board of directors of Waldbaum and the wife of its founder. Julia Waldbaum also was the mother of Ira Waldbaum, the president and controlling shareholder of Waldbaum. From 1982 to 1986, Chestman executed several transactions involving Waldbaum restricted and common stock for Keith Loeb. To facilitate some of these trades, Loeb sent Chestman a copy of his wife's birth certificate, which indicated that his wife's mother was Shirley Waldbaum Witkin.

      16

      On November 21, 1986, Ira Waldbaum agreed to sell Waldbaum to the Great Atlantic and Pacific Tea Company (A & P). The resulting stock purchase agreement required Ira to tender a controlling block of Waldbaum shares to A & P at a price of $50 per share. Ira told three of his children, all employees of Waldbaum, about the pending sale two days later, admonishing them to keep the news quiet until a public announcement. He also told his sister, Shirley Witkin, and nephew, Robert Karin, about the sale, and offered to tender their shares along with his controlling block of shares to enable them to avoid the administrative difficulty of tendering after the public announcement. He cautioned them "that [the sale was] not to be discussed," that it was to remain confidential.

      17

      In spite of Ira's counsel, Shirley told her daughter, Susan Loeb, on November 24 that Ira was selling the company. Shirley warned Susan not to tell anyone except her husband, Keith Loeb, because disclosure could ruin the sale. The next day, Susan told her husband about the pending tender offer and cautioned him not to tell anyone because "it could possibly ruin the sale."

      18

      The following day, November 26, Keith Loeb telephoned Robert Chestman at 8:59 a.m. Unable to reach Chestman, Loeb left a message asking Chestman to call him "ASAP." According to Loeb, he later spoke with Chestman between 9:00 a.m. and 10:30 a.m. that morning and told Chestman that he had "some definite, some accurate information" that Waldbaum was about to be sold at a "substantially higher" price than its market value. Loeb asked Chestman several times what he thought Loeb should do. Chestman responded that he could not advise Loeb what to do "in a situation like this" and that Loeb would have to make up his own mind.

      19

      That morning Chestman executed several purchases of Waldbaum stock. At 9:49 a.m., he bought 3,000 shares for his own account at $24.65 per share. Between 11:31 a.m. and 12:35 p.m., he purchased an additional 8,000 shares for his clients' discretionary accounts at prices ranging from $25.75 to $26.00 per share. One of the discretionary accounts was the Loeb account, for which Chestman bought 1,000 shares.

      20

      Before the market closed at 4:00 p.m., Loeb claims that he telephoned Chestman a second time. During their conversation Loeb again pressed Chestman for advice. Chestman repeated that he could not advise Loeb "in a situation like this," but then said that, based on his research, Waldbaum was a "buy." Loeb subsequently ordered 1,000 shares of Waldbaum stock.

      21

      Chestman presented a different version of the day's events. Before the SEC and at trial, he claimed that he had purchased Waldbaum stock based on his own research. He stated that his purchases were consistent with previous purchases of Waldbaum stock and other retail food stocks and were supported by reports in trade publications as well as the unusually high trading volume of the stock on November 25. He denied having spoken to Loeb about Waldbaum stock on the day of the trades.

      22

      At the close of trading on November 26, the tender offer was publicly announced. Waldbaum stock rose to $49 per share the next business day. In December 1986 Loeb learned that the National Association [556] of Securities Dealers had started an investigation concerning transactions in Waldbaum stock. Loeb contacted Chestman who, according to Loeb, "reassured" him that Chestman had bought the stock for Loeb's account based on his research. Loeb called Chestman again in April 1987 after learning of an SEC investigation into the trading of Waldbaum stock. Chestman again stated that he bought the stock based on research. Similar conversations ensued. After one of these conversations, Chestman asked Loeb what his "position" was, Loeb replied, "I guess it's the same thing." Loeb subsequently agreed, however, to cooperate with the government. The terms of his cooperation agreement required that he disgorge the $25,000 profit from his purchase and sale of Waldbaum stock and pay a $25,000 fine.

      23

      A grand jury returned an indictment on July 20, 1988, charging Chestman with the following counts of insider trading and perjury: ten counts of fraudulent trading in connection with a tender offer in violation of Rule 14e-3(a), ten counts of securities fraud in violation of Rule 10b-5, ten counts of mail fraud, and one count of perjury in connection with his testimony before the SEC. The district court thereafter denied Chestman's motion to dismiss the indictment. 704 F.Supp. 451 (S.D.N.Y.1989). After a jury trial, Chestman was found guilty on all counts.

      24

      Chestman appealed. He claimed that Rule 14e-3(a) was invalid because the SEC had exceeded its statutory authority in promulgating a rule that dispensed with one of the common law elements of fraud. He also argued that there was insufficient evidence to sustain his Rule 10b-5, mail fraud and perjury convictions.

      25

      A panel of this Court reversed Chestman's convictions on all counts, issuing three separate opinions on the Rule 14e-3(a) charges. 903 F.2d 75 (2d Cir.1990). Familiarity with the panel's opinions is assumed.

      26

      A majority of the active judges of the Court voted to rehear in banc the panel's decision with respect to the Rule 14e-3(a), Rule 10b-5, and mail fraud convictions. We directed the parties to file additional briefs on these issues and heard oral argument on November 9, 1990.

      27
      DISCUSSION
      28
      A. Rule 14e-3(a)
      29

      Chestman challenges his Rule 14e-3(a) convictions on three grounds. He first contends that the SEC exceeded its rulemaking authority when it promulgated Rule 14e-3(a). He then argues that the government presented insufficient evidence to support these convictions. Finally, he contends that his convictions should be over-turned on due process notice grounds. We begin with his facial attack on the validity of Rule 14e-3(a).

      30
      1. Validity of Rule 14e-3(a)
      31

      Chestman's first challenge concerns the validity of a rule prescribed by the SEC pursuant to a congressional delegation of rulemaking authority. The question presented is whether Rule 14e-3(a) represents a proper exercise of the SEC's statutory authority. While we have not heretofore addressed this question, several district court judges in this Circuit have concluded that Rule 14e-3(a) represents a valid exercise of rulemaking authority. See United States v. Marcus Schloss & Co., Inc., 710 F.Supp. 944, 955-57 (S.D.N.Y.1989) (Haight, J.); U.S. v. Chestman, 704 F.Supp. 451, 454-58 (S.D.N.Y.1989) (Walker, J.). See also O'Connor & Assoc. v. Dean Witter Reynolds, Inc., 529 F.Supp. 1179, 1190-91 (S.D.N.Y.1981) (Lasker, J.) (rejecting contention that Rule 14e-3 exceeds the scope of section 14(e) because the rule covers transactions on the open market, and not just transactions between the tender offeror and a shareholder of a target company).

      32

      The enabling statutes for Rule 14e-3(a) are section 14(e) and section 23(a)(1) of the 1934 Act. Section 14(e) provides:

      33
      It shall be unlawful for any person to make any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements made, in the light of the circumstances [557] under which they are made, not misleading, or to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer or request or invitation for tenders, or any solicitation of security holders in opposition to or in favor of any such offer, request, or invitation. The Commission shall, for the purposes of this subsection, by rules and regulations define, and prescribe means reasonably designed to prevent, such acts and practices as are fraudulent, deceptive, or manipulative.
      34

      15 U.S.C. § 78n(e). The first sentence of section 14(e) is a self-operative provision, which Congress enacted as part of the Williams Act, Pub.L. No. 90-439, 82 Stat. 454 (1968). Congress added the second sentence, a rulemaking provision, in 1970. Section 23(a)(1), in turn, authorizes the SEC "to make such rules and regulations as may be necessary or appropriate to implement the provisions of this chapter for which [it is] responsible or for the execution of the functions vested in [it] by this chapter." 15 U.S.C. § 78w(a)(1).

      35

      Acting pursuant to the authority granted by sections 14(e) and 23(a)(1), the SEC promulgated Rule 14e-3 in 1980. Rule 14e-3(a), the subsection under which Chestman was convicted, provides:

      36

      If any person has taken a substantial step or steps to commence, or has commenced, a tender offer (the "offering person"), it shall constitute a fraudulent, deceptive or manipulative act or practice within the meaning of section 14(e) of the Act for any other person who is in possession of material information relating to such tender offer which information he knows or has reason to know is nonpublic and which he knows or has reason to know has been acquired directly or indirectly from:

      (1) The offering person,
      37
      (2) The issuer of the securities sought or to be sought by such tender offer, or
      38
      (3) Any officer, director, partner or employee or any other person acting on behalf of the offering person or such issuer, to purchase or sell or cause to be purchased or sold any of such securities or any securities convertible into or exchangeable for any such securities or any option or right to obtain or to dispose of any of the foregoing securities, unless within a reasonable time prior to any purchase or sale such information and its source are publicly disclosed by press release or otherwise.
      39

      17 C.F.R. § 240.14e-3(a).

      40

      One violates Rule 14e-3(a) if he trades on the basis of material nonpublic information concerning a pending tender offer that he knows or has reason to know has been acquired "directly or indirectly" from an insider of the offeror or issuer, or someone working on their behalf. Rule 14e-3(a) is a disclosure provision. It creates a duty in those traders who fall within its ambit to abstain or disclose, without regard to whether the trader owes a pre-existing fiduciary duty to respect the confidentiality of the information. Chestman claims that the SEC exceeded its authority in drafting Rule 14e-3(a) — more specifically, in drafting a rule that dispenses with one of the common law elements of fraud, breach of a fiduciary duty.

      41

      In reviewing this claim, our scope of review is limited. "If Congress has explicitly left a gap for the agency to fill, there is an express delegation of authority to the agency to elucidate a specific provision of the statute by regulation. Such legislative regulations are given controlling weight unless they are arbitrary, capricious, or manifestly contrary to the statute." Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 843-44, 104 S.Ct. 2778, 2781-83, 81 L.Ed.2d 694 (1984) (upholding the EPA's construction of the Clean Air Act term "stationary source"). When Congress delegates to an agency the power to promulgate rules,

      42
      the [agency] adopts regulations with legislative effect. A reviewing court is not free to set aside those regulations simply because it would have interpreted the statute in a different manner....
      43
      The [rule] is therefore entitled to more than mere deference or weight. It can be set aside only if the [agency] exceeded [558] [its] statutory authority or if the regulation is "arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law."
      44

      Batterton v. Francis, 432 U.S. 416, 425-26, 97 S.Ct. 2399, 2405-06, 53 L.Ed.2d 448 (1977) (internal citations omitted) (quoting 5 U.S.C. § 706(2)(A), (C)) (upholding the power of the Secretary of Health, Education and Welfare to prescribe "standards" for determining what constitutes "unemployment" for purposes of benefit eligibility). We thus will reject only those rules that are "`inconsistent with the statutory mandate or that frustrate the policy that Congress sought to implement.'" Securities Industry Ass'n v. Board of Governors, 468 U.S. 137, 143, 104 S.Ct. 2979, 2982, 82 L.Ed.2d 107 (1984) (quoting Federal Election Comm'n v. Democratic Senatorial Campaign Comm., 454 U.S. 27, 32, 102 S.Ct. 38, 42, 70 L.Ed.2d 23 (1981)). See also 2 K. Davis, Administrative Law Treatise § 7:8, at 37 (2d ed. 1979) (noting the deferential standard of review for "legislative rules"). Furthermore, we remain mindful that, in construing legislation, we must "`give effect, if possible, to every clause and word of a statute.'" United States v. Menasche, 348 U.S. 528, 538-39, 75 S.Ct. 513, 520, 99 L.Ed. 615 (1955) (quoting Montclair v. Ramsdell, 107 U.S. 147, 152, 2 S.Ct. 391, 395, 27 L.Ed. 431 (1882)). Keeping these principles in mind, we consider whether Congress authorized the SEC to enact Rule 14e-3(a).

      45

      The plain language of section 14(e) represents a broad delegation of rulemaking authority. The statute explicitly directs the SEC to "define" fraudulent practices and to "prescribe means reasonably designed to prevent" such practices. It is difficult to see how the power to "define" fraud could mean anything less than the power to "set forth the meaning of" fraud in the tender offer context. See Webster's Third New International Dictionary 592 (1971). This delegation of rulemaking responsibility becomes a hollow gesture if we cabin the SEC's rulemaking authority, as Chestman urges we should, by common law definitions of fraud. Under Chestman's construction of the statute, the separate grant of rulemaking power would be rendered superfluous because the SEC could never define as fraud anything not already prohibited by the self-operative provision. Such a narrow construction of the congressional grant of authority would cramp the SEC's ability to define fraud flexibly in the context of the discrete and highly sensitive area of tender offers. And such a delegation of "power," paradoxically, would allow the SEC to limit, but not extend, a trader's duty to disclose.

      46

      Even if we were to accept the argument that the SEC's definitional authority is circumscribed by common law fraud, which we do not, the SEC's power to "prescribe means reasonably designed to prevent" fraud extends the agency's rulemaking authority further. The language of this portion of section 14(e) is clear. The verb "prevent" has a plain meaning: "[T]o keep from happening or existing esp[ecially] by precautionary measures." Webster's New Third International Dictionary 1798 (1971). A delegation of authority to enact rules "reasonably designed to prevent" fraud, then, necessarily encompasses the power to proscribe conduct outside the purview of fraud, be it common law or SEC-defined fraud. Because the operative words of the statute, "define" and "prevent," have clear connotations, the language of the statute is sufficiently clear to be dispositive here. Chevron, 467 U.S. at 842-43, 104 S.Ct. at 2781-82. We note, however, other factors that bolster our interpretation.

      47

      Nothing in the legislative history of section 14(e) indicates that the SEC frustrated congressional intent by enacting Rule 14e-3(a). To the contrary, what legislative history there is suggests that Congress intended to grant broad rulemaking authority to the SEC in this instance.

      48

      As originally enacted, section 14(e) was part of the Williams Act. The Williams Act, the Supreme Court has concluded, was "a disclosure provision," Piper v. Chris-Craft Indus., Inc., 430 U.S. 1, 27, 97 S.Ct. 926, 942, 51 L.Ed.2d 124 (1977), whose "sole purpose ... was the protection of investors who are confronted with a tender [559] offer." Id. at 35, 97 S.Ct. at 946. Although the legislative history "specifically concerning § 14(e) is sparse," Schreiber v. Burlington Northern, Inc., 472 U.S. 1, 11, 105 S.Ct. 2458, 2464, 86 L.Ed.2d 1 (1985), the congressional reports indicate that section 14(e) was directed at ensuring "full disclosure" in connection with the trading of the securities of a tender offer target. Id. (quoting H.R.Rep. No. 1711, 90th Cong., 2nd Sess. 11 (1968); S.Rep. No. 550, 90th Cong., 1st Sess. 11 (1967) U.S.Code Cong. & Admin.News 1968, 2811) (emphasis supplied by Supreme Court). Analyzing the legislative history of section 14(e), the Schreiber Court explained:

      49
      Section 14(e) adds a "broad antifraud prohibition" modeled on the antifraud provisions of § 10(b) of the Act and Rule 10b-5.... It supplements the more precise disclosure provisions found elsewhere in the Williams Act, while requiring disclosure more explicitly addressed to the tender offer context than that required by § 10(b).
      50

      Id. at 10-11, 105 S.Ct. at 2463-64 (quoting Piper, 430 U.S. at 24, 97 S.Ct. at 940) (footnote omitted). The "very purpose of the [Williams] Act," we have said, was "informed decisionmaking by shareholders." Lewis v. McGraw, 619 F.2d 192, 195 (2d Cir.) (per curiam), cert. denied, 449 U.S. 951, 101 S.Ct. 354, 66 L.Ed.2d 214 (1980).

      51

      The legislative history of the 1970 amendment to section 14(e), the rulemaking provision, likewise suggests a broad grant of congressional authority. Senator Williams, the bill's sponsor, asserted the "utmost necessity" of granting "full rulemaking powers" to the SEC in the area of tender offers. 116 Cong.Rec. 3024 (Feb. 10, 1970). The amendment "would add to the Commission's rulemaking power," Senator Williams explained, "and enable it to deal promptly and ... flexib[ly]" with problems in that area. Hearings on S.3431 before the Subcom. on Securities of the Senate Comm. on Banking and Currency, 91st Cong., 2nd Sess. 2 (1970) [hereinafter S.3431 Hearings]; see also H.R.Rep. No. 1655, 91st Cong., 2nd Sess. 4, reprinted in 1970 U.S.Code Cong. & Admin.News 5025, 5028. During hearings on the 1970 Amendment, moreover, Senator Williams asked the SEC chairman for "examples of the fraudulent, deceptive, or manipulative practices used in tender offers which the proposed [SEC] rulemaking powers would prevent," noting that the information "would be most helpful to the committee as we continue developing this legislation." S. 3431 Hearings, at 11. Responding to the Senator's request, the SEC identified one such "problem" that the SEC's proposed rulemaking authority would be used to prevent:

      52
      The person who has become aware that a tender bid is to be made, or has reason to believe that such bid will be made, may fail to disclose material facts with respect thereto to persons who sell to him securities for which the tender bid is to be made.
      53

      Id. at 12. Notably, this hypothetical does not contain any requirement that the trader breach a fiduciary duty. All told, the legislative history indicates that Congress intended to grant broad rulemaking power to the SEC under section 14(e). This delegation of authority was aimed at promoting full disclosure in the tender offer context and, in so doing, contributing to informed decisionmaking by shareholders.

      54

      In promulgating Rule 14e-3(a), the SEC acted well within the letter and spirit of section 14(e). Recognizing the highly sensitive nature of tender offer information, its susceptibility to misuse, and the often difficult task of ferreting out and proving fraud, Congress sensibly delegated to the SEC broad authority to delineate a penumbra around the fuzzy subject of tender offer fraud. See generally Loewenstein, Section 14(e) of the Williams Act and the Rule 10b-5 Comparisons, 71 Geo.L.J. 1311, 1356 (1983) ("It is difficult to see why Congress would grant such broad powers to the SEC if the SEC was not expected to have some leeway in utilizing its powers."). To be certain, the SEC's rulemaking power under this broad grant of authority is not unlimited. The rule must still be "reasonably related to the purposes of the enabling legislation." Mourning v. Family Publications Service, Inc., 411 U.S. 356, 369, 93 [560] S.Ct. 1652, 1661, 36 L.Ed.2d 318 (1973) (quoting Thorpe v. Housing Authority of the City of Durham, 393 U.S. 268, 280-81, 89 S.Ct. 518, 525-26, 21 L.Ed.2d 474 (1969)). The SEC, however, in adopting Rule 14e-3(a), acted consistently with this authority. While dispensing with the subtle problems of proof associated with demonstrating fiduciary breach in the problematic area of tender offer insider trading, the Rule retains a close nexus between the prohibited conduct and the statutory aims.

      55

      Legislative activity since the SEC promulgated Rule 14e-3(a) further supports the Rule's validity. Congress acknowledged and left untouched the force of Rule 14e-3(a) when it enacted the Insider Trading Sanctions Act of 1984 (ITSA), 15 U.S.C. § 78u-1. ITSA imposes treble civil penalties on those who violate SEC rules "by purchasing or selling a security while in possession of material, nonpublic information," id. § 78u-1(a)(1), an activity covered by Rule 14e-3(a). Congress, in fact, was advised that a Rule 14e-3 violation would trigger treble damages under ITSA. See H.R.Rep. No. 355, 98th Cong., 1st Sess. 4, 11, 13 n. 20, reprinted in 1984 U.S.Code Cong. & Admin.News 2274, 2277, 2284, 2286 n. 20; see also H.R.Rep. No. 910, 100th Cong., 2nd Sess. 14, reprinted in 1988 U.S.Code Cong. & Admin.News 6043, 6051 (in enacting the Insider Trading and Securities Fraud Enforcement Act of 1988, Congress noted that Rule 14e-3 had triggered efforts by private securities firms "to detect insider trading and other market abuses by their employees").

      56

      These references to Rule 14e-3 during debates on proposed insider trading legislation may not amount to congressional ratification of the Rule, see Red Lion Broadcasting Co. v. FCC, 395 U.S. 367, 381-82, 89 S.Ct. 1794, 1801-03, 23 L.Ed.2d 371 (1969), but they do support the Rule's validity. Congressional silence in the face of administrative construction of a statute lends support to the validity of that interpretation. See United States v. Rutherford, 442 U.S. 544, 554 n. 10, 99 S.Ct. 2470, 2476 n. 10, 61 L.Ed.2d 68 (1979) ("once an agency's statutory construction has been `fully brought to the attention of the public and the Congress,' and the latter has not sought to alter that interpretation although it has amended the statute in other respects, then presumably the legislative intent has been correctly discerned") (citations omitted); Red Lion Broadcasting Co., 395 U.S. at 381, 89 S.Ct. at 1802; Zemel v. Rusk, 381 U.S. 1, 11, 85 S.Ct. 1271, 1278, 14 L.Ed.2d 179 (1965) ("Congress' failure to repeal or revise in the face of ... administrative interpretation has been held to constitute persuasive evidence that that interpretation is the one intended by Congress.").

      57

      In sum, the language and legislative history of section 14(e), as well as congressional inactivity toward it since the SEC promulgated Rule 14e-3(a), all support the view that Congress empowered the SEC to prescribe a rule that extends beyond the common law.

      58

      Chestman points to nothing in the language or legislative history of section 14(e) to refute our construction of the statute. Instead he relies principally on Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), and Schreiber, 472 U.S. 1, 105 S.Ct. 2458, to advance his argument that section 14(e) parallels common law fraud. That reliance is misplaced.

      59

      Chiarella considered whether trading stock on the basis of material nonpublic information in the absence of a fiduciary breach constitutes fraud under section 10(b). Confronted with both congressional and SEC silence on the issue, see section 10(b) and Rule 10b-5, the Court applied common law principles of fraud. It concluded, based on those principles, that liability under section 10(b) requires a fiduciary breach.

      60

      Several factors limit Chiarella's precedential value in this case. First, Chiarella of course concerns section 10(b), not section 14(e). Section 10(b) is a general antifraud statute, while section 14(e) is an antifraud provision specifically tailored to the field of tender offers, an area of the securities industry that, the Williams Act makes clear, deserves special regulation.

      61

      [561] Second, section 14(e) evinces a clear indication of congressional intent, while section 10(b) does not. See Chiarella, 445 U.S. at 226, 100 S.Ct. at 1113 ("neither the legislative history nor the statute itself affords specific guidance for the resolution of this case"). Section 10(b) speaks in terms of the use "in connection with the purchase or sale of any security" of "any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors." 15 U.S.C. § 78j(b). Section 14(e) directly proscribes, in self-operative fashion, "any fraudulent, deceptive, or manipulative acts or practices" in connection with a tender offer. Then, in a separate sentence, the statute directs the SEC to draft rules to define these practices and to prevent them: "The [SEC] shall, for the purposes of this subsection, by rules and regulations define, and prescribe means reasonably designed to prevent, such acts and practices as are fraudulent, deceptive, or manipulative." The contrast in statutory language is telling. It underscores, first of all, the dubious premise of Chestman's argument — that section 14(e) was modeled after section 10(b). The two provisions are hardly identical in scope. The language of section 14(e)'s rulemaking provision, instead of tracking section 10(b), in fact mirrors section 15(c)(2), 15 U.S.C. § 78o(c)(2), which concerns broker-dealer relations. "The language of the addition to section 14(e) is identical to that contained in section 15(c)(2) of the Securities Exchange Act concerning practices of brokers and dealers in securities transactions in the over-the-counter markets." H.R.Rep. No. 1655, 91st Cong., 2nd Sess. 4, reprinted in 1970 U.S.Code Cong. & Admin.News 5025, 5028. The contrast also illustrates that section 14(e) provides a more compelling legislative delegation to the SEC to prescribe rules than does section 10(b). While section 10(b) refers to such rules as the SEC "may prescribe as necessary or appropriate," section 14(e) commands the SEC to prescribe rules that will "define" and "prevent" fraud. See Loewenstein, supra, 71 Geo.L.J. at 1356 ("By comparison, the Commission's rulemaking authority under section 10(b) does not include the power to define manipulative or deceptive" acts or to adopt prophylatic measures.).

      62

      Indeed, in Chiarella, the Court even distinguished sections 10(b) and 14(e). The Court acknowledged that the SEC had recently acted pursuant to its rulemaking authority under section 14(e) to bar warehousing, a form of insider trading involving tender offers:

      63
      In this case, as in warehousing, a buyer of securities purchases stock in a target corporation on the basis of market information which is unknown to the seller. In both of these situations, the seller's behavior presumably would be altered if he had the nonpublic information. Significantly, however, the Commission has acted to bar warehousing under its authority to regulate tender offers [citing proposed Rule 14e-3] after recognizing that action under § 10(b) would rest on a "somewhat different theory" than that previously used to regulate insider trading as fraudulent activity.
      64

      Chiarella, 445 U.S. at 234, 100 S.Ct. at 1117-18 (footnotes omitted). That "somewhat different theory" is one that does not embrace "any fiduciary duty to [the target] company or its shareholders." 1 SEC Institutional Investor Study Report, H.R.Doc. No. 64, 92nd Cong. 1st Sess., pt. 1, at xxxii (1971) (cited in Chiarella, 445 U.S. at 234 n. 19, 100 S.Ct. at 1118 n. 19). Significantly, the Chiarella Court did not disapprove of this exercise of the SEC's rulemaking power under section 14(e).

      65

      Finally, Chiarella faced not only statutory silence on the issue before it but also administrative reticence. Neither the language of Rule 10b-5, SEC discussions of the rule, nor administrative interpretations of the rule offered any evidence that the SEC, in drafting Rule 10b-5, intended the rule to go beyond common law fraud. See Rule 10b-5 (referring to "artifice to defraud" and to "fraud ... upon any person"); see also Chiarella, 445 U.S. at 226, 100 S.Ct. at 1113 ("When Rule 10b-5 was promulgated in 1942, the SEC did not discuss [562] the possibility that failure to provide information might run afoul of § 10(b).") (footnote omitted); id. at 230, 100 S.Ct. at 1115; id. 445 U.S. at 233, 100 S.Ct. at 1117 ("neither the Congress nor the Commission ever has adopted a parity-of-information rule"). The language of Rule 14e-3(a), on the other hand, reveals express SEC intent to proscribe conduct not covered by common law fraud. And "[p]resumably the SEC perceived Rule 14e-3 as a valid exercise of its statutory authority." United States v. Marcus Schloss & Co., Inc., 710 F.Supp. 944, 956 (S.D.N.Y.1989).

      66

      Thus, the question presented here differs markedly from that presented in Chiarella. It is not whether section 14(e), standing alone, prohibits insider trading in the absence of a fiduciary breach. It is whether section 14(e)'s broad rulemaking provision, together with SEC action under that authority in the form of Rule 14e-3(a), represent a valid exercise of administrative rulemaking. In Chiarella, the Court refused to recognize "a general duty between all participants in market transactions to forgo actions based on material nonpublic information ... absent some explicit evidence of congressional intent." 445 U.S. at 233, 100 S.Ct. at 1117. Our task is easier. Rule 14e-3(a) creates a narrower duty than that once proposed for Rule 10b-5 — a parity of information rule — and, as the language and legislative history of section 14(e) make clear, the rule has Congress' blessing.

      67

      Equally unavailing is Chestman's reliance on Schreiber. The Schreiber case arose from a hostile tender offer initiated by Burlington Northern, Inc. for El Paso Gas Co. stock. After a majority of El Paso's shareholders subscribed to the tender offer, Burlington rescinded its offer, deciding to enter into a friendly takeover agreement with El Paso. Pursuant to its agreement with El Paso, Burlington substituted a new tender offer, which was soon oversubscribed. Several shareholders who had tendered their shares during the first tender offer received a diminished payment due to the oversubscription of the second tender offer. They claimed that Burlington's conduct violated section 14(e) as a "manipulative" distortion of the market for El Paso stock. Absent congressional guidance concerning the meaning of the term "manipulative," it fell to the Court to determine whether misrepresentation or nondisclosure is a necessary element of a violation of section 14(e). Schreiber, 472 U.S. at 6-8, 105 S.Ct. at 2461-62. The Court looked to the ordinary and common law meaning of the term, as well as the legislative history of section 14(e), with its focus on nondisclosure. Relying on these sources, the Court held that misrepresentation or nondisclosure was an indispensable element of a section 14(e) violation. Id. at 8, 105 S.Ct. at 2462.

      68

      Chestman claims that Schreiber demonstrates that section 14(e), like section 10(b), projects no further than common law fraud. To support this argument, he points to a statement in Schreiber indicating that section 14(e) is "modeled on the antifraud provisions of § 10(b)." Id. at 10, 105 S.Ct. at 2463. What Chestman ignores, however, is that Schreiber contrasted as well as compared the two statutes. Following the language Chestman quotes, the Court stated that section 14(e) "supplements" the other disclosure provisions in the Williams Act and requires "disclosure more explicitly addressed to the tender offer context than that required by § 10(b)." Id. at 10-11, 105 S.Ct. at 2464. In addition, the Court's reference to the similarity between sections 10(b) and 14(e) only refers to section 14(e)'s substantive provision. Section 10(b), as we have emphasized, lacks a separate rulemaking grant akin to section 14(e). Moreover, even to the extent section 10(b) may be accurately described as the father of section 14(e), as well as all later antifraud provisions under the 1934 Act, we cannot agree that section 10(b) therefore confines section 14(e), and its other antifraud progeny, to an identical reach.

      69

      Chestman also attempts to draw support from footnote 11 in Schreiber. There, in rejecting petitioner's argument that the 1970 amendment to section 14(e), the rulemaking provision, would be meaningless if section 14(e) concerned disclosure only, the Court observed:

      70
      [563] In adding the 1970 amendment, Congress simply provided a mechanism for defining and guarding against those acts and practices which involve material misrepresentation or nondisclosure. The amendment gives the [SEC] latitude to regulate nondeceptive activities as a "reasonably designed" means of preventing manipulative acts, without suggesting any change in the meaning of the term "manipulative" itself.
      71

      Id. at 11 n. 11, 105 S.Ct. at 2464 n. 11. Whatever may be gleaned from the footnote on the SEC's definitional authority under section 14(e), the footnote plainly endorses the SEC's authority to draft prophylactic rules under section 14(e). It states that the rulemaking provision "gives the [SEC] latitude to regulate nondeceptive activities as a `reasonably designed' means of preventing manipulative acts." Id. (emphasis added). Chestman offers no persuasive explanation why the authority "to regulate nondeceptive activities" would not also allow the SEC to regulate nonfraudulent conduct.

      72

      As for the SEC's authority to define the operative words of section 14(e), Schreiber seems to be saying only that section 14(e)'s rulemaking provision does not itself change the common law meaning of "manipulative." The Court was not confronted with the question raised here — whether SEC action pursuant to the rulemaking delegation exceeds statutory authority — because the petitioner did not point to any SEC rules drafted under section 14(e) that covered Burlington's activities. Moreover, even if we were to agree with Chestman that, under Schreiber, the common law confines the SEC in defining "manipulative," we would still uphold the validity of Rule 14e-3(a). In Schreiber, the definition of "manipulative" proffered by the plaintiff would have eliminated a requirement that there be a nondisclosure or material misrepresentation, the primary evils at which section 14(e) took aim. Rule 14e-3(a), in contrast, does not stray from congressional intent; it remains a disclosure provision.

      73

      Therefore, based on the plain language of section 14(e), and congressional activity both before section 14(e) was enacted and after Rule 14e-3(a) was promulgated, we hold that the SEC did not exceed its statutory authority in drafting Rule 14e-3(a).

      74
      2. Sufficiency of the Evidence
      75

      Chestman also argues that the evidence was insufficient to sustain his Rule 14e-3(a) convictions. In an argument raised for the first time in his in banc brief, Chestman contends that the government failed to present sufficient evidence to show that he knew that the information had been acquired "directly or indirectly" from the Waldbaum company, a Waldbaum company insider, or a person acting on the company's behalf. This argument merits only brief consideration.

      76

      The jury heard the following evidence. Chestman knew that Keith Loeb was a member of the Waldbaum family. Chestman knew that the information concerned the Waldbaum family business. He also knew that the information was not publicly available. Furthermore, he had heard Loeb describe the information as "definite" and "accurate." While more than one inference could be drawn from this evidence, the jury's conclusion was far from an irrational one. A jury could reasonably infer that Chestman knew that the information originated from a Waldbaum insider. We disagree with Chestman's intimation that Loeb had to describe the information to Chestman as "confidential." A description of the information as "definite" and "accurate," together with Chestman's knowledge that Loeb was a Waldbaum relative, provided the crucial basis from which to infer confidentiality. It was not necessary that Chestman be told the family channels through which the information had travelled. In sum, Chestman's knowledge of Loeb's status as a Waldbaum family member and the nature of the information conveyed provided sufficient evidence from which a rational trier of fact could infer that the information originated, "directly or indirectly," from a Waldbaum insider.

      77
      3. Due Process
      78

      Chestman next argues that his Rule 14e-3(a) convictions violate due process because [564] he did not have fair notice that his conduct was criminal. Given the explicit language of Rule 14e-3(a), we also reject this claim.

      79

      The purpose of the "fair notice" requirement of due process is "to give a person of ordinary intelligence fair notice that his contemplated conduct is forbidden by the statute." United States v. Harriss, 347 U.S. 612, 617, 74 S.Ct. 808, 812, 98 L.Ed. 989 (1954). That requirement was met here. As we have seen, Rule 14e-3(a) explicitly proscribes trading on the basis of material nonpublic information derived from insider sources. Unlike Rule 10b-5, Rule 14e-3(a) is not a general, catchall provision. It targets specific conduct arising in a unique context — tender offers. The language of the rule gave Chestman, a sophisticated stockbroker, fair notice that the conduct in which he engaged was criminal.

      80

      That leaves Chestman with the dubious argument that, while he had notice that Rule 14e-3(a) prohibited his activity, he could not have known whether a court would find the rule valid. Due process does not extend this far. When statutory language provides notice that conduct is illegal, the notice requirements of due process have been met. The government need not await every conceivable challenge to a law's validity before it prosecutes conduct covered by a statute. Chestman "treaded closely enough along proscribed lines ... to find that [he] had adequate notice of the illegality of [his] acts." United States v. Carpenter, 791 F.2d 1024, 1034 (2d Cir. 1986), aff'd, 484 U.S. 19, 108 S.Ct. 316, 98 L.Ed.2d 275 (1987).

      81
      B. Rule 10b-5
      82

      Chestman's Rule 10b-5 convictions were based on the misappropriation theory, which provides that "one who misappropriates nonpublic information in breach of a fiduciary duty and trades on that information to his own advantage violates Section 10(b) and Rule 10b-5." SEC v. Materia, 745 F.2d 197, 203 (2d Cir.1984), cert. denied, 471 U.S. 1053, 105 S.Ct. 2112, 85 L.Ed.2d 477 (1985). With respect to the shares Chestman purchased on behalf of Keith Loeb, Chestman was convicted of aiding and abetting Loeb's misappropriation of nonpublic information in breach of a duty Loeb owed to the Waldbaum family and to his wife Susan. As to the shares Chestman purchased for himself and his other clients, Chestman was convicted as a "tippee" of that same misappropriated information. Thus, while Chestman is the defendant in this case, the alleged misappropriator was Keith Loeb. The government agrees that Chestman's convictions cannot be sustained unless there was sufficient evidence to show that (1) Keith Loeb breached a duty owed to the Waldbaum family or Susan Loeb based on a fiduciary or similar relationship of trust and confidence, and (2) Chestman knew that Loeb had done so. We have heretofore never applied the misappropriation theory — and its predicate requirement of a fiduciary breach — in the context of family relationships. As a prologue to that analysis, we canvass past Rule 10b-5 jurisprudence.

      83

      Section 10(b) prohibits the use "in connection with the purchase or sale of any security ... [of] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe." 15 U.S.C. § 78j(b). Pursuant to that mandate, the SEC promulgated Rule 10b-5, which, in pertinent part, makes it unlawful "[t]o employ any device, scheme, or artifice to defraud" or "[t]o engage in any act ... which operates ... as a fraud or deceit upon any person, in connection with the purchase or sale of any security." 17 C.F.R. § 240.10b-5 (1988). While more than one interpretation has been given to this expansive language, fraud has remained the centerpiece of a Rule 10b-5 criminal violation. At this juncture, two general theories of Rule 10b-5 fraud have emerged to fill the interstitial gaps of the rule.

      84
      1. Traditional Theory of Rule 10b-5 Liability
      85

      The traditional theory of insider trader liability derives principally from the Supreme Court's holdings in Chiarella, 445 [565] U.S. 222, 100 S.Ct. 1108, and Dirks v. SEC, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983). A securities trader commits Rule 10b-5 fraud, the Chiarella Court held, only if he "fails to disclose material information prior to the consummation of a transaction ... when he is under a duty to do so." Chiarella, 445 U.S. at 228, 100 S.Ct. at 1114. The Chiarella Court then delineated when a person possessing material nonpublic information owes such a duty — what it called "[t]he obligation to disclose or abstain" from trading. Id. at 227, 100 S.Ct. at 1114. It held that this duty "does not arise from the mere possession of nonpublic market information." Id. at 235, 100 S.Ct. at 1118. That is, the duty inquiry does not turn on whether the parties to the transaction have "equal information." Dirks, 463 U.S. at 657, 103 S.Ct. at 3263 (construing Chiarella). Rather, a duty to disclose or abstain arises only from "`a fiduciary or other similar relation of trust and confidence between [the parties to the transaction].'" Chiarella, 445 U.S. at 228, 100 S.Ct. at 1114 (quoting Restatement (Second) of Torts § 551(2)(a) (1976)).

      86

      In Dirks, an action concerning the liability of a tippee of material nonpublic information, the Court built on its holding in Chiarella. Dirks again rejected a parity of information theory of Rule 10b-5 liability, reiterating the "requirement of a specific relationship between the shareholders and the individual trading on inside information." Dirks, 463 U.S. at 655, 103 S.Ct. at 3261. It then examined when a tippee inherits a fiduciary duty to the corporation's shareholders to disclose or refrain from trading. Noting the "derivative" nature of tippee liability, id. at 659, 103 S.Ct. at 3264, the Court held that tippee liability attaches only when an "insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach." Id. at 660, 103 S.Ct. at 3264.

      87

      Dirks established, in dictum, an additional means by which erstwhile outsiders become fiduciaries of a corporation's shareholders. Justice Powell explained:

      88
      Under certain circumstances, such as where corporate information is revealed legitimately to an underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders may become fiduciaries of the shareholders. The basis for recognizing this fiduciary duty is not simply that such persons acquired nonpublic corporate information, but rather that they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes.... For such a duty to be imposed, however, the corporation must expect the outsider to keep the disclosed nonpublic information confidential, and the relationship at least must imply such a duty.
      89

      Id. at 655 n. 14, 103 S.Ct. at 3262 n. 14 (citations omitted). This theory clothes an outsider with temporary insider status when the outsider obtains access to confidential information solely for corporate purposes in the context of "a special confidential relationship." The temporary insider thereby acquires a correlative fiduciary duty to the corporation's shareholders.

      90

      Binding these strands of Rule 10b-5 liability are two principles — one, the predicate act of fraud must be traceable to a breach of duty to the purchasers or sellers of securities,[2] two, a fiduciary duty does [566] not run to the purchasers or sellers solely as a result of one's possession of material nonpublic information.

      91
      2. Misappropriation Theory
      92

      The second general theory of Rule 10b-5 liability, the misappropriation theory, has not yet been the subject of a Supreme Court holding,[3] but has been adopted in the Second, Third, Seventh and Ninth Circuits. See, e.g., SEC v. Cherif, 933 F.2d 403 (7th Cir.1991); SEC v. Clark, 915 F.2d 439 (9th Cir.1990); Rothberg v. Rosenbloom, 771 F.2d 818 (3d Cir.1985), rev'd on other grounds after remand, 808 F.2d 252 (3d Cir.1986), cert. denied, 481 U.S. 1017, 107 S.Ct. 1895, 95 L.Ed.2d 501 (1987); United States v. Newman, 664 F.2d 12 (2d Cir. 1981), aff'd after remand, 722 F.2d 729 (2d Cir.1983), cert. denied, 464 U.S. 863, 104 S.Ct. 193, 78 L.Ed.2d 170 (1983). Under this theory, a person violates Rule 10b-5 when he misappropriates material nonpublic information in breach of a fiduciary duty or similar relationship of trust and confidence and uses that information in a securities transaction. See, e.g., Carpenter, 791 F.2d at 1028-29; Materia, 745 F.2d at 201; Newman, 664 F.2d at 17-18. In contrast to Chiarella and Dirks, the misappropriation theory does not require that the buyer or seller of securities be defrauded. Newman, 664 F.2d at 17. Focusing on the language "fraud or deceit upon any person" (emphasis added), we have held that the predicate act of fraud may be perpetrated on the source of the nonpublic information, even though the source may be unaffiliated with the buyer or seller of securities. See Carpenter, 791 F.2d at 1032. To date we have applied the theory only in the context of employment relationships. See Carpenter, 791 F.2d at 1032 (financial columnist breached duty to his newspaper); Materia, 745 F.2d at 202 (copyholder breached duty to his printing company); Newman, 664 F.2d at 17 (investment banker breached duty to his firm). District courts in this Circuit have applied the theory in other settings as well as in the employment context. See, e.g., United States v. Willis, 737 F.Supp. 269 (S.D.N.Y.1990) (denying motion to dismiss indictment of psychiatrist who traded on the basis of information obtained from patient, in breach of duty arising from relationship of trust and confidence); United States v. Reed, 601 F.Supp. 685 (S.D.N.Y.), rev'd on other grounds, 773 F.2d 477 (2d Cir.1985) (allegation that son breached fiduciary duty to father, a corporate director, withstood motion to dismiss indictment); SEC v. Musella, 578 F.Supp. 425 (S.D.N.Y.1984) (office services manager of law firm breached duty to law firm and its clients by trading on the basis of material nonpublic information acquired in the course of his employment).

      93

      One point at which the misappropriation theory and the traditional theory of insider trading merge warrants brief consideration. Our first applications of the misappropriation theory, in Newman and Materia, concerned conduct that occurred before the Supreme Court's holding in Dirks. Dirks noted that an outsider could obtain temporary insider status by gaining access to confidential information through certain relationships with a corporation — as, for example, an underwriter, lawyer or consultant. 463 U.S. at 655 n. 14, 103 S.Ct. at 3262 n. 14. A temporary insider theory of prosecution might well have covered the activities of the investment banker in Newman and the printer in Materia. In Newman and Materia, the defendants appeared to have "entered into a special confidential relationship in the conduct of the business of the enterprise and [were] given access to information solely for corporate purposes." Dirks, 463 U.S. at 655 n. 14, 103 S.Ct. at 3262 n. 14. In view of the [567] overlap between Newman and Materia on the one hand and the Dirks concept of temporary insiders on the other, we arguably did not break ranks with the traditional theory of insider trading until our holding in Carpenter. In Carpenter none of the prongs of liability under the traditional theory applied. That is, the defendants did not owe the people with whom they traded a duty to disclose or abstain from trading — absent resurrection of the twice-rejected parity of information theory. Carpenter, then, represents the first fact pattern we have considered that is clearly beyond the pale of the traditional theory of insider trading.

      94

      After Carpenter, the fiduciary relationship question takes on special importance. This is because a fraud-on-the-source theory of liability extends the focus of Rule 10b-5 beyond the confined sphere of fiduciary/shareholder relations to fiduciary breaches of any sort, a particularly broad expansion of 10b-5 liability if the add-on, a "similar relationship of trust and confidence," is construed liberally. One concern triggered by this broadened inquiry is that fiduciary duties are circumscribed with some clarity in the context of shareholder relations but lack definition in other contexts. See generally Reed, 601 F.Supp. 685 (and authorities cited therein). Tethered to the field of shareholder relations, fiduciary obligations arise within a narrow, principled sphere. The existence of fiduciary duties in other common law settings, however, is anything but clear. Our Rule 10b-5 precedents under the misappropriation theory, moreover, provide little guidance with respect to the question of fiduciary breach, because they involved egregious fiduciary breaches arising solely in the context of employer/employee associations. See Carpenter, 791 F.2d at 1028 ("It is clear that defendant Winans ... breached a duty of confidentiality to his employer"); Newman, 664 F.2d at 17 ("we need spend little time on the issue of fraud and deceit"); Materia, 745 F.2d at 201 (same). For these reasons we tread cautiously in extending the misappropriation theory to new relationships, lest our efforts to construe Rule 10b-5 lose method and predictability, taking over "the whole corporate universe." United States v. Chiarella, 588 F.2d 1358, 1377 (2d Cir.1978) (Meskill, J., dissenting) (quoting Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 480, 97 S.Ct. 1292, 1304, 51 L.Ed.2d 480 (1977)), rev'd, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980).

      95
      3. Fiduciary Duties and Their Functional Equivalent
      96

      Against this backdrop, we turn to our central inquiry — what constitutes a fiduciary or similar relationship of trust and confidence in the context of Rule 10b-5 criminal liability? We begin by noting two factors that do not themselves create the necessary relationship.

      97

      First, a fiduciary duty cannot be imposed unilaterally by entrusting a person with confidential information. Walton v. Morgan Stanley & Co., 623 F.2d 796, 799 (2d Cir.1980) (applying Delaware law). Walton concerned the conduct of an investment bank, Morgan Stanley. While investigating possible takeover targets for one of its clients, Morgan Stanley obtained unpublished material information (internal earnings reports) on a confidential basis from a prospective target, Olinkraft. After its client abandoned the planned takeover, Morgan Stanley was charged with trading in Olinkraft's stock on the basis of the confidential information. Observing that the parties had bargained at "arm's length" and that there had not been a preexisting agreement of confidentiality between Morgan Stanley and Olinkraft, we rejected the argument that

      98
      Morgan Stanley became a fiduciary of Olinkraft by virtue of the receipt of the confidential information.... [T]he fact that the information was confidential did nothing, in and of itself, to change the relationship between Morgan Stanley and Olinkraft's management. Put bluntly, although, according to the complaint, Olinkraft's management placed its confidence in Morgan Stanley not to disclose the information, Morgan Stanley owed no duty to observe that confidence.
      99

      Walton, 623 F.2d at 799. See also Dirks, 463 U.S. at 662 n. 22, 103 S.Ct. at 3265 n. 22 (citing Walton approvingly as "a case [568] turning on the court's determination that the disclosure did not impose any fiduciary duties on the recipient of the inside information"). Reposing confidential information in another, then, does not by itself create a fiduciary relationship.

      100

      Second, marriage does not, without more, create a fiduciary relationship. "`[M]ere kinship does not of itself establish a confidential relation.' ... Rather, the existence of a confidential relationship must be determined independently of a preexisting family relationship." Reed, 601 F.Supp. at 706 (quoting G.G. Bogert, The Law of Trusts and Trustees § 482, at 300-11 (Rev. 2d ed. 1978)) (other citations omitted). Although spouses certainly may by their conduct become fiduciaries, the marriage relationship alone does not impose fiduciary status. In sum, more than the gratuitous reposal of a secret to another who happens to be a family member is required to establish a fiduciary or similar relationship of trust and confidence.

      101

      We take our cues as to what is required to create the requisite relationship from the securities fraud precedents and the common law. See Chiarella, 445 U.S. at 227-30, 100 S.Ct. at 1114-16. The common law has recognized that some associations are inherently fiduciary. Counted among these hornbook fiduciary relations are those existing between attorney and client, executor and heir, guardian and ward, principal and agent, trustee and trust beneficiary, and senior corporate official and shareholder. Reed, 601 F.Supp. at 704 (citing Coffee, From Tort to Crime: Some Reflections on the Criminalization of Fiduciary Breaches and the Problematic Line Between Law and Ethics, 19 Am.Crim. L.Rev. 117, 150 (1981); and Scott, The Fiduciary Principle, 37 Cal.L.Rev. 539, 541 (1949)); Black's Law Dictionary 564 (5th ed. 1979). While this list is by no means exhaustive, it is clear that the relationships involved in this case — those between Keith and Susan Loeb and between Keith Loeb and the Waldbaum family — were not traditional fiduciary relationships.

      102

      That does not end our inquiry, however. The misappropriation theory requires us to consider not only whether there exists a fiduciary relationship but also whether there exists a "similar relationship of trust and confidence." As the term "similar" implies, a "relationship of trust and confidence" must share the essential characteristics of a fiduciary association. Absent reference to the adjective "similar," interpretation of a "relationship of trust and confidence" becomes an exercise in question begging. Consider: when one entrusts a secret (read confidence) to another, there then exists a relationship of trust and confidence. Walton, however, instructs that entrusting confidential information to another does not, without more, create the necessary relationship and its correlative duty to maintain the confidence. A "similar relationship of trust and confidence," therefore, must be the functional equivalent of a fiduciary relationship. To determine whether such a relationship exists, we must ascertain the characteristics of a fiduciary relationship.

      103

      "[A]t the heart of the fiduciary relationship" lies "reliance, and de facto control and dominance." United States v. Margiotta, 688 F.2d 108, 125 (2d Cir.1982) (citations omitted) (nonpublic office holder found to owe a fiduciary duty to general citizenry, breach of which created predicate for violation of mail fraud statute) (construing New York law), cert. denied, 461 U.S. 913, 103 S.Ct. 1891, 77 L.Ed.2d 282 (1983). The relation "exists when confidence is reposed on one side and there is resulting superiority and influence on the other." Mobil Oil Corp. v. Rubenfeld, 72 Misc.2d 392, 400, 339 N.Y.S.2d 623, 632 (Civ.Ct.1972) (discussing fiduciary duty in the franchisee context), aff'd, 77 Misc.2d 962, 357 N.Y.S.2d 589 (Sup.Ct.App.1974), rev'd on other grounds, 48 A.D.2d 428, 370 N.Y.S.2d 943 (2d Dep't 1975), aff'd, 40 N.Y.2d 936, 390 N.Y.S.2d 57, 358 N.E.2d 882 (1976)). One acts in a "fiduciary capacity" when

      104
      the business which he transacts, or the money or property which he handles, is not his own or for his own benefit, but for the benefit of another person, as to whom he stands in a relation implying [569] and necessitating great confidence and trust on the one part and a high degree of good faith on the other part.
      105

      Black's Law Dictionary 564 (5th ed. 1979). See also 29 U.S.C. § 1002(21)(A) (defining a fiduciary for purposes of ERISA as one "who exercises any discretionary authority or discretionary control").

      106

      A fiduciary relationship involves discretionary authority and dependency: One person depends on another — the fiduciary — to serve his interests. In relying on a fiduciary to act for his benefit, the beneficiary of the relation may entrust the fiduciary with custody over property of one sort or another. Because the fiduciary obtains access to this property to serve the ends of the fiduciary relationship, he becomes duty-bound not to appropriate the property for his own use. What has been said of an agent's duty of confidentiality applies with equal force to other fiduciary relations: "an agent is subject to a duty to the principal not to use or to communicate information confidentially given him by the principal or acquired by him during the course of or on account of his agency." Restatement (Second) of Agency § 395 (1958). These characteristics represent the measure of the paradigmatic fiduciary relationship. A similar relationship of trust and confidence consequently must share these qualities.

      107

      In Reed, 601 F.Supp. 685, the district court confronted the question whether these principal characteristics of a fiduciary relationship — dependency and influence — were necessary factual prerequisites to a similar relationship of trust and confidence. There a member of the board of directors of Amax, Gordon Reed, disclosed to his son on several occasions confidential information concerning a proposed tender offer for Amax. Allegedly relying on this information, the son purchased Amax stock call options. The son was subsequently indicted for violating, among other things, Rule 10b-5 based on breach of a fiduciary duty arising between the father and son. The son then moved to dismiss the indictment, contending that he did not breach a fiduciary duty to his father. The district court sustained the indictment.

      108

      Both the government and Chestman rely on Reed. The government draws on Reed's application of the misappropriation theory in the family context and its expansive construction of relationships of trust and confidence. Chestman, without challenging the holding in Reed, argues that Reed cannot sustain his Rule 10b-5 convictions because, unlike Reed senior and junior, Keith and Susan Loeb did not customarily repose confidential business information in one another. Neither party challenges the holding of Reed. And we decline to do so sua sponte. To remain consistent with our interpretation of a "similar relationship of trust and confidence," however, we limit Reed to its essential holding: the repeated disclosure of business secrets between family members may substitute for a factual finding of dependence and influence and thereby sustain a finding of the functional equivalent of a fiduciary relationship. We note, in this regard, that Reed repeatedly emphasized that the father and son "frequently discussed business affairs." Id. at 690; see also id. at 705, 709, 717-18.

      109

      We recognize, as Reed did, that equity has occasionally established a less rigorous threshold for a fiduciary-like relationship in order to right civil wrongs arising from non-compliance with the statute of frauds, statute of wills and parol evidence rule. See Bogert, supra § 482, at 286 (explaining that equity's flexible treatment of confidential relationships has been particularly useful in evading the harsh consequences of the statute of frauds). Commenting on the boundless nature of relations of trust and confidence, one scholar observed:

      110
      Equity has never bound itself by any hard and fast definition of the phrase "confidential relation" and has not listed all the necessary elements of such a relation, but has reserved discretion to apply the doctrine whenever it believes that a suitable occasion has arisen.
      111

      Reed, 601 F.Supp. at 712 n. 38 (quoting G.G. Bogert, The Law of Trusts and Trustees § 482, at 284-86 (Rev. 2d ed. 1978)). [570] Useful as such an elastic and expedient definition of confidential relations, i.e., relations of trust and confidence, may be in the civil context, it has no place in the criminal law. A "suitable occasion" test for determining the presence of criminal fraud would offend not only the rule of lenity but due process as well. See Chiarella, 445 U.S. at 235 n. 20, 100 S.Ct. at 1118 n. 20 ("a judicial holding that certain undefined activities `generally are prohibited' by § 10(b) would raise questions whether either criminal or civil defendants would be given fair notice that they have engaged in illegal activity"). See also Dirks, 463 U.S. at 658 n. 17, 103 S.Ct. at 3263 n. 17 (In rejecting an SEC variation on the parity of information theory, the Court wrote: "[T]his rule is inherently imprecise, and imprecision prevents parties from ordering their actions in accord with legal requirements."). More than a perfunctory nod at the rule of lenity, then, is required. We will not apply outer permutations of chancery relief in addressing what is frequently the core inquiry in a Rule 10b-5 criminal conviction — whether a fiduciary duty has been breached.

      112
      4. Application of the Law of Fiduciary Duties
      113

      The alleged misappropriator in this case was Keith Loeb. According to the government's theory of prosecution, Loeb breached a fiduciary duty to his wife Susan and the Waldbaum family when he disclosed to Robert Chestman information concerning a pending tender offer for Waldbaum stock. Chestman was convicted as an aider and abettor of the misappropriation and as a tippee of the misappropriated information. Convictions under both theories, the government concedes, required the government to establish two critical elements — Loeb breached a fiduciary duty to Susan Loeb or to the Waldbaum family and Chestman knew that Loeb had done so.

      114

      Chestman challenges the sufficiency of the evidence to establish each of these elements of the convictions. Although such a challenge carries a "heavy burden," United States v. Chang An-Lo, 851 F.2d 547, 553 (2d Cir.), cert. denied, 488 U.S. 966, 109 S.Ct. 493, 102 L.Ed.2d 530 (1988), that burden was carried here.

      115

      We have little trouble finding the evidence insufficient to establish a fiduciary relationship or its functional equivalent between Keith Loeb and the Waldbaum family. The government presented only two pieces of evidence on this point. The first was that Keith was an extended member of the Waldbaum family, specifically the family patriarch's (Ira Waldbaum's) "nephew-in-law." The second piece of evidence concerned Ira's discussions of the business with family members. "My children," Ira Waldbaum testified, "have always been involved with me and my family and they know we never speak about business outside of the family." His earlier testimony indicates that the "family" to which he referred were his "three children who were involved in the business."

      116

      Lending this evidence the reasonable inferences to which it is entitled, United States v. Zabare, 871 F.2d 282, 286 (2d Cir.), cert. denied, 493 U.S. 856, 110 S.Ct. 161, 107 L.Ed.2d 119 (1989), it falls short of establishing the relationship necessary for fiduciary obligations. Kinship alone does not create the necessary relationship. The government proffered nothing more to establish a fiduciary-like association. It did not show that Keith Loeb had been brought into the family's inner circle, whose members, it appears, discussed confidential business information either because they were kin or because they worked together with Ira Waldbaum. Keith was not an employee of Waldbaum and there was no showing that he participated in confidential communications regarding the business. The critical information was gratuitously communicated to him. The disclosure did not serve the interests of Ira Waldbaum, his children or the Waldbaum company. Nor was there any evidence that the alleged relationship was characterized by influence or reliance of any sort. Measured against the principles of fiduciary relations, the evidence does not support a finding that Keith Loeb and the [571] Waldbaum family shared either a fiduciary relation or its functional equivalent.

      117

      The government's theory that Keith breached a fiduciary duty of confidentiality to Susan suffers from similar defects. The evidence showed: Keith and Susan were married; Susan admonished Keith not to disclose that Waldbaum was the target of a tender offer; and the two had shared and maintained confidences in the past.

      118

      Keith's status as Susan's husband could not itself establish fiduciary status. Nor, absent a pre-existing fiduciary relation or an express agreement of confidentiality, could the coda — "Don't tell." That leaves the unremarkable testimony that Keith and Susan had shared and maintained generic confidences before. The jury was not told the nature of these past disclosures and therefore it could not reasonably find a relationship that inspired fiduciary, rather than normal marital, obligations.

      119

      In the absence of evidence of an explicit acceptance by Keith of a duty of confidentiality, the context of the disclosure takes on special import. While acceptance may be implied, it must be implied from a pre-existing fiduciary-like relationship between the parties. Here the government presented the jury with insufficient evidence from which to draw a rational inference of implied acceptance. Susan's disclosure of the information to Keith served no purpose, business or otherwise. The disclosure also was unprompted. Keith did not induce her to convey the information through misrepresentation or subterfuge. Superiority and reliance, moreover, did not mark this relationship either before or after the disclosure of the confidential information. Nor did Susan's dependence on Keith to act in her interests for some purpose inspire the disclosure. The government failed even to establish a pattern of sharing business confidences between the couple. The government, therefore, failed to offer sufficient evidence to establish the functional equivalent of a fiduciary relation.

      120

      In sum, because Keith owed neither Susan nor the Waldbaum family a fiduciary duty or its functional equivalent, he did not defraud them by disclosing news of the pending tender offer to Chestman. Absent a predicate act of fraud by Keith Loeb, the alleged misappropriator, Chestman could not be derivatively liable as Loeb's tippee or as an aider and abettor. Therefore, Chestman's Rule 10b-5 convictions must be reversed.

      121
      C. Mail Fraud
      122

      The fortunes of Chestman's mail fraud convictions are tied closely to his securities fraud convictions. "Chestman's mail fraud convictions," the government concedes, "were based on the same theory as his Rule 10b-5 convictions." The same fraudulent scheme that underlay the Rule 10b-5 convictions also was the basis for the mail fraud convictions. A scheme to misappropriate material nonpublic information in breach of a fiduciary duty of confidentiality may indeed constitute a fraudulent scheme sufficient to sustain a mail fraud conviction. See Carpenter, 484 U.S. at 27-28, 108 S.Ct. at 321-22; Newman, 664 F.2d at 19. However, whatever ethical obligation Loeb may have owed the Waldbaum family or Susan Loeb, it was too ethereal to be protected by either the securities or mail fraud statutes.

      123
      CONCLUSION
      124

      Accordingly, we affirm the Rule 14e-3(a) convictions and reverse the Rule 10b-5 and mail fraud convictions. The reversal of these convictions does not warrant reconsideration of the sentence since the sentences on the Rule 10b-5 and mail fraud convictions are concurrent with the sentences in the Rule 14(e)-3(a) counts. The panel's reversal of the perjury conviction remains intact.

      125
      WINTER, Circuit Judge (joined by OAKES, Chief Judge, NEWMAN, KEARSE, and McLAUGHLIN, Circuit Judges), concurring in part and dissenting in part:
      126

      I concur in the decision to affirm Chestman's convictions under Section 14(e) of the [572] Securities Exchange Act of 1934 ("'34 Act"), and under Rule 14e-3. I respectfully dissent, however, from the reversals of his convictions under Section 10(b) and under the mail fraud statute, 18 U.S.C. § 1341 (1988).

      127
      1) INSIDER TRADING
      128

      The difficulty this court finds in resolving the issues raised by this appeal stems largely from the history of the development of the law concerning insider trading. For that reason, I begin by tracing that history in somewhat tiresome fashion.

      129
      a) Statutory Law and Caselaw
      130

      The legal rules governing insider trading under Section 10(b) are based solely on administrative and judicial caselaw. This caselaw establishes that some trading on material nonpublic information is illegal and some is not. The line between the two is less than clear. Although Congress has enhanced the penalties for illegal insider trading, see Insider Trading Sanctions Act of 1984, Pub.L. No. 98-376, 98 Stat. 1264,[1] it has not defined the criteria by which legal insider trading is separated from illegal trading. And, although the Securities and Exchange Commission ("SEC") seems to take a somewhat more expansive view of what is illegal than the courts, see Complaint in SEC v. Phillip J. Stevens, No. 91 Civ. 1869 (S.D.N.Y. filed Mar. 19, 1991) (insider trading suit where sole allegation of benefit to insider was that selective leaking would enhance insider's reputation); see also Coffee, The SEC and the Securities Analyst, N.Y.L.J. May 30, 1991, at 5, col. 1, the SEC has, apart from Rule 14e-3, forgone the opportunity to use its rulemaking power to define what insider trading is.

      131

      Federal regulation of insider trading began with the passage of Section 16(b) of the '34 Act. 15 U.S.C. § 78p (1988). That provision regulates short-swing trading by insiders and requires that they disgorge any profits from such trading to the corporation. Until 1961, it constituted the sole federal regulation of insider trading. Section 16(b) regulates trading over a statutorily-defined six-month period without regard to the purpose of the trading or its basis in nonpublic information, id. § 78p(b) ("irrespective of any intention"), defines insider precisely as a holder of 10 percent of the corporation's shares ("directly or indirectly the beneficial owner of more than 10 per centum"), or as a director or an officer, id. § 78p(a), and provides a mechanical method of determining "profits" under which disgorgement is required even when the trades as a whole have resulted in losses, id. § 78p(b) ("any sale and purchase ... within any period of less than six months"); see Gratz v. Claughton, 187 F.2d 46, 50-52 (2d Cir.), cert. denied, 341 U.S. 920, 71 S.Ct. 741, 95 L.Ed. 1353 (1951). As a result, Section 16(b)'s enforcement by courts has led to no more, and perhaps fewer, problems of statutory interpretation than have resulted from any other provision of federal securities law.

      132

      The existence of Section 16(b), which indicates that Congress expressly addressed the issue, might well have led the SEC and the courts to conclude that Congress intended that Section 16(b) be the sole provision governing insider trading. No other provision explicitly addresses the problem, and Section 16(b) eliminates what is perhaps the most obvious danger inherent in insider trading, namely the creation of an incentive for directors or officers to make share price volatile in order to profit from short-swing trading.[2] Moreover, one might [573] have inferred from Section 16(b)'s mechanical approach, ignoring purpose and actual profit, that regulation of insider trading without legislative or regulatory guidelines would involve a mare's nest of analytic and definitional problems.

      133

      Nevertheless, in 1961 the SEC held that insider trading might also violate Section 10(b) of the '34 Act. See Cady, Roberts & Co., 40 SEC 907 (1961). Although Section 10(b) is familiar to any federal judge with a month of service, it is worth quoting its pertinent language:

      134
      It shall be unlawful for any person, directly or indirectly
      135
      * * * * * *
      136
      (b) To use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe....
      137

      15 U.S.C. § 78j (1988). The regulation promulgated by the SEC pertinent to the instant case is Rule 10b-5. That rule reads:

      138
      It shall be unlawful for any person, directly or indirectly ...
      139
      (a) To employ any device, scheme, or artifice to defraud,
      140
      (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
      141
      (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
      142
      in connection with the purchase or sale of any security.
      143

      17 C.F.R. § 240.10b-5 (1990).

      144

      Even the most fervent opponents of insider trading must concede that the language of Section 10(b) and Rule 10b-5 is at best a general authorization to the SEC and to the courts to fashion rules founded largely on those tribunals' judgments as to why insider trading is or is not fraudulent, deceptive or manipulative. That much was evident in Cady, Roberts & Co. itself, which was decided almost a generation after Section 10(b) had been passed and yet was without direct precedent. The grounds for the decision are also worth quoting in detail:

      145
      We have already noted that the antifraud provisions are phrased in terms of `any person' and that a special obligation has been traditionally required of corporate insiders, e.g., officers, directors and controlling stockholders. These three groups, however, do not exhaust the classes of persons upon whom there is such an obligation. Analytically, the obligation rests on two principal elements; first, the existence of a relationship giving access, directly or indirectly, to information intended to be available only for a corporate purpose and not for the personal benefit of anyone, and second, the inherent unfairness involved where a party takes advantage of such information knowing it is unavailable to those with whom he is dealing.... Thus our task here is to identify those persons who are in a special relationship with a company and privy to its internal affairs, and thereby suffer correlative duties in trading in its securities. Intimacy demands restraint lest the uninformed be exploited.
      146
      * * * * * *
      147
      We cannot accept respondents' contention that an insider's responsibility is limited to existing stockholders and that he has no special duties when sales of securities are made to non-stockholders. This approach is too narrow. It ignores the plight of the buying public — wholly unprotected from the misuse of special information.
      148
      ... Whatever distinctions may have existed at common law based on the view that an officer or director may stand in a fiduciary relationship to existing stockholders [574] from whom he purchases but not to members of the public to whom he sells, it is clearly not appropriate to introduce these into the broader anti-fraud concepts embodied in the securities acts.
      149
      Respondents further assert that they made no express representations and did not in any way manipulate the market, and urge that in a transaction on an exchange there is no further duty such as may be required in a `face-to-face' transaction. We reject this suggestion. It would be anomalous indeed if the protection afforded by the antifraud provisions were withdrawn from transactions effected on exchanges, primary markets for securities transactions. If purchasers on an exchange had available material information known by a selling insider, we may assume that their investment judgment would be affected and their decision whether to buy might accordingly be modified. Consequently, any sales by the insider must await disclosure of the information.
      150

      (footnotes omitted). Cady, Roberts & Co. thus adopted a rule against insider trading with two elements: (i) a trader's relationship giving special access to corporate information not intended for private use and (ii) the unfairness resulting from trading with those who lack the informational advantage afforded by that special access. Under the theory of Cady, Roberts & Co., the second element furnishes the fraud or deception that links the prohibition on insider trading to Section 10(b).

      151

      In SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir.1968), cert. denied, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969) ("TGS"), we adopted the dual element rule of Cady, Roberts & Co. We also noted, however, that Cady, Roberts & Co. — which involved a tippee who was a partner in a brokerage firm that employed a director, the tipper, of the corporation in question — had stated that Section 10(b)'s ban on insider trading applied to more than traditional insiders such as officers, directors and controlling stockholders. 401 F.2d at 848. We thus stated that "anyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it in order to protect a corporate confidence, or he chooses not to do so, must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed." Id. We stressed that Congress wanted investors to "be subject to identical market risks." Id. at 852. Section 10(b)'s ban on insider trading was thus designed to eliminate "inequities based upon unequal access to knowledge." Id.

      152

      TGS thus emphasized the second element in Cady, Roberts & Co., the perceived unfairness to those who trade with the insider. Although each trader in TGS probably had a relationship to the corporation with regard to the information in question sufficient to satisfy the first element of Cady, Roberts & Co., TGS suggested that possession of material, nonpublic information, however acquired, was sufficient by itself to trigger an obligation to disclose or abstain from trading.

      153

      In a subsequent decision, United States v. Chiarella, 588 F.2d 1358 (2d Cir.1978), rev'd, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), we affirmed the conviction of an employee of a printer who determined from coded takeover documents the identity of target corporations and thereafter purchased stock in those corporations. The basis for our decision tracked TGS, namely, the perceived unfairness of trading on information that is not generally available. We thus stated, "[a]nyone — corporate insider or not — who regularly receives material nonpublic information may not use that information to trade in securities without incurring an affirmative duty to disclose. And if he cannot disclose, he must abstain from buying or selling." 588 F.2d at 1365 (emphasis in original, footnote omitted). In a footnote to the quoted passage, we noted that Chiarella was legally disabled from disclosing because he owed a duty to his employer not to reveal confidential information belonging to the employer's clients. Id. at 1365 n. 9. Chiarella thus extended the ban on insider trading to "anyone," limited only by the phrase "regularly receives," and relegated the role of Cady, Roberts & Co.'s first element — a [575] relationship to the firm giving access to confidential corporate information — to eliminating the option of disclosure (and thus trading) by insiders.

      154

      Our rationale seemed overbroad to many, including the Solicitor General, whose task it was to defend the judgment we had affirmed. The brief filed in the Supreme Court on behalf of the government thus downplayed the fact that Chiarella had traded on information unavailable to others and instead relied upon the first reason given in Cady, Roberts & Co., namely, that Chiarella's trading was based on information that belonged to his employer's clients. See Brief for Government at 70-71 n. 48, Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980); Easterbrook, supra, at 314-15.

      155

      The Supreme Court reversed Chiarella. However, rather than making an ab initio determination of whether Section 10(b) prohibited insider trading, the Court described the state of the caselaw in the SEC and lower federal courts, including Cady, Roberts & Co. and TGS, and impliedly adopted that caselaw. 445 U.S. at 225-30, 100 S.Ct. at 1113-16. Notwithstanding its seeming adoption of that caselaw, the Court's opinion rejected the view that any trading on material nonpublic information triggered a duty to disclose. Id. at 231-35, 100 S.Ct. at 1116-18. It reasoned that fraud must be shown under Section 10(b) and that silence cannot constitute a fraud absent a duty to speak owed to those who are injured. Id. at 232-33, 100 S.Ct. at 1116-17. Because Chiarella had no prior dealings with those from whom he bought the stock, was not their agent, fiduciary or someone in whom they placed trust — as is true of all buyers and sellers trading on impersonal exchanges — Chiarella owed those from whom he purchased stock no duty to disclose before trading. Id. The Court declined to decide whether his conviction might be affirmed on the theory advanced by the Solicitor General that he had breached a duty to his employer's clients, the acquiring corporations, because the instructions to the jury did not include that theory. Id. at 235-36, 100 S.Ct. at 1118-19.

      156

      Although Chiarella's description of prior caselaw appeared to adopt Cady, Roberts & Co. and TGS, it cannot be reconciled with those decisions. By explicitly holding that Chiarella's access to material nonpublic information did not create a duty on Chiarella's part to those from whom he purchased stock of the target corporations, Chiarella is inconsistent with Cady, Roberts & Co., which explicitly found a duty to those with whom the trader dealt even when the trade was made on an impersonal exchange. 40 S.E.C. at 912-13. Moreover, Chiarella stated that even if the informational edge insiders have over those with whom they trade is unfair, that advantage was not fraud under Section 10(b). 445 U.S. at 232, 100 S.Ct. at 1116-17.

      157

      The Chiarella opinion is thus an enigma. It appears to state that Section 10(b) bars some kinds of insider trading. However, it rejects the element of Cady, Roberts & Co. that provided the fraud or deception linking the conduct to the provisions of Section 10(b).

      158

      Matters were clarified a tad in Dirks v. SEC, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983). Dirks had learned from employees of Equity Funding that the corporation had systematically and fraudulently overstated its assets. Id. at 649, 103 S.Ct. at 3258-59. Dirks informed his clients and the Wall Street Journal as well. His clients, who could sell their Equity Funding shares without risking a libel action, acted on Dirks' information while the Journal did not. Id. at 649-50, 103 S.Ct. at 3258-59. The SEC commenced a proceeding against Dirks on the ground that he had illegally aided and abetted insider trading by informing his clients of the material nonpublic information that Equity Funding was a fraud. The Supreme Court disagreed.

      159

      In the Court's view, a tippee such as Dirks may be liable under Section 10(b) if the tipper breaches a fiduciary obligation by transmitting the material nonpublic information to the tippee. Id. at 661-64, 103 S.Ct. at 3265-66. Whether the tip breaches such a fiduciary obligation depends upon [576] whether the tipper "receives a direct or indirect personal benefit from the disclosure, such as a pecuniary gain or a reputational benefit that will translate into future earnings." Id. at 663, 103 S.Ct. at 3266. "The elements of fiduciary duty and exploitation of nonpublic information also exist when an insider makes a gift of confidential information to a trading relative or friend. The tip and trade resemble trading by the insider himself followed by a gift of profits to the recipient." Id. at 664, 103 S.Ct. at 3266.

      160

      However, the Court concluded that Dirks owed no duty to Equity Funding, its shareholders, or, under Chiarella, to those who purchased stock from his clients. Id. at 665, 103 S.Ct. at 3267. Moreover, it also held that the employees of Equity Funding who had provided information to Dirks breached no duty to Equity Funding or its shareholders. Id. at 666, 103 S.Ct. at 3267. The Court noted that the employees neither had received a benefit from their disclosure to Dirks nor had intended to make a gift of such information to Dirks. Id. at 667, 103 S.Ct. at 3268. Instead, they were motivated soley by a desire to expose fraud. Id. It also noted that their action prevented the fraud from continuing and injuring yet new victims. Id. at 666, n. 27, 103 S.Ct. at 3267, n. 27.

      161

      Apart from the 4-4 vote in Carpenter v. United States, 484 U.S. 19, 108 S.Ct. 316, 98 L.Ed.2d 275 (1987), regarding the so-called misappropriation theory, Supreme Court caselaw regarding insider trading under Section 10(b) stops with Dirks. Omitted from the Court's opinions is a statement of the reasons why Section 10(b) prohibits the kind of trading the Court has declared to be illegal. Having rejected the Cady, Roberts & Co. theory of fraud or deception in the superiority of information available to the inside trader and a resultant duty in the trader to the persons with whom trading occurs, the Court's decisions have severed the link to Section 10(b) perceived in prior caselaw. While Dirks has established a rule concerning the insider's breach of an obligation to the corporation whose shares are traded, the Court's rationale is obscure, and, as a result, so is the scope of the rule.

      162

      Notwithstanding the ambiguities surrounding Section 10(b)'s impact on insider trading — including its very definition — Congress has increased the penalties for violations of that prohibition. See Insider Trading Sanctions Act of 1984, Pub.L. No. 98-376, 98 Stat. 1264. The SEC in turn has failed to promulgate rules outside the area of tender offers but its decisions have continued to march, in the eyes of one commentator, to the beat of its own drummer. See Coffee, supra, at 5., col. 1 ("in Stevens ... the SEC has announced a theory that trivializes Dirks").

      163

      It is hardly surprising that disagreement exists within an in banc court of appeals as to the import of present caselaw. Nor is it surprising that the lower courts have added to the Dirks breach of duty doctrine a misappropriation of information doctrine, which prohibits trading in securities based on material, nonpublic information acquired in violation of a duty to any owner of such information, whether or not the owner is the corporation whose shares are traded. See SEC v. Materia, 745 F.2d 197, 203 (2d Cir.1984) ("one who misappropriates [material] nonpublic information in breach of a fiduciary duty and trades on that information" violates Section 10(b) and Rule 10b-5); cert. denied, 471 U.S. 1053, 105 S.Ct. 2112, 85 L.Ed.2d 477 (1985); accord SEC v. Cherif, 933 F.2d 403, 408-10 (7th Cir.1991); SEC v. Clark, 915 F.2d 439, 443-49 (9th Cir.1990); Rothberg v. Rosenbloom, 771 F.2d 818, 822 (3d Cir.1985).

      164
      b) Property Rights in Inside Information
      165

      One commentator has attempted to explain the Supreme Court decisions in terms of the business-property rationale for banning insider trading mentioned in Cady, Roberts & Co. See Easterbrook, supra, at 309-39. That rationale may be summarized as follows. Information is perhaps the most precious commodity in commercial markets. It is expensive to produce, and, because it involves facts and ideas that can be easily photocopied or carried in one's head, there is a ubiquitous risk that those [577] who pay to produce information will see others reap the profit from it. Where the profit from an activity is likely to be diverted, investment in that activity will decline. If the law fails to protect property rights in commercial information, therefore, less will be invested in generating such information. Id. at 313.

      166

      For example, mining companies whose investments in geological surveys have revealed valuable deposits do not want word of the strike to get out until they have secured rights to the land.[3] If word does get out, the price of the land not only will go up, but other mining companies may also secure the rights. In either case, the mining company that invested in geological surveys (including the inevitably sizeable number of unsuccessful drillings) will see profits from that investment enjoyed by others. If mining companies are unable to keep the results of such surveys confidential, less will be invested in them.

      167

      Similarly, firms that invest money in generating information about other companies with a view to some form of combination will maintain secrecy about their efforts, and if secrecy cannot be maintained, less will be invested in acquiring such information. Hostile acquirers will want to keep such information secret lest the target mount defensive actions or speculators purchase the target's stock. Even when friendly negotiations with the other company are undertaken, the acquirer will often require the target corporation to maintain secrecy about negotiations, lest the very fact of negotiation tip off others on the important fact that the two firms think a combination might be valuable. See, e.g., Staffin v. Greenberg, 672 F.2d 1196, 1207 n. 12 (3d Cir.1982) ("If, as is often the case, a merger will benefit both the acquired company and its shareholders, an insider may be obliged to maintain strict confidentiality to avoid ruining the corporate opportunity through premature disclosure. Indeed, the record is clear in this case that [the buyer] very nearly withdrew from merger discussions upon hearing of [the seller's] ... press release."); Flamm v. Eberstadt, 814 F.2d 1169, 1174-79 (7th Cir.) ("[P]otential acquires ... may fear that premature disclosure may spark competition that will deprive them of part of the value of their effort, so that bids in a world of early disclosure will be lower than bids in a world of deferred disclosure."), cert. denied, 484 U.S. 853, 108 S.Ct. 157, 98 L.Ed.2d 112 (1987). In the instant matter, A & P made secrecy a condition of its acquisition of Waldbaum's.

      168

      Insider trading may reduce the return on information in two ways. First, it creates incentives for insiders to generate or disclose information that may disregard the welfare of the corporation. Easterbrook, supra, at 332-33. That risk is not implicated by the facts in the present case, and no further discussion is presently required.

      169

      Second, insider trading creates a risk that information will be prematurely disclosed by such trading, and the corporation will lose part or all of its property in that information. Id. at 331. Although trades by an insider may rarely affect market price, others who know of the insider's trading may notice that a trader is unusually successful, or simply perceive unusual activity in a stock and guess the information and/or make piggyback trades.[4] Id. at 336. A broker who executes a trade for a geologist or for a financial printer may well draw relevant conclusions. Or, as in the instant matter, the trader, Loeb, may tell his or her broker about the inside information, who may then trade on his or her account, on clients' accounts, or may tell [578] friends and relatives. One inside trader has publicly attributed his exposure in part to the fact that the bank through which he made trades piggybacked on the trades, as did the broker who made the trades for the bank. See Levine, The Inside Story of An Inside Trader, Fortune, May 21, 1990, at 80. Once activity in a stock reaches an unusual stage, others may guess the reason for the trading — the corporate secret. Insider trading thus increases the risk that confidential information acquired at a cost may be disclosed. If so, the owner of the information may lose its investment.

      170

      This analysis provides a policy rationale for prohibiting insider trading when the property rights of a corporation in information are violated by traders. However, the rationale stops well short of prohibiting all trading on material nonpublic information. Efficient capital markets depend on the protection of property rights in information. However, they also require that persons who acquire and act on information about companies be able to profit from the information they generate so long as the method by which the information is acquired does not amount to a form of theft. A rule commanding equal access would result in a securities market governed by relative degrees of ignorance because the profit motive for independently generating information about companies would be substantially diminished. Easterbrook, supra, at 313-14. Under such circumstances, the pricing of securities would be less accurate than in circumstances in which the production of information is encouraged by legal protection.

      171

      One may speculate that it was for these reasons that the Supreme Court declined in Chiarella to adopt a broad ban on trading on material nonpublic information[5] and then imposed in Dirks a breach of fiduciary duty requirement — not running to those with whom the trader buys or sells. Under the Dirks rule, insider trading is illegal only where the trader has received the information as a result of the trader's or tipper's breach of a duty to keep information confidential.

      172

      The misappropriation theory adopted by several circuits fits within this rationale. Misappropriation also involves the misuse of confidential information in a way that risks making information public in a fashion similar to trading by corporate insiders. In U.S. v. Carpenter, 791 F.2d 1024 (2d Cir.1986), aff'd, 484 U.S. 19, 108 S.Ct. 316, 98 L.Ed.2d 275 (1987), for example, where the information belonged to the Wall Street Journal rather than to the corporations whose shares were traded, the misuse of information created an incentive on the part of the traders to create false information that might affect the efficiency of the market's pricing of the corporations' stock. Moreover, the potential for piggybacking would add to that inefficiency.

      173

      It must be noted, however, that, although the rationale set out above provides a policy for prohibiting a specific kind of insider trading, any obvious relationship to Section 10(b) is presently missing because theft rather than fraud or deceit, seems the gravamen of the prohibition. Indeed, Carpenter analogized the conduct there to embezzlement. 791 F.2d at 1033 n. 11. Nevertheless, the law is far enough down this road — indeed, the Insider Trading Sanctions Act seems premised on Section 10(b)'s applicability — that a court of appeals has no option but to continue the route.

      174
      [579] c) The Instant Case
      175

      When this analysis is applied to a family-controlled corporation such as that involved in the instant case, I believe that family members who have benefitted from the family's control of the corporation are under a duty not to disclose confidential corporate information that comes to them in the ordinary course of family affairs. In the case of family-controlled corporations, family and business affairs are necessarily intertwined, and it is inevitable that from time to time normal familial interactions will lead to the revelation of confidential corporate matters to various family members. Indeed, the very nature of familial relationships may cause the disclosure of corporate matters to avoid misunderstandings among family members or suggestions that a family member is unworthy of trust.

      176

      Keith Loeb learned of the pending acquisition of Waldbaum's by A & P through precisely such interactions. His wife Susan was asked one day by her sister to take carpool responsibilities for their children. When Susan inquired as to why this was necessary, the sister was vague and said that she had to take their mother somewhere. After further inquiry, the sister flatly declined to tell Susan what was going on. Susan did not say, "Gee, confidential corporate information must be involved, and I have no right to such information." Instead, concerned about her mother's ongoing health problems, Susan made direct inquiry of her mother, who revealed that Susan's sister took her to get stock certificates to give to Ira Waldbaum for the initial phase of the A & P acquisition. The mother swore Susan to secrecy, telling Susan that the acquisition would be very profitable to the family and premature disclosure could ruin the deal. Susan then asked whether she could tell her husband Keith. Instead of saying, "No, Keith may be your husband but you are to button your lips in his presence," her mother assented but warned against disclosure to anyone else.

      177

      Susan and Keith Loeb jointly owned a large number of Waldbaum shares at that time, all of which had been a gift from her mother. The Loebs' children also owned shares received as a gift from their grandmother. Susan told Keith about the A & P acquisition in the course of discussing the financial benefits they and their children would receive as a result of that transaction. She stressed the need for absolute secrecy. Susan testified that she and her husband had shared confidences in the past and that on each such occasion they had indicated to each other that the confidences would be respected. Thereafter, Keith Loeb informed Chestman about the A & P acquisition in the hope of making a profit.

      178

      I have little difficulty in concluding that Chestman's convictions can be affirmed on either the Dirks rule or on a misappropriation theory. The disclosure of information concerning the A & P acquisition among Ira Waldbaum's extended family was the result of ordinary familial interactions that can be expected in the case of family-controlled corporations. Members of a family who receive such information are placed in a position in which their trading on the information risks financial injury to the corporation, its public shareholders and other family members. When members of a family have benefitted from the family's control of a corporation and are in a position to acquire such information in the ordinary course of family interactions, that position carries with it a duty not to disclose. The family relationship gives such members access to confidential information, not so that they can trade on it but so that informal family relationships can be maintained. The purpose of allowing this access can hardly be fulfilled if there is no accompanying duty not to trade. Such a duty is of course based on mutual understandings among family members — quite explicit in this case — and owed to the family. However, the duty originates in the corporation and is ultimately intended to protect the corporation and its public shareholders. The duty is thus also owed to the corporation, to a degree sufficient in my view to trigger the Dirks rule. Because trading on inside information so acquired by family members amounts to theft, the misappropriation theory also applies.

      179

      [580] Under my colleagues' theory, the disclosure of family corporate information can be avoided only by family members extracting formal, express promises of confidentiality or by elderly mothers in poor health refusing to tell their daughters about mysterious travels. If disclosure is made, daughters may not disclose their mother's doings or potential financial benefits to the daughters' husbands without a formal, express promise of confidentiality. If, for example, Susan had earlier shared with Keith her concerns about her mother's mysterious travels before learning of their purpose, she would not have been able to tell him what she later learned about those travels no matter how persistently he asked. For my colleagues in the majority, the critical gap in the government's case was that Susan did not testify either that on this occasion Keith agreed not to disclose the pending acquisition by A & P or that prior confidential communications between her and her husband had involved the Waldbaum's corporation.

      180

      I have no lack of sympathy with my colleagues' concern about the difficulty of drawing lines in this area. Nevertheless, the line they draw seems very unrealistic in that it expects family members to behave like strangers toward each other. It also leads to the perverse and circular result that where family business interests are concerned, family members must act as if there are no mutual obligations of trust and confidence because the law does not recognize such obligations. Under such a regime, parents and children must conceal their comings and goings, family members must cease to speak when a son-in-law enters a room, and offended members of the family must understand that such conduct is always related only to business.

      181

      The law may have been reluctant to recognize obligations based solely on family relationships. However, the failure to recognize these commonly observed obligations as legal obligations is in large part derived from a concern that intra-family litigation would exacerbate strained relationships and weaken rather than strengthen the sense of mutual obligation underlying family relationships. See, e.g., Kilgrow v. Kilgrow, 268 Ala. 475, 107 So.2d 885 (1958) (judicial intervention in family affairs more likely to serve as "spark to a smoldering fire" than to prevent disruption); McGuire v. McGuire, 157 Neb. 226, 59 N.W.2d 336 (1953) (no action for maintenance and support where married couple living together).

      182

      This concern, however, is of no weight where insider trading is concerned. In such cases, the litigation is almost universally brought by the government or third party. Moreover, where the family connection to the corporation has benefitted the trader, the relationship is commercial as well as familial, and disclosure is potentially injurious to the corporation and public shareholders as well as other members of the family.

      183

      I thus believe that a family member (i) who has received or expects (e.g., through inheritance) benefits from family control of a corporation, here gifts of stock, (ii) who is in a position to learn confidential corporate information through ordinary family interactions, and (iii) who knows that under the circumstances both the corporation and the family desire confidentiality, has a duty not to use information so obtained for personal profit where the use risks disclosure. The receipt or expectation of benefits increases the interest of such family members in corporate affairs and thus increases the chance that they will learn confidential information. Disclosure in the present case occurred in the course of a discussion that included, inter alia, an examination of the benefits of the A & P acquisition to Susan, Keith and their children. Susan's warning to Keith about secrecy was clearly intended to protect the corporation as well as the family and clearly had originated with Ira Waldbaum. In such circumstances, Susan's saying "Don't tell" is enough for me. Not to have such a rule means that a family-controlled corporation with public shareholders is subject to greater risk of disclosure of confidential information than is a corporation that is entirely publicly owned.

      184

      I see no room for argument over whether there was sufficient evidence for the [581] jury to find that Chestman knew Keith Loeb was violating an obligation. The record fairly brims with Chestman's consciousness that Keith Loeb was behaving improperly. Loeb's initial message asked for a return call "asap." When they spoke, Loeb told Chestman that he, Loeb, had some "definite, some accurate information" that Waldbaum's was about to be sold at a price substantially greater than that at which it was trading. Chestman had been a broker for fourteen years, and the jury would have little trouble finding that he knew that, if word of the A & P acquisition had not already gotten out, profiting from purchases of Waldbaum's stock was as close to a sure thing as there can be in the securities market. Instead of telling Loeb to buy, however, Chestman said that he could not tell him what to do "in a situation like this" and told Loeb to make up his own mind. Clearly, Chestman's and Loeb's concerns were not about the commercial wisdom, but rather about the propriety, of Loeb's trading on the "definite" and "accurate" information. Indeed, Loeb did not give Chestman an order to buy Waldbaum's shares, and their conversation ended on an inconclusive note.

      185

      The only explanation for Chestman's and Loeb's failing to agree upon the entirely obvious course of buying Waldbaum's stock was their consciousness that Loeb's trading would be improper. This conclusion is strengthened by Chestman's conduct thereafter. Having failed to advise Loeb to buy, Chestman sought information as to whether there was unusual activity in Waldbaum's stock, and, learning there was not, bought Waldbaum's stock for his and his clients' accounts, including Loeb's. Chestman's attempt at concealment when he recorded the purchases for all of his clients but Loeb further showed Chestman's knowledge that Loeb was acting improperly. The evidence was thus more than sufficient to show Chestman's knowledge that Loeb was breaching an obligation of non-disclosure.

      186
      2) RULE 14e-3
      187

      I have little difficulty in concurring in the affirmance of Chestman's conviction for violating Section 14(e) and Rule 14e-3. Although the rule lacks a specific reference to a duty not to disclose, the sources of information specified in that rule — "(1) The offering person, (2) The issuer ... or (3) Any officer, director, partner or employee or any other person acting on behalf of the offering person or such issuer" — all have such a duty under state law not to disclose nonpublic information concerning tender offers. Information relating to tender offers is always either notoriously public or a carefully guarded secret. The sources of information designated by the rule are necessarily under an obligation by reason of their very position not to disclose such nonpublic information. One who receives such information knowing the source can be held to know of a breach of duty. The rule is thus in the nature of a traditional prophylactic rule. Although the use of the word "indirectly" may lend itself to some extension down the line of tippees and tippers, it is sufficiently cabined to circumstances in which the defendant knows of the source. Chestman easily fits that definition.

      188
      3) MAIL FRAUD
      189

      With regard to appellant's convictions for mail fraud, my view that they should be affirmed follows from my discussion of the conviction for violations of Sections 10(b) and Rule 10b-5.

      190

      I would add a brief observation, however. I am unclear as to whether the breach of duty and the tippee's knowledge of that breach as required by Dirks is coextensive with the similar requirements in Carpenter. The Dirks rule is derived from securities law, and its limitation to information obtained through a breach of a fiduciary duty is, as noted, influenced by the need to allow persons to profit from generating information about firms so that the pricing of securities is efficient. The Carpenter rule, however, is derived from the law of theft or embezzlement, and a tippee's liability may be governed by rules concerning the possession of stolen property. Logic is therefore certainly not a barrier to the growth of disparate rules concerning a tippee's liability depending on whether [582] Section 10(b) or mail fraud is the source of law. However, because under any such disparity in rules the Section 10(b) charge would be harder to prove than a mail fraud charge, I need not explore the issue further.

      191
      MINER, Circuit Judge, concurring:
      192

      I concur in the comprehensive opinion of Judge Meskill, which I take to be wholly in accordance with the views I expressed in the original panel opinion as to all the issues before us. See United States v. Chestman, 903 F.2d 75 (2d Cir.1990). I write only to comment upon the "familial relationship" rule of insider trading proposed by Judge Winter in his partially dissenting opinion.

      193

      The rule urged upon us would impose a duty of nondisclosure upon "a family member (i) who has received or expects (e.g., through inheritance) benefits from family control of a corporation, here gifts of stock, (ii) who is in a position to learn confidential corporate information through ordinary family interactions, and (iii) who knows that under the circumstances both the corporation and the family desire confidentiality." At 580. The duty is said to consist of an obligation "not to use information so obtained for personal profit where the use risks disclosure." Id.

      194

      The rationale for the proposed rule apparently is rooted in the notion that family members would be encouraged to speak freely on all matters pertaining to the family, knowing that the lips of those who receive confidential corporate information in the course of ongoing family interchanges would be sealed. Thus, in this case, so the argument goes, Ira Waldbaum could reveal the pending stock sale to his sister, Shirley Witkin, who could reveal it to her daughter, Susan Loeb, who could reveal it to her husband, Keith Loeb, all with the understanding that a duty imposed by law on each family member would protect against use of the confidential information for profit. Without the rule, it is maintained, family members in this case would have been inhibited from discussing such matters as the reason for Shirley Witkin's unusual absence from her home, because such a discussion inevitably would lead to disclosure of the confidential information regarding the sale of Waldbaum stock to A & P.

      195

      It seems to me, however, that family discourse would be inhibited, rather than promoted, by a rule that would automatically assure confidentiality on the part of a family member receiving non-public corporate information. What speaker, secure in the knowledge that a relative could be prosecuted for insider trading, would reveal to that relative anything remotely connected with corporate dealings? Given the uncertainties surrounding the definition of insider trading, a term as yet unclarified by Congress, what family members would want to receive any information whatsoever that might bear on the family business? How could family news be disseminated freely in an atmosphere where the members must be ultra-sensitive to whether "both the corporation and the family" are seeking some measure of confidentiality "under the circumstances."

      196

      The difficulty of identifying those who would be covered by the proposed familial rule adds an additional element of uncertainty to what already are uncertain crimes. It is not clear just who would be subject to the duty of confidentiality: family members "who ha[ve] received or expect[] ... benefits from family control of a corporation" belong to a very broad category indeed. Here, those who have received gifts of stock are included. But does the category include those who have received only small amounts of stock? Does it matter what proportion the stock bears to the total issued and outstanding shares? Does the category include one who expects to receive stock through inheritance but never receives any? Does it include grandchildren who expect ultimately to inherit assets purchased with the proceeds of the sale of the family-controlled corporation? The net would be spread wider than appropriate in a criminal context. Cf. Cantwell v. Connecticut, 310 U.S. 296, 308, 60 S.Ct. 900, 905, 84 L.Ed. 1213 (1940) ("Here we have a situation analogous to a conviction under a statute sweeping in a great variety [583] of conduct under a general and indefinite characterization, and leaving to the executive and judicial branches too wide a discretion in its application").

      197

      In the same vein, it is conceivable that minor children could find themselves "in a position to learn confidential corporate information through ordinary family interactions." If they came into the possession of such information and somehow acquired the knowledge "that under the circumstances both the corporation and the family desire[d] confidentiality," would they become tippers who would expose other family members to criminal liability as tippees when they passed the information along?

      198

      It is important to note that in the case at bar we deal with an attenuated trail of family confidences in which information was received without any assurance of confidentiality by the receiver and without any prior sharing of business information within the family. Neither Shirley Witkin nor her daughter nor her son-in-law were involved in any way in the operation of the Waldbaum business or privy to any of its past secrets. Family relationships being what they are, it makes little sense under the circumstances to imply assurances that confidentiality would be maintained. Of course, a different situation obtains where the giver of business confidences, in addition to having a family relationship with the receiver, also has a history of reposing such confidences in the receiver. See United States v. Reed, 601 F.Supp. 685, 712, 717 (S.D.N.Y.), rev'd on other grounds, 773 F.2d 477 (2d Cir.1985) (son of corporate director as receiver of non-public corporate information). Under those circumstances, the duty of confidentiality is implied from the business relationship coupled with the family one.

      199

      Finally, to further extend the concept of confidential duty would be to take the courts into an area of securities regulation not yet entered by Congress. It would give the wrong signal to prosecutors in their continuing efforts to push against existing boundaries in the prosecution of securities fraud cases. "[P]rosecutors can often claim that some confidential relationship was abused — whether between lovers, family members, longtime friends, or simply that well-known confidential relationship between bartender and drunk. Such a test inherently creates legal uncertainty and invites selective prosecutions." Coffee, Outsider Trading, That New Crime, Wall St.J., Nov. 14, 1990, at 16, col. 4. I would await further instructions from Congress before sailing into this unchartered area.

      200
      MAHONEY, Circuit Judge, concurring in part and dissenting in part:
      201

      I concur in Judge Meskill's opinion for the majority except as to its ruling that the SEC did not exceed its rulemaking authority when it promulgated rule 14e-3(a), from which I respectfully dissent. Accordingly, I am also in disagreement with the brief discussion of this issue in Judge Winter's separate opinion, which concurs in Judge Meskill's resolution of the question.

      202

      The majority concludes that: "based on the plain language of section 14(e), and congressional activity both before section 14(e) was enacted and after Rule 14-3(a) was promulgated, we hold that the SEC did not exceed its statutory authority in drafting Rule 14e-3(a)," adding that neither Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), nor Schreiber v. Burlington Northern, Inc., 472 U.S. 1, 105 S.Ct. 2458, 86 L.Ed.2d 1 (1985), poses any barrier to this ruling. I will therefore address: (1) the pertinent language of section 14(e), (2) its pre- and post-enactment legislative history, and (3) the impact of Chiarella and Schreiber upon this issue.

      203

      As the majority notes, rule 14e-3 "creates a duty in those traders who fall within its ambit to abstain or disclose, without regard to whether the trader owes a preexisting fiduciary duty to respect the confidentiality of the information." The question presented is whether, in doing so, rule 14e-3(a) properly derives from the second sentence of section 14(e), which states: "The Commission shall, for the purposes of this subsection, by rules and regulations define, and prescribe means reasonably designed [584] to prevent, such acts and practices as are fraudulent, deceptive, or manipulative."

      204

      The majority opinion swiftly collapses this language into an authorization for the SEC to "define fraud." If this is a legitimate construction of the statutory language, of course, the issue is decided and does not warrant extended discussion. It is clear, however, that the statute says something significantly different.

      205

      The second sentence of section 14(e) authorizes the SEC to define, and prescribe preventive measures for, "such acts and practices as are fraudulent, deceptive, or manipulative." This statutory mandate became law in 1970, two years after the Williams Act was originally enacted and in the early years of the tender offer phenomenon and its attendant regulation.

      206

      Especially in view of this context, the plain meaning of the dispositive language is that the SEC is empowered to identify and regulate, in this (then) novel context, the "acts and practices" that fit within the existing legal categories of the "fraudulent, deceptive, or manipulative," but not to redefine the categories themselves. Furthermore, these venerable terms are used in section 14(e) in their normal, accepted legal definitions. The Supreme Court has made clear that in adding the 1970 amendment, Congress did not "suggest[] any change in the meaning of the term `manipulative' itself." Schreiber, 472 U.S. at 11 n. 11, 105 S.Ct. at 2464 n. 11. There is no reason to reach a different conclusion as to the term "fraudulent." Finally, the focus upon novel and emerging "acts and practices" rebuts the majority's view that unless the 1970 amendment is deemed to authorize the SEC to engage in creative redefinitions of the terms "fraudulent, deceptive or manipulative," the amendment will become a meaningless repetition of the preexisting self-operative provisions of section 14(e).

      207

      In the majority's view, moreover, even the meaning of the term "fraudulent" as used in the second sentence of section 14(e) is irrelevant. Because the statute empowers the SEC to "prescribe means reasonably designed to prevent ... such acts and practices as are fraudulent," the majority concludes that the statutory authorization "necessarily encompasses the power to proscribe conduct outside the purview of fraud, be it common law or SEC-defined fraud."

      208

      This is a truly breathtaking construction of a delegation to the SEC, we must bear in mind, of the authority to prescribe a federal felony. See 15 U.S.C. § 78ff(a) (1988) (defining any willful violation of the Securities Exchange Act of 1934, "or any rule or regulation thereunder," as a felony subject to ten years imprisonment and a $1,000,000 fine); Touby v. United States, ___ U.S. ___, 111 S.Ct. 1752, 1756, 114 L.Ed.2d 219 (1991) (reserving for future consideration question whether enhanced guidance must be provided "when Congress authorizes another Branch to promulgate regulations that contemplate criminal sanctions"). In any event, the majority's gloss on the statutory language is transparently implausible. While the SEC was authorized to utilize flexible regulatory means in this emerging area, those means had to be directed at "such acts and practices as are fraudulent" within the meaning of the statute. It is thus clearly unacceptable to conclude that Chestman can be validly convicted of a felony violation of section 14(e) and rule 14e-3(a) for, in the words of the majority, "conduct outside the purview of fraud, be it common law or SEC-defined fraud."

      209

      The legislative history of the 1970 amendment similarly lends little support to the majority's position. Aside from some amiable generalities by Senator Williams, the majority points only to a memorandum by the SEC Division of Corporation Finance that, in response to an inquiry by Senator Williams, listed the following as one of the seven "problem areas which may be dealt with by [the] rule-making authority" provided by the 1970 amendment to section 14(e): "5. The person who has become aware that a tender bid is to be made, or has reason to believe that such bid will be made, may fail to disclose material facts with respect thereto to persons who sell to him securities for which the tender bid is to be made." Additional Consumer Protection [585] in Corporate Takeovers and Increasing the Securities Act Exemptions for Small Businessmen, Hearings on S. 336 and S. 3431 before the Subcomm. on Securities of the Senate Comm. on Banking and Currency, 91st Cong., 2d Sess. 12 (1970).

      210

      It is plainly inappropriate to suggest that this rough outline of a regulatory "problem area" should be read to provide a precise delineation of the scope and purpose of the 1970 amendment. I note, for example, that this scenario does not suggest the source of the hypothetical buyer's knowledge, or "reason to believe," that a tender offer is imminent. Are we therefore to conclude that the derivation of the information is irrelevant? For example, would the buyer be guilty of a federal felony if his information as to the likelihood of a tender offer was derived from his observation of heavy trading in the target company's stock, without any direct or indirect input from the target company or the offeror? I am not aware of any responsible authority that reads the 1970 amendment of section 14(e) as authorizing so sweeping a revision of federal securities law, and the SEC made no such assertion in promulgating rule 14e-3(a), but such a purchaser would clearly fall within the "problem area" outlined in the SEC memorandum. Similarly, I suggest, this thumbnail sketch of a "problem area" should not be accorded significance in determining whether the 1970 amendment empowered the SEC to disregard existing legal concepts of fraud in devising regulations addressed to the definition and prevention of "such acts and practices as are fraudulent."

      211

      The post-enactment history is even less supportive of the majority's position. The majority points to legislative reports accompanying Congress' enactment of the Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 as somehow indicating Congressional support of the SEC's 1980 departure from prior law in promulgating rule 14e-3(a). As I stated in my concurring opinion during the panel consideration of this appeal, in addressing the identical legislative history:

      212
      [T]he very casual references to rule 14e-3 in H.R.Rep. No. 910, 100th Cong., 2d Sess. 14 (1988), reprinted in 1988 U.S.Code Cong. & Admin.News 6043, 6051, and H.R.Rep. No. 355, 98th Cong., 1st Sess. 13 n. 20 (1983), reprinted in 1984 U.S.Code Cong. & Admin.News 2286 n. 20, provide no basis for concluding that later statutory enactments have recognized not only the promulgation and existence of rule 14e-3, but also the Commission's claim that rule 14e-3 effects an implied repeal of any fiduciary duty requirement in the area of tender offer fraud.
      213
      In particular, H.R.Rep. No. 98-355 explicitly states that the legislation on which it reports, the Insider Trading Sanctions Act of 1984, "does not change the underlying substantive case law of insider trading as reflected in judicial and administrative holdings." Id. at 13. Similarly, H.R. No. 100-910 makes clear that the Insider Trading and Securities Fraud Enforcement Act of 1988 does not address the substantive law of insider trading. Id. at 7.
      214

      United States v. Chestman, 903 F.2d 75, 86 (2d Cir.1990) (MAHONEY, J., concurring in part and dissenting in part).

      215

      The cases cited by the majority on this issue are easily distinguished. In United States v. Rutherford, 442 U.S. 544, 99 S.Ct. 2470, 61 L.Ed.2d 68 (1979), the committee reports accompanying amendatory legislation subsequent to the agency ruling at issue explicitly approved the challenged agency position. See id. at 553, 99 S.Ct. at 2475-76. In Red Lion Broadcasting Co. v. FCC, 395 U.S. 367, 89 S.Ct. 1794, 23 L.Ed.2d 371 (1969), Congress had adopted explicit statutory language that "vindicated" the agency position on the issue in litigation. See id. at 380, 89 S.Ct. at 1801. Zemel v. Rusk, 381 U.S. 1, 85 S.Ct. 1271, 14 L.Ed.2d 179 (1965), noted that "[u]nder some circumstances," Congressional silence in the face of an administrative position has been deemed acquiescent in that position, but stated that "[i]n this case ... the inference is supported by more than mere congressional inaction." Id. at 11, 85 S.Ct. at 1278 (emphasis added).

      216

      [586] As indicated above, the circumstances presented here provide no support for a finding of Congressional acquiescence in the novel legal theory embodied in rule 14e-3(a). Congress' subsequent consideration of enhanced penalties for insider trading violations, explicitly eschewing any intention to address the pertinent issues of substantive law, does nothing to validate rule 14e-3. Furthermore, the majority opinion surprisingly disregards the most germane Supreme Court authority on this issue. In Aaron v. SEC, 446 U.S. 680, 100 S.Ct. 1945, 64 L.Ed.2d 611 (1980), the Court rejected a similar argument for Congressional ratification of an SEC position, stating:

      217
      The Commission finds further support for its interpretation of § 10(b) as not requiring proof of scienter in injunctive proceedings in the fact that Congress was expressly informed of the Commission's interpretation on two occasions when significant amendments to the securities laws were enacted — The Securities Act Amendments of 1975, Pub.L. 94-29, 89 Stat. 97, and the Foreign Corrupt Practices Act of 1977, Pub.L. 95-213, 91 Stat. 1494 — and on each occasion Congress left the administrative interpretation undisturbed. See S.Rep. No. 94-75, p. 76 (1975), U.S.Code Cong. & Admin.News 1975, p. 179; H.R.Rep. No. 95-640, p. 10 (1977). But, since the legislative consideration of those statutes was addressed principally to matters other than that at issue here, it is our view that the failure of Congress to overturn the Commission's interpretation falls far short of providing a basis to support a construction of § 10(b) so clearly at odds with its plain meaning and legislative history. See SEC v. Sloan, 436 U.S. 103, 119-121, 98 S.Ct. 1702, 1712-1713, 56 L.Ed.2d 148 [1978].
      218

      Id. at 694 n. 11, 100 S.Ct. at 1954 n. 11 (emphasis added). In Sloan, the Court rejected the SEC's interpretation of a statute despite subsequent reenactment of that statute coupled with an endorsement of the SEC's view in a committee report addressing the issue. See 436 U.S. at 119-20 & n. 10, 98 S.Ct. at 1712-13 & n. 10. A fortiori, no ratification has occurred as to rule 14e-3(a).

      219

      Rule 14e-3(a) was enacted in the immediate aftermath of the Supreme Court's ruling in Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980). Addressing section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j (1988), and rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (1991), the Court ruled in Chiarella that "[w]hen an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak." 445 U.S. at 235, 100 S.Ct. at 1118. If that rule applies in the area of tender offers and section 14(e), of course, rule 14e-3(a) is clearly illegal. See American Bar Association Committee on Federal Regulation of Securities, Report of the Task Force on Regulation of Insider Trading, 41 Bus.Law. 223, 252 (1985) ("Rule 14e-3 squarely raises the issue whether the [SEC] has the authority to impose a limited equal-access rule in the aftermath of Chiarella, Dirks [v. SEC, 463 U.S. 646, 103 S.Ct. 3255, 77 L.Ed.2d 911 (1983) ], and Schreiber."); id. at 251 & n. 109 (collecting commentaries expressing doubt as to validity of rule).

      220

      The majority would confine Chiarella's authority to section 10(b) and rule 10b-5, deeming it entirely without precedential value as to section 14(e) and rule 14e-3(a). Chiarella drew heavily, however, upon common law concepts of fraud. Its key ruling is that "the duty to disclose arises when one party has information `that the other [party] is entitled to know because of a fiduciary or other similar relation of trust and confidence between them.'" 445 U.S. at 228, 100 S.Ct. at 1114. The internal quotation is from the Restatement (Second) of Torts § 551(2)(a) (1976), with an added notation that the American Law Institute regards the rule as applicable to "securities transactions." See id. at 228 n. 9, 100 S.Ct. at 1114 n. 9. No reason appears why this generally applicable rule of law, not derived in any way from the language or history of section 10(b) and rule 10b-5, should have definitive force in the construction and interpretation of those provisions, [587] but none where section 14(e) and rule 14e-3(a) are concerned.

      221

      Furthermore, both the Supreme Court and this court have explicitly recognized that section 14(e) is modeled upon the antifraud provisions of § 10(b) and Rule 10b-5. See Schreiber, 472 U.S. at 10 & n. 10, 105 S.Ct. at 2463 & n. 10; Connecticut Nat'l Bank v. Fluor Corp., 808 F.2d 957, 961 (2d Cir.1987) (citing Chris-Craft Indus. v. Piper Aircraft Corp., 480 F.2d 341, 362 (2d Cir.), cert. denied, 414 U.S. 910, 94 S.Ct. 231, 232, 38 L.Ed.2d 148 (1973)).

      222

      Against this background, the majority's efforts to distinguish Chiarella are less than convincing. It is true that section 14(e), unlike section 10(b), directly proscribes "fraudulent" acts and practices, but this is a barely discernible departure from section 10(b)'s prohibition of "deceptive device[s] or contrivance[s]," see Restatement (Second) of Torts at 55 (1977) (equating "fraudulent representation" and "deceit"), and both sections envision implementation by SEC regulations. In any event, this proscription hardly heralds an intention to change the meaning of the term "fraud" as previously understood in both the general law and securities law. Nor does the slight difference in language between the two provisions' delegation of rulemaking authority to the SEC plausibly signify that Congress vested the SEC with the power to make such a change. Further, while the language of rule 14e-3(a) concededly "reveals express SEC intent to proscribe conduct not covered by common law fraud," as the majority states, that revelation poses, rather than decides, the question that we must resolve.

      223

      The majority opinion notes a passage in Chiarella that alludes to (then) proposed rule 14e-3 as a bar to warehousing of target stock in a tender offer "on a `somewhat different theory' than that previously used to regulate insider trading as fraudulent activity." Chiarella, 445 U.S. at 234, 100 S.Ct. at 1118 (quoting 1 SEC Institutional Investor Study Report, H.R.Doc. No. 64, 92nd Cong., 1st Sess., pt. 1 (the "Report"), at xxxii (1971)). The majority then identifies the "theory" as "one that does not embrace `any fiduciary duty to the [target] company or its shareholders,'" quoting the Report at xxxii. In fact, the Report only states that people who plan takeovers do not "usually have any fiduciary duty to [the target] company or its shareholders." Further, the majority vests significance in the fact that "the Chiarella Court did not disapprove of this exercise of the SEC's rulemaking power under section 14(e)." Such a disapproval would have been wholly gratuitous in the circumstances. In sum, this passage cannot fairly be read as obviating the fact that Chiarella establishes a general rule linking securities fraud to a breach of fiduciary duty, and that rule 14e-3(a) represents an obvious effort by the SEC to circumvent that rule by exercising an authority that has not been entrusted to that body.

      224

      Schreiber, as I have noted, establishes that section 14(e) was modeled upon section 10(b) and rule 10b-5, see 472 U.S. at 10 n. 10, 105 S.Ct. at 2463 n. 10, thus reinforcing the precedential value of Chiarella for the present case; and discountenances any notion that the 1970 amendment to section 14(e) intended any change in the meaning of the fundamental term "manipulative," see 472 U.S. at 12 n. 11, 105 S.Ct. at 2464 n. 11, undercutting the notion that the term "fraudulent" was invested by the same amendment with the novel content for which the SEC contends. Dirks v. SEC, 463 U.S. 646, 653, 103 S.Ct. 3255, 3260-61, 77 L.Ed.2d 911 (1983), explicitly rejected, in the section 10(b)/rule 10b-5 context, the SEC's view "that anyone who knowingly receives nonpublic material information from an insider has a fiduciary duty to disclose before trading." Rule 14e-3(a) purports to avoid the impact of Dirks by simply discarding the concept of fiduciary duty in the tender offer context.

      225

      I am aware, of course, that we ordinarily defer to the interpretation of a statute provided by an agency charged with its enforcement. See Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-45, 104 S.Ct. 2778, 2781-83, 81 L.Ed.2d 694 (1984); IBT v. Daniel, 439 U.S. 551, 566 n. 20, 99 S.Ct. 790, 800 n. [588] 20, 58 L.Ed.2d 808 (1979). As the Court made clear in Daniel, however:

      226
      [T]his deference is constrained by our obligation to honor the clear meaning of a statute, as revealed by its language, purpose, and history. On a number of occasions in recent years this Court has found it necessary to reject the SEC's interpretation of various provisions of the Securities Acts. See SEC v. Sloan, 436 U.S. 103, 117-119, 98 S.Ct. 1702, 1711-1712, 56 L.Ed.2d 148 (1978); Piper v. Chris-Craft Industries, Inc., 430 U.S. 1, 41 n. 27, 97 S.Ct. 926, 949 [n. 27], 51 L.Ed.2d 124 (1977); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 212-214, 96 S.Ct. 1375, 1390-1391, 47 L.Ed.2d 668 (1976); [United Hous. Found., Inc. v.] Forman, 421 U.S. [837, 858 n. 25, 95 S.Ct. 2051, 2063 n. 25, 44 L.Ed.2d 621 (1975)]; Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 759 n. 4, 95 S.Ct. 1917, 1936 [n. 4], 44 L.Ed.2d 539 (1975) (POWELL, J., concurring); Reliance Electric Co. v. Emerson Electric Co., 404 U.S. 418, 425-427, 92 S.Ct. 596, 600-602, 30 L.Ed.2d 575 (1972).
      227

      439 U.S. at 566 n. 20, 99 S.Ct. at 800 n. 20; see also Aaron, 446 U.S. at 694 n. 11, 100 S.Ct. at 1954 n. 11 (rejecting SEC view that scienter not required in § 10(b) injunctive proceedings); Business Roundtable v. SEC, 905 F.2d 406, 407 (D.C.Cir.1990) (holding that SEC exceeded its statutory authority in promulgating rule 19c-4 to bar national securities exchanges and associations from listing stocks violative of one share/one vote principle).

      228

      In promulgating rule 14e-3(a), the SEC has once again, in my view, acted in excess of its statutory authority. This is especially so because its action implicates serious criminal penalties. See Touby, 111 S.Ct. at 1756. Thus, to the extent that there is any ambiguity as to the authority vested in the SEC by the 1970 amendment of section 14(e), it should be resolved in Chestman's favor. As the Supreme Court said in Crandon v. United States, 494 U.S. 152, 110 S.Ct. 997, 1001, 108 L.Ed.2d 132 (1990), "because the governing standard is set forth in a criminal statute [here, 15 U.S.C. § 78ff(a) in tandem with rule 14e-3], it is appropriate to apply the rule of lenity in resolving any ambiguity in the ambit of the statute's coverage.".

      229

      Accordingly, I would reverse all of Chestman's convictions, in accordance with the panel disposition. See Chestman, 903 F.2d at 84. I therefore dissent from the majority's affirmance of Chestman's convictions under section 14(e) and rule 14e-3, while joining in the balance of the majority opinion.

      230

      --------

      231

      [*] Judge Feinberg participated in the decision to rehear the appeal in banc and heard oral argument. He subsequently retired from regular active service, however, and thus did not vote in the in banc decision. See 28 U.S.C. § 46(c); United States v. American-Foreign S.S. Corp., 363 U.S. 685, 80 S.Ct. 1336, 4 L.Ed.2d 1491 (1960).

      232

      [1]The indictment and judgment of conviction charge Chestman with violating Rule 14e-3(a) as well as Rule 14e-3(d). The record provides no other indications, however, that Rule 14e-3(d) was involved in this case. In fact, in the government's Memorandum of Law in Opposition to Defendant's Pretrial Motions, the government states:

      233

      The rule [Rule 14e-3] also contains limited exceptions pertaining to multi-service financial institutions and brokerage transactions and establishes an "anti-tipping" rule with respect to material, nonpublic information concerning a tender offer. Rule 14e-3(b), (c), and (d). These provisions are not at issue here. The indictment invokes only subsection (a) of Rule 14e-3.

      234

      Thus, like the district court, 704 F.Supp. 451, 456 n. 4 (S.D.N.Y.1989), and the panel, 903 F.2d 75, 85 (2d Cir.1990), we assume that Chestman was convicted only under subsection (a) of Rule 14e-3.

      235

      [2] The insider's fiduciary duties, it should be noted, run to a buyer (a shareholder-to-be) and to a seller (a pre-existing shareholder) of securities, even though the buyer technically does not have a fiduciary relationship with the insider prior to the trade. As the Court explained in Chiarella:

      236

      The transaction in Cady, Roberts involved sale of stock to persons who previously may not have been shareholders in the corporation. The Commission embraced the reasoning of Judge Learned Hand that "the director or officer assumed a fiduciary relation to the buyer by the very sale; for it would be a sorry distinction to allow him to use the advantage of his position to induce the buyer into the position of a beneficiary although he was forbidden to do so once the buyer had become one."

      237

      445 U.S. at 227 n. 8, 100 S.Ct. at 1114 n. 8 (quoting Cady, Roberts & Co., 40 S.E.C. 907, 914 n. 23 (1961) (quoting Gratz v. Claughton, 187 F.2d 46, 49 (2d Cir.), cert. denied, 341 U.S. 920, 71 S.Ct. 741, 95 L.Ed. 1353 (1951))) (internal citation omitted).

      238

      [3] In Carpenter v. United States, 484 U.S. 19, 24, 108 S.Ct. 316, 320, 98 L.Ed.2d 275 (1987), an "evenly divided" Court affirmed the securities fraud convictions brought pursuant to the misappropriation theory. An affirmance by an evenly divided court is "not entitled to precedential weight." See Neil v. Biggers, 409 U.S. 188, 192, 93 S.Ct. 375, 379, 34 L.Ed.2d 401 (1972). Thus, Supreme Court support for the misappropriation theory is still unclear.

      239

      --------

      240

      [1] Although the public appears to have a strongly negative view of insider trading, there are academics who believe it to be beneficial, see H. Manne, Insider Trading and the Stock Market (1966), and considerable diversity as to why insider trading should be regulated exists among its academic opponents, see, e.g., Kaplan, Wolf v. Weinstein: Another Chapter on Insider Trading, 1963 Sup.Ct.Rev. 273; Brudney, Insiders, Outsiders, and Informational Advantages Under the Federal Securities Laws, 93 Harv. L.Rev. 322 (1979); Easterbrook, Insider Trading, Secret Agents, Evidentiary Privileges, and the Production of Information, 1981 Sup.Ct.Rev. 309.

      241

      [2] Some commentators have suggested that Section 16(b) is designed, or at least operates, to increase management's autonomy from shareholder control because it limits the freedom of owners of large blocs of stock to trade and thus deters institutional investors from acquiring such blocs. Roe, A Political Theory of American Corporate Finance, 91 Colum.L.Rev. 10, 27 (1991).

      242

      [3] Although TGS stressed the unfairness of insider trading to those who deal with the trader, the reason for the nondisclosure that allowed insider trading in TGS stock was the company's insider trading in real estate.

      243

      [4] Section 16(a) of the '34 Act requires insiders to report trades in a corporation's stock (i) at the time of a new issue, (ii) when they become an insider, and (iii) each month thereafter in which trades occur. Where insiders are able to avoid "profits" as defined in Section 16(b) and trade heavily — e.g., a series of purchases that cannot be matched with sales during the six months at either end of the activity — other traders may well draw accurate inferences. In that respect, federal law causes the information on which insiders are trading to become known.

      244

      [5] Comprehensive protection of those who trade with insiders is unattainable because the most common form of insider trading by far is failing to trade. An insider possessing nonpublic information may purchase or sell other securities or borrow instead of trading in the corporation's stock. Such trading seems virtually undiscoverable and unregulable, however, although it is functionally indistinguishable from insider trading so far as those who deal with the trader are concerned.

      245

      Under the business property rationale, not-trading because of inside information is not the functional equivalent of trading because not-trading creates at most a negligible risk of disclosure of corporate secrets. Unlike trading, not-trading does not involve persons other than the trader, such as brokers, and does not create an unusual volume. But see Easterbrook, supra, at 336-37 (discussing signals sent to such parties by not trading). 

    • 3.4 Rule 10b5-2 Duties of trust or confidence

      Preliminary Note to § 240.10b5-2:

      This section provides a non-exclusive definition of circumstances in which a person has a duty of trust or confidence for purposes of the “misappropriation” theory of insider trading under Section 10(b) of the Act and Rule 10b-5. The law of insider trading is otherwise defined by judicial opinions construing Rule 10b-5, and Rule 10b5-2 does not modify the scope of insider trading law in any other respect.
       
      (a) Scope of Rule. This section shall apply to any violation of Section 10(b) of the Act (15 U.S.C. 78j(b)) and § 240.10b-5 thereunder that is based on the purchase or sale of securities on the basis of, or the communication of, material nonpublic information misappropriated in breach of a duty of trust or confidence.
      (b) Enumerated “duties of trust or confidence.” For purposes of this section, a “duty of trust or confidence” exists in the following circumstances, among others:
      (1) Whenever a person agrees to maintain information in confidence;
      (2) Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or
      (3) Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling; provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties' history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information.
  • 4 Misappropriation Theory

    This playlist is intended to be used as a “virtual” casebook for an introductory corporations class. This virtual casebook is an experiment using the H20 platform of Harvard's Berkman Center. This casebook can be printed and used in a hard copy form, or students can read and access the cases and materials online.

    The materials in this casebook follow a format that is familiar to a student in any of my previous corporations classes. The materials start with an extended focus on the concepts of agency. Then we turn to the Delaware corporate code. While the various conceptual approaches to the corporate law are extremely interesting and important, it is critical that law students master the code. Consequently, after an introduction to the concepts of agency, we will focus on the Delaware code. Although we could study the Model code or the Massachusetts code, for most corporate lawyers, the Delaware corporate law will be central to their practice.

    Beyond the code, Delaware has a very deep corporate common law. It is in the corporate common law that the courts have developed the law of corporate fiduciary duties. It is through fiduciary duties that the corporate law attempts to regulate the relationship between shareholders and the corporation, between managers and the corporation, as well as the relationships of controlling shareholders and minority shareholders.

    Fiduciary duties are tested most often in the context of corporate takeovers. The corporate takeover materials in this casebook attempt to highlight the most important issues in takeover situations as well as the court's doctrinal efforts to mitigate the transaction costs that arise in these situations.

    • 4.1 U.S. v. O'Hagan

      Misappropriation Theory

      1
      521 U.S. 642 (1997)
      2
      UNITED STATES
      v.
      O'HAGAN
      3
      No. 96-842.
      United States Supreme Court.
      4
      Argued April 16, 1997.
      5
      Decided June 25, 1997.
      6
      CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE EIGHTH CIRCUIT
      7

      [643] [644] [645] [646] Ginsburg, J., delivered the opinion of the Court, in which Stevens, O'Connor, Kennedy, Souter, and Breyer, JJ., joined, and in which Scalia, J., joined as to Parts I, III, and IV. Scalia, J., filed an opinion concurring in part and dissenting in part, post, p. 679. Thomas, J., filed an opinion concurring in the judgment in part and dissenting in part, in which Rehnquist, C. J., joined, post, p. 680.

      8

      Deputy Solicitor General Dreeben argued the cause for the United States. With him on the briefs were Acting Solicitor General Dellinger, Acting Assistant Attorney General Richard, Paul R. Q. Wolfson, Joseph C. Wyderko, Richard H. Walker, Paul Gonson, Jacob H. Stillman, Eric Summergrad, and Randall W. Quinn.

      9

      John D. French argued the cause for respondent. With him on the brief was Elizabeth L. Taylor.[1]

      10
      Justice Ginsburg, delivered the opinion of the Court.
      11

      This case concerns the interpretation and enforcement of § 10(b) and § 14(e) of the Securities Exchange Act of 1934, and rules made by the Securities and Exchange Commission pursuant to these provisions, Rule 10b—5 and Rule 14e—3(a). [647] Two prime questions are presented. The first relates to the misappropriation of material, nonpublic information for securities trading; the second concerns fraudulent practices in the tender offer setting. In particular, we address and resolve these issues: (1) Is 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, guilty of violating § 10(b) and Rule 10b—5? (2) Did the Commission exceed its rulemaking authority by adopting Rule 14e—3(a), which proscribes trading on undisclosed information in the tender offer setting, even in the absence of a duty to disclose? Our answer to the first question is yes, and to the second question, viewed in the context of this case, no.

      12
      I
      13

      Respondent James Herman O'Hagan was a partner in the law firm of Dorsey & Whitney in Minneapolis, Minnesota. In July 1988, Grand Metropolitan PLC (Grand Met), a company based in London, England, retained Dorsey & Whitney as local counsel to represent Grand Met regarding a potential tender offer for the common stock of the Pillsbury Company, headquartered in Minneapolis. Both Grand Met and Dorsey & Whitney took precautions to protect the confidentiality of Grand Met's tender offer plans. O'Hagan did no work on the Grand Met representation. Dorsey & Whitney withdrew from representing Grand Met on September 9, 1988. Less than a month later, on October 4, 1988, Grand Met publicly announced its tender offer for Pillsbury stock.

      14

      On August 18, 1988, while Dorsey & Whitney was still representing Grand Met, O'Hagan began purchasing call options for Pillsbury stock. Each option gave him the right to purchase 100 shares of Pillsbury stock by a specified date in September 1988. Later in August and in September, O'Hagan made additional purchases of Pillsbury call options. By the end of September, he owned 2,500 unexpired Pillsbury options, apparently more than any other individual investor. [648] See App. 85, 148. O'Hagan also purchased, in September 1988, some 5,000 shares of Pillsbury common stock, at a price just under $39 per share. When Grand Met announced its tender offer in October, the price of Pillsbury stock rose to nearly $60 per share. O'Hagan then sold his Pillsbury call options and common stock, making a profit of more than $4.3 million.

      15

      The Securities and Exchange Commission (SEC or Commission) initiated an investigation into O'Hagan's transactions, culminating in a 57-count indictment. The indictment alleged that O'Hagan defrauded his law firm and its client, Grand Met, by using for his own trading purposes material, nonpublic information regarding Grand Met's planned tender offer. Id., at 8.[2] According to the indictment, O'Hagan used the profits he gained through this trading to conceal his previous embezzlement and conversion of unrelated client trust funds. Id., at 10.[3] O'Hagan was charged with 20 counts of mail fraud, in violation of 18 U. S. C. § 1341; 17 counts of securities fraud, in violation of § 10(b) of the Securities Exchange Act of 1934 (Exchange Act), 48 Stat. 891, 15 U. S. C. § 78j(b), and SEC Rule 10b—5, 17 CFR § 240.10b—5 [649] (1996); 17 counts of fraudulent trading in connection with a tender offer, in violation of § 14(e) of the Exchange Act, 15 U. S. C. § 78n(e), and SEC Rule 14e—3(a), 17 CFR § 240.14e— 3(a) (1996); and 3 counts of violating federal money laundering statutes, 18 U. S. C. §§ 1956(a)(1)(B)(i), 1957. See App. 13-24. A jury convicted O'Hagan on all 57 counts, and he was sentenced to a 41-month term of imprisonment.

      16

      A divided panel of the Court of Appeals for the Eighth Circuit reversed all of O'Hagan's convictions. 92 F. 3d 612 (1996). Liability under § 10(b) and Rule 10b—5, the Eighth Circuit held, may not be grounded on the "misappropriation theory" of securities fraud on which the prosecution relied. Id., at 622. The Court of Appeals also held that Rule 14e— 3(a)—which prohibits trading while in possession of material, nonpublic information relating to a tender offer—exceeds the SEC's § 14(e) rulemaking authority because the Rule contains no breach of fiduciary duty requirement. Id., at 627. The Eighth Circuit further concluded that O'Hagan's mail fraud and money laundering convictions rested on violations of the securities laws, and therefore could not stand once the securities fraud convictions were reversed. Id., at 627-628. Judge Fagg, dissenting, stated that he would recognize and enforce the misappropriation theory, and would hold that the SEC did not exceed its rulemaking authority when it adopted Rule 14e—3(a) without requiring proof of a breach of fiduciary duty. Id., at 628.

      17

      Decisions of the Courts of Appeals are in conflict on the propriety of the misappropriation theory under § 10(b) and Rule 10b—5, see infra this page and 650, and n. 3, and on the legitimacy of Rule 14e—3(a) under § 14(e), see infra, at 669— 670. We granted certiorari, 519 U. S. 1087 (1997), and now reverse the Eighth Circuit's judgment.

      18
      II
      19

      We address first the Court of Appeals' reversal of O'Hagan's convictions under § 10(b) and Rule 10b—5. Following [650] the Fourth Circuit's lead, see United States v. Bryan, 58 F. 3d 933, 943-959 (1995), the Eighth Circuit rejected the misappropriation theory as a basis for § 10(b) liability. We hold, in accord with several other Courts of Appeals,[4] that criminal liability under § 10(b) may be predicated on the misappropriation theory.[5]

      20
      A
      21

      In pertinent part, § 10(b) of the Exchange Act provides:

      22
      "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange—
      23

      . . . . .

      24
      "(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors." 15 U. S. C. § 78j(b). [651] The statute thus proscribes (1) using any deceptive device (2) in connection with the purchase or sale of securities, in contravention of rules prescribed by the Commission. The provision, as written, does not confine its coverage to deception of a purchaser or seller of securities, see United States v. Newman, 664 F. 2d 12, 17 (CA2 1981); rather, the statute reaches any deceptive device used "in connection with the purchase or sale of any security."
      25

      Pursuant to its § 10(b) rulemaking authority, the Commission has adopted Rule 10b—5, which, as relevant here, provides:

      26
      "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
      27
      "(a) To employ any device, scheme, or artifice to defraud, [or]
      28

      . . . . .

      29
      "(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, "in connection with the purchase or sale of any security." 17 CFR § 240.10b—5 (1996).
      30

      Liability under Rule 10b—5, our precedent indicates, does not extend beyond conduct encompassed by § 10(b)'s prohibition. See Ernst & Ernst v. Hochfelder, 425 U. S. 185, 214 (1976) (scope of Rule 10b—5 cannot exceed power Congress granted Commission under § 10(b)); see also Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U. S. 164, 173 (1994) ("We have refused to allow [private] 10b—5 challenges to conduct not prohibited by the text of the statute.").

      31

      Under the "traditional" or "classical theory" of insider trading liability, § 10(b) and Rule 10b—5 are violated when a corporate insider trades in the securities of his corporation [652] on the basis of material, nonpublic information. Trading on such information qualifies as a "deceptive device" under § 10(b), we have affirmed, because "a relationship of trust and confidence [exists] between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation." Chiarella v. United States, 445 U. S. 222, 228 (1980). That relationship, we recognized, "gives rise to a duty to disclose [or to abstain from trading] because of the `necessity of preventing a corporate insider from . . . tak[ing] unfair advantage of . . . uninformed . . . stockholders.' " Id., at 228-229 (citation omitted). The classical theory applies not only to officers, directors, and other permanent insiders of a corporation, but also to attorneys, accountants, consultants, and others who temporarily become fiduciaries of a corporation. See Dirks v. SEC, 463 U. S. 646, 655, n. 14 (1983).

      32

      The "misappropriation theory" holds that a person commits fraud "in connection with" a securities transaction, and thereby violates § 10(b) and Rule 10b—5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. See Brief for United States 14. 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.

      33

      The two theories are complementary, each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities. The classical theory targets a corporate insider's breach of duty to shareholders with whom the insider transacts; the misappropriation theory outlaws [653] trading on the basis of nonpublic information by a corporate "outsider" in breach of a duty owed not to a trading party, but to the source of the information. The misappropriation theory is thus designed to "protec[t] the integrity of the securities markets against abuses by `outsiders' to a corporation who have access to confidential information that will affect th[e] corporation's security price when revealed, but who owe no fiduciary or other duty to that corporation's shareholders." Ibid.

      34

      In this case, the indictment alleged that O'Hagan, in breach of a duty of trust and confidence he owed to his law firm, Dorsey & Whitney, and to its client, Grand Met, traded on the basis of nonpublic information regarding Grand Met's planned tender offer for Pillsbury common stock. App. 16. This conduct, the Government charged, constituted a fraudulent device in connection with the purchase and sale of securities.[6]

      35
      B
      36

      We agree with the Government that misappropriation, as just defined, satisfies § 10(b)'s requirement that chargeable conduct involve a "deceptive device or contrivance" used "in connection with" the purchase or sale of securities. We observe, first, that misappropriators, as the Government describes them, deal in deception. A fiduciary who "[pretends] loyalty to the principal while secretly converting the principal's information for personal gain," Brief for United States [654] 17, "dupes" or defrauds the principal. See Aldave, Misappropriation: A General Theory of Liability for Trading on Nonpublic Information, 13 Hofstra L. Rev. 101, 119 (1984).

      37

      We addressed fraud of the same species in Carpenter v. United States, 484 U. S. 19 (1987), which involved the mail fraud statute's proscription of "any scheme or artifice to defraud," 18 U. S. C. § 1341. Affirming convictions under that statute, we said in Carpenter that an employee's undertaking not to reveal his employer's confidential information "became a sham" when the employee provided the information to his co-conspirators in a scheme to obtain trading profits. 484 U. S., at 27. A company's confidential information, we recognized in Carpenter, qualifies as property to which the company has a right of exclusive use. Id., at 25-27. The undisclosed misappropriation of such information, in violation of a fiduciary duty, the Court said in Carpenter, constitutes fraud akin to embezzlement—"`the fraudulent appropriation to one's own use of the money or goods entrusted to one's care by another.' " Id., at 27 (quoting Grin v. Shine, 187 U. S. 181, 189 (1902)); see Aldave, 13 Hofstra L. Rev., at 119. Carpenter `s discussion of the fraudulent misuse of confidential information, the Government notes, "is a particularly apt source of guidance here, because [the mail fraud statute] (like Section 10(b)) has long been held to require deception, not merely the breach of a fiduciary duty." Brief for United States 18, n. 9 (citation omitted).

      38

      Deception through nondisclosure is central to the theory of liability for which the Government seeks recognition. As counsel for the Government stated in explanation of the theory at oral argument: "To satisfy the common law rule that a trustee may not use the property that [has] been entrusted [to] him, there would have to be consent. To satisfy the requirement of the Securities Act that there be no deception, there would only have to be disclosure." Tr. of Oral Arg. 12; see generally Restatement (Second) of Agency §§ 390, 395 [655] (1958) (agent's disclosure obligation regarding use of confidential information).[7]

      39

      The misappropriation theory advanced by the Government is consistent with Santa Fe Industries, Inc. v. Green, 430 U. S. 462 (1977), a decision underscoring that § 10(b) is not an all-purpose breach of fiduciary duty ban; rather, it trains on conduct involving manipulation or deception. See id., at 473-476. In contrast to the Government's allegations in this case, in Santa Fe Industries, all pertinent facts were disclosed by the persons charged with violating § 10(b) and Rule 10b—5, see id., at 474; therefore, there was no deception through nondisclosure to which liability under those provisions could attach, see id., at 476. Similarly, full disclosure forecloses liability under the misappropriation theory: Because the deception essential to the misappropriation theory involves feigning fidelity to the source of information, if the fiduciary discloses to the source that he plans to trade on the nonpublic information, there is no "deceptive device" and thus no § 10(b) violation—although the fiduciary-turnedtrader may remain liable under state law for breach of a duty of loyalty.[8]

      40

      We turn next to the § 10(b) requirement that the misappropriator's deceptive use of information be "in connection with [656] 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 securities transaction and the breach of duty thus coincide. This is so even though the person or entity defrauded is not the other party to the trade, but is, instead, the source of the nonpublic information. See Aldave, 13 Hofstra L. Rev., at 120 ("a fraud or deceit can be practiced on one person, with resultant harm to another person or group of persons"). A misappropriator who trades on the basis of material, nonpublic information, in short, gains his advantageous market position through deception; he deceives the source of the information and simultaneously harms members of the investing public. See id., at 120-121, and n. 107.

      41

      The misappropriation theory targets information of a sort that misappropriators ordinarily capitalize upon to gain norisk profits through the purchase or sale of securities. Should a misappropriator put such information to other use, the statute's prohibition would not be implicated. The theory does not catch all conceivable forms of fraud involving confidential information; rather, it catches fraudulent means of capitalizing on such information through securities transactions.

      42

      The Government notes another limitation on the forms of fraud § 10(b) reaches: "The misappropriation theory would not . . . apply to a case in which a person defrauded a bank into giving him a loan or embezzled cash from another, and then used the proceeds of the misdeed to purchase securities." Brief for United States 24, n. 13. In such a case, the Government states, "the proceeds would have value to the malefactor apart from their use in a securities transaction, and the fraud would be complete as soon as the money was obtained." Ibid. In other words, money can buy, if not anything, then at least many things; its misappropriation [657] may thus be viewed as sufficiently detached from a subsequent securities transaction that § 10(b)'s "in connection with" requirement would not be met. Ibid.

      43

      Justice Thomas' charge that the misappropriation theory is incoherent because information, like funds, can be put to multiple uses, see post, at 681-686 (opinion concurring in judgment in part and dissenting in part), misses the point. The Exchange Act was enacted in part "to insure the maintenance of fair and honest markets," 15 U. S. C. § 78b, and there is no question that fraudulent uses of confidential information fall within § 10(b)'s prohibition if the fraud is "in connection with" a securities transaction. It is hardly remarkable that a rule suitably applied to the fraudulent uses of certain kinds of information would be stretched beyond reason were it applied to the fraudulent use of money.

      44

      Justice Thomas does catch the Government in overstatement. Observing that money can be used for all manner of purposes and purchases, the Government urges that confidential information of the kind at issue derives its value only from its utility in securities trading. See Brief for United States 10, 21; post, at 683-684 (several times emphasizing the word "only"). Substitute "ordinarily" for "only," and the Government is on the mark.[9]

      45

      [658] Our recognition that the Government's "only" is an overstatement has provoked the dissent to cry "new theory." See post, at 687-689. But the very case on which Justice Thomas relies, Motor Vehicle Mfrs. Assn. of United States, Inc. v. State Farm Mut. Automobile Ins. Co., 463 U. S. 29 (1983), shows the extremity of that charge. In State Farm, we reviewed an agency's rescission of a rule under the same "arbitrary and capricious" standard by which the promulgation of a rule under the relevant statute was to be judged, see id., at 41-42; in our decision concluding that the agency had not adequately explained its regulatory action, see id., at 57, we cautioned that a "reviewing court should not attempt itself to make up for such deficiencies," id., at 43. Here, by contrast, Rule 10b—5's promulgation has not been challenged; we consider only the Government's charge that O'Hagan's alleged fraudulent conduct falls within the prohibitions of the Rule and § 10(b). In this context, we acknowledge simply that, in defending the Government's interpretation of the Rule and statute in this Court, the Government's lawyers have pressed a solid point too far, something lawyers, occasionally even judges, are wont to do.

      46

      The misappropriation theory comports with § 10(b)'s language, which requires deception "in connection with the purchase or sale of any security," not deception of an identifiable purchaser or seller. The theory is also well tuned to an animating purpose of the Exchange Act: to insure honest securities markets and thereby promote investor confidence. See 45 Fed. Reg. 60412 (1980) (trading on misappropriated information "undermines the integrity of, and investor confidence in, the securities markets"). Although informational disparity is inevitable in the securities markets, investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law. An investor's informational disadvantage vis-à-vis a misappropriator with material, nonpublic information [659] stems from contrivance, not luck; it is a disadvantage that cannot be overcome with research or skill. See Brudney, Insiders, Outsiders, and Informational Advantages Under the Federal Securities Laws, 93 Harv. L. Rev. 322, 356 (1979) ("If the market is thought to be systematically populated with . . . transactors [trading on the basis of misappropriated information] some investors will refrain from dealing altogether, and others will incur costs to avoid dealing with such transactors or corruptly to overcome their unerodable informational advantages."); Aldave, 13 Hofstra L. Rev., at 122-123.

      47

      In sum, considering the inhibiting impact on market participation of trading on misappropriated information, and the congressional purposes underlying § 10(b), it makes scant sense to hold a lawyer like O'Hagan a § 10(b) violator if he works for a law firm representing the target of a tender offer, but not if he works for a law firm representing the bidder. The text of the statute requires no such result.[10] The misappropriation at issue here was properly made the subject of a § 10(b) charge because it meets the statutory requirement that there be "deceptive" conduct "in connection with" securities transactions.

      48
      [660] C
      49

      The Court of Appeals rejected the misappropriation theory primarily on two grounds. First, as the Eighth Circuit comprehended the theory, it requires neither misrepresentation nor nondisclosure. See 92 F. 3d, at 618. As we just explained, however, see supra, at 654-655, deceptive nondisclosure is essential to the § 10(b) liability at issue. Concretely, in this case, "it [was O'Hagan's] failure to disclose his personal trading to Grand Met and Dorsey, in breach of his duty to do so, that ma[de] his conduct `deceptive' within the meaning of [§ ]10(b)." Reply Brief 7.

      50

      Second and "more obvious," the Court of Appeals said, the misappropriation theory is not moored to § 10(b)'s requirement that "the fraud be `in connection with the purchase or sale of any security.' " 92 F. 3d, at 618 (quoting 15 U. S. C. § 78j(b)). According to the Eighth Circuit, three of our decisions reveal that § 10(b) liability cannot be predicated on a duty owed to the source of nonpublic information: Chiarella v. United States, 445 U. S. 222 (1980); Dirks v. SEC, 463 U. S. 646 (1983); and Central Bank of Denver, N. A. v. First Interstate Bank of Denver, N. A., 511 U. S. 164 (1994). "[O]nly a breach of a duty to parties to the securities transaction," the Court of Appeals concluded, "or, at the most, to other market participants such as investors, will be sufficient to give rise to § 10(b) liability." 92 F. 3d, at 618. We read the statute and our precedent differently, and note again that § 10(b) refers to "the purchase or sale of any security," not to identifiable purchasers or sellers of securities.

      51

      Chiarella involved securities trades by a printer employed at a shop that printed documents announcing corporate takeover bids. See 445 U. S., at 224. Deducing the names of target companies from documents he handled, the printer bought shares of the targets before takeover bids were announced, expecting (correctly) that the share prices would rise upon announcement. In these transactions, the printer did not disclose to the sellers of the securities (the target [661] companies' shareholders) the nonpublic information on which he traded. See ibid. For that trading, the printer was convicted of violating § 10(b) and Rule 10b—5. We reversed the Court of Appeals judgment that had affirmed the conviction. See id., at 225.

      52

      The jury in Chiarella had been instructed that it could convict the defendant if he willfully failed to inform sellers of target company securities that he knew of a takeover bid that would increase the value of their shares. See id., at 226. Emphasizing that the printer had no agency or other fiduciary relationship with the sellers, we held that liability could not be imposed on so broad a theory. See id., at 235. There is under § 10(b), we explained, no "general duty between all participants in market transactions to forgo actions based on material, nonpublic information." Id., at 233. Under established doctrine, we said, a duty to disclose or abstain from trading "arises from a specific relationship between two parties." Ibid.

      53

      The Court did not hold in Chiarella that the only relationship prompting liability for trading on undisclosed information is the relationship between a corporation's insiders and shareholders. That is evident from our response to the Government's argument before this Court that the printer's misappropriation of information from his employer for purposes of securities trading—in violation of a duty of confidentiality owed to the acquiring companies—constituted fraud in connection with the purchase or sale of a security, and thereby satisfied the terms of § 10(b). Id., at 235-236. The Court declined to reach that potential basis for the printer's liability, because the theory had not been submitted to the jury. See id., at 236-237. But four Justices found merit in it. See id., at 239 (Brennan, J., concurring in judgment); id., at 240-243 (Burger, C. J., dissenting); id., at 245 (Blackmun, J., joined by Marshall, J., dissenting). And a fifth Justice stated that the Court "wisely le[ft] the resolution of this issue for another day." Id., at 238 (Stevens, J., concurring).

      54

      [662] Chiarella thus expressly left open the misappropriation theory before us today. Certain statements in Chiarella, however, led the Eighth Circuit in the instant case to conclude that § 10(b) liability hinges exclusively on a breach of duty owed to a purchaser or seller of securities. See 92 F. 3d, at 618. The Court said in Chiarella that § 10(b) liability "is premised upon a duty to disclose arising from a relationship of trust and confidence between parties to a transaction, " 445 U. S., at 230 (emphasis added), and observed that the printshop employee defendant in that case "was not a person in whom the sellers had placed their trust and confidence," see id., at 232. These statements rejected the notion that § 10(b) stretches so far as to impose "a general duty between all participants in market transactions to forgo actions based on material, nonpublic information," id., at 233, and we confine them to that context. The statements highlighted by the Eighth Circuit, in short, appear in an opinion carefully leaving for future resolution the validity of the misappropriation theory, and therefore cannot be read to foreclose that theory.

      55

      Dirks, too, left room for application of the misappropriation theory in cases like the one we confront.[11] Dirks involved an investment analyst who had received information from a former insider of a corporation with which the analyst had no connection. See 463 U. S., at 648-649. The information indicated that the corporation had engaged in a massive fraud. The analyst investigated the fraud, obtaining corroborating information from employees of the corporation. During his investigation, the analyst discussed his findings with clients and investors, some of whom sold their holdings in the company the analyst suspected of gross wrongdoing. See id., at 649.

      56

      [663] The SEC censured the analyst for, inter alia, aiding and abetting § 10(b) and Rule 10b—5 violations by clients and investors who sold their holdings based on the nonpublic information the analyst passed on. See id., at 650-652. In the SEC's view, the analyst, as a "tippee" of corporation insiders, had a duty under § 10(b) and Rule 10b—5 to refrain from communicating the nonpublic information to persons likely to trade on the basis of it. See id., at 651, 655-656. This Court found no such obligation, see id., at 665-667, and repeated the key point made in Chiarella: There is no "`general duty between all participants in market transactions to forgo actions based on material, nonpublic information.' " 463 U. S., at 655 (quoting Chiarella, 445 U. S., at 233); see Aldave, 13 Hofstra L. Rev., at 122 (misappropriation theory bars only "trading on the basis of information that the wrongdoer converted to his own use in violation of some fiduciary, contractual, or similar obligation to the owner or rightful possessor of the information").

      57

      No showing had been made in Dirks that the "tippers" had violated any duty by disclosing to the analyst nonpublic information about their former employer. The insiders had acted not for personal profit, but to expose a massive fraud within the corporation. See 463 U. S., at 666-667. Absent any violation by the tippers, there could be no derivative liability for the tippee. See id., at 667. Most important for purposes of the instant case, the Court observed in Dirks: "There was no expectation by [the analyst's] sources that he would keep their information in confidence. Nor did [the analyst] misappropriate or illegally obtain the information . . . ." Id., at 665. Dirks thus presents no suggestion that a person who gains nonpublic information through misappropriation in breach of a fiduciary duty escapes § 10(b) liability when, without alerting the source, he trades on the information.

      58

      Last of the three cases the Eighth Circuit regarded as warranting disapproval of the misappropriation theory, Cen- [664] tral Bank held that "a private plaintiff may not maintain an aiding and abetting suit under § 10(b)." 511 U. S., at 191. We immediately cautioned in Central Bank that secondary actors in the securities markets may sometimes be chargeable under the securities Acts: "Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b—5, assuming . . . the requirements for primary liability under Rule 10b—5 are met." Ibid. (emphasis added). The Eighth Circuit isolated the statement just quoted and drew from it the conclusion that § 10(b) covers only deceptive statements or omissions on which purchasers and sellers, and perhaps other market participants, rely. See 92 F. 3d, at 619. It is evident from the question presented in Central Bank, however, that this Court, in the quoted passage, sought only to clarify that secondary actors, although not subject to aiding and abetting liability, remain subject to primary liability under § 10(b) and Rule 10b—5 for certain conduct.

      59

      Furthermore, Central Bank`s discussion concerned only private civil litigation under § 10(b) and Rule 10b—5, not criminal liability. Central Bank`s reference to purchasers or sellers of securities must be read in light of a longstanding limitation on private § 10(b) suits. In Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723 (1975), we held that only actual purchasers or sellers of securities may maintain a private civil action under § 10(b) and Rule 10b—5. We so confined the § 10(b) private right of action because of "policy considerations." Id., at 737. In particular, Blue Chip Stamps recognized the abuse potential and proof problems inherent in suits by investors who neither bought nor sold, but asserted they would have traded absent fraudulent conduct by others. See id., at 739-747; see also Holmes v. Securities Investor Protection Corporation, 503 U. S. 258, 285 [665] (1992) (O'Connor, J., concurring in part and concurring in judgment); id., at 289-290 (Scalia, J., concurring in judgment). Criminal prosecutions do not present the dangers the Court addressed in Blue Chip Stamps, so that decision is "inapplicable" to indictments for violations of § 10(b) and Rule 10b—5. United States v. Naftalin, 441 U. S. 768, 774, n. 6 (1979); see also Holmes, 503 U. S., at 281 (O'Connor, J., concurring in part and concurring in judgment) ("[T]he purchaser/seller standing requirement for private civil actions under § 10(b) and Rule 10b—5 is of no import in criminal prosecutions for willful violations of those provisions.").

      60

      In sum, the misappropriation theory, as we have examined and explained it in this opinion, is both consistent with the statute and with our precedent.[12] Vital to our decision that criminal liability may be sustained under the misappropriation theory, we emphasize, are two sturdy safeguards Congress has provided regarding scienter. To establish a criminal violation of Rule 10b—5, the Government must prove that a person "willfully" violated the provision. See 15 U. S. C. [666] § 78ff(a).[13] Furthermore, a defendant may not be imprisoned for violating Rule 10b—5 if he proves that he had no knowledge of the Rule. See ibid.[14] O'Hagan's charge that the misappropriation theory is too indefinite to permit the imposition of criminal liability, see Brief for Respondent 30— 33, thus fails not only because the theory is limited to those who breach a recognized duty. In addition, the statute's "requirement of the presence of culpable intent as a necessary element of the offense does much to destroy any force in the argument that application of the [statute]" in circumstances such as O'Hagan's is unjust. Boyce Motor Lines, Inc. v. United States, 342 U. S. 337, 342 (1952).

      61

      The Eighth Circuit erred in holding that the misappropriation theory is inconsistent with § 10(b). The Court of Appeals may address on remand O'Hagan's other challenges to his convictions under § 10(b) and Rule 10b—5.

      62
      III
      63

      We consider next the ground on which the Court of Appeals reversed O'Hagan's convictions for fraudulent trading in connection with a tender offer, in violation of § 14(e) of the Exchange Act and SEC Rule 14e—3(a). A sole question is before us as to these convictions: Did the Commission, as the Court of Appeals held, exceed its rulemaking authority under § 14(e) when it adopted Rule 14e—3(a) without requiring a showing that the trading at issue entailed a breach of [667] fiduciary duty? We hold that the Commission, in this regard and to the extent relevant to this case, did not exceed its authority.

      64

      The governing statutory provision, § 14(e) of the Exchange Act, reads in relevant part:

      65
      "It shall be unlawful for any person . . .to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer . . . . The [SEC] shall, for the purposes of this subsection, by rules and regulations define, and prescribe means reasonably designed to prevent, such acts and practices as are fraudulent, deceptive, or manipulative." 15 U. S. C. § 78n(e).
      66

      Section 14(e)'s first sentence prohibits fraudulent acts in connection with a tender offer. This self-operating proscription was one of several provisions added to the Exchange Act in 1968 by the Williams Act, 82 Stat. 454. The section's second sentence delegates definitional and prophylactic rulemaking authority to the Commission. Congress added this rulemaking delegation to § 14(e) in 1970 amendments to the Williams Act. See § 5, 84 Stat. 1497.

      67

      Through § 14(e) and other provisions on disclosure in the Williams Act,[15] Congress sought to ensure that shareholders "confronted by a cash tender offer for their stock [would] not be required to respond without adequate information." Rondeau v. Mosinee Paper Corp. , 422 U. S. 49, 58 (1975); see Lewis v. McGraw, 619 F. 2d 192, 195 (CA2 1980) (per curiam) [668] ("very purpose" of Williams Act was "informed decisionmaking by shareholders"). As we recognized in Schreiber v. Burlington Northern, Inc. , 472 U. S. 1 (1985), Congress designed the Williams Act to make "disclosure, rather than court-imposed principles of `fairness' or `artificiality,' . . . the preferred method of market regulation." Id., at 9, n. 8. Section 14(e), we explained, "supplements the more precise disclosure provisions found elsewhere in the Williams Act, while requiring disclosure more explicitly addressed to the tender offer context than that required by § 10(b)." Id., at 10-11.

      68

      Relying on § 14(e)'s rulemaking authorization, the Commission, in 1980, promulgated Rule 14e—3(a). That measure provides:

      69

      "(a) If any person has taken a substantial step or steps to commence, or has commenced, a tender offer (the `offering person'), it shall constitute a fraudulent, deceptive or manipulative act or practice within the meaning of section 14(e) of the [Exchange] Act for any other person who is in possession of material information relating to such tender offer which information he knows or has reason to know is nonpublic and which he knows or has reason to know has been acquired directly or indirectly from:

      70

      "(1) The offering person,

      71

      "(2) The issuer of the securities sought or to be sought by such tender offer, or

      72

      "(3) Any officer, director, partner or employee or any other person acting on behalf of the offering person or such issuer, to purchase or sell or cause to be purchased or sold any of such securities or any securities convertible into or exchangeable for any such securities or any option or right to obtain or to dispose of any of the foregoing securities, unless within a reasonable time prior to any purchase or sale such information and its source [669] are publicly disclosed by press release or otherwise." 17 CFR § 240.14e—3(a) (1996).

      73

      As characterized by the Commission, Rule 14e—3(a) is a "disclose or abstain from trading" requirement. 45 Fed. Reg. 60410 (1980).[16] The Second Circuit concisely described the Rule's thrust:

      74
      "One violates Rule 14e—3(a) if he trades on the basis of material nonpublic information concerning a pending tender offer that he knows or has reason to know has been acquired `directly or indirectly' from an insider of the offer or or issuer, or someone working on their behalf. Rule 14e—3(a) is a disclosure provision. It creates a duty in those traders who fall within its ambit to abstain or disclose, without regard to whether the trader owes a pre-existing fiduciary duty to respect the confidentiality of the information." United States v. Chestman, 947 F. 2d 551, 557 (1991) (en banc) (emphasis added), cert. denied, 503 U. S. 1004 (1992).
      75

      See also SEC v. Maio, 51 F. 3d 623, 635 (CA7 1995) ("Rule 14e—3 creates a duty to disclose material non-public information, or abstain from trading in stocks implicated by an impending tender offer, regardless of whether such information was obtained through a breach of fiduciary duty." (emphasis added)); SEC v. Peters, 978 F. 2d 1162, 1165 (CA10 1992) (as written, Rule 14e—3(a) has no fiduciary duty requirement).

      76

      In the Eighth Circuit's view, because Rule 14e—3(a) applies whether or not the trading in question breaches a fiduciary duty, the regulation exceeds the SEC's § 14(e) rulemaking authority. See 92 F. 3d, at 624, 627. Contra, Maio, 51 F. 3d, at 634-635 (CA7); Peters, 978 F. 2d, at 1165-1167 (CA10); [670] Chestman, 947 F. 2d, at 556-563 (CA2) (all holding Rule 14e— 3(a) a proper exercise of SEC's statutory authority). In support of its holding, the Eighth Circuit relied on the text of § 14(e) and our decisions in Schreiber and Chiarella. See 92 F. 3d, at 624-627.

      77

      The Eighth Circuit homed in on the essence of § 14(e)'s rulemaking authorization: "[T]he statute empowers the SEC to `define' and `prescribe means reasonably designed to prevent' `acts and practices' which are `fraudulent.' " Id., at 624. All that means, the Eighth Circuit found plain, is that the SEC may "identify and regulate," in the tender offer context, "acts and practices" the law already defines as "fraudulent"; but, the Eighth Circuit maintained, the SEC may not "create its own definition of fraud." Ibid. (internal quotation marks omitted).

      78

      This Court, the Eighth Circuit pointed out, held in Schreiber that the word "manipulative" in the § 14(e) phrase "fraudulent, deceptive, or manipulative acts or practices" means just what the word means in § 10(b): Absent misrepresentation or nondisclosure, an act cannot be indicted as manipulative. See 92 F. 3d, at 625 (citing Schreiber, 472 U. S., at 7-8, and n. 6). Section 10(b) interpretations guide construction of § 14(e), the Eighth Circuit added, see 92 F. 3d, at 625, citing this Court's acknowledgment in Schreiber that § 14(e)'s "`broad antifraud prohibition' . . . [is] modeled on the antifraud provisions of § 10(b) . . . and Rule 10b—5," 472 U. S., at 10 (citation omitted); see id., at 10-11, n. 10.

      79

      For the meaning of "fraudulent" under § 10(b), the Eighth Circuit looked to Chiarella. See 92 F. 3d, at 625. In that case, the Eighth Circuit recounted, this Court held that a failure to disclose information could be "fraudulent" under § 10(b) only when there was a duty to speak arising out of "`a fiduciary or other similar relation of trust and confidence.' " Chiarella, 445 U. S., at 228 (quoting Restatement (Second) of Torts § 551(2)(a) (1976)). Just as § 10(b) demands a showing [671] of a breach of fiduciary duty, so such a breach is necessary to make out a § 14(e) violation, the Eighth Circuit concluded.

      80

      As to the Commission's § 14(e) authority to "prescribe means reasonably designed to prevent" fraudulent acts, the Eighth Circuit stated: "Properly read, this provision means simply that the SEC has broad regulatory powers in the field of tender offers, but the statutory terms have a fixed meaning which the SEC cannot alter by way of an administrative rule." 92 F. 3d, at 627.

      81

      The United States urges that the Eighth Circuit's reading of § 14(e) misapprehends both the Commission's authority to define fraudulent acts and the Commission's power to prevent them. "The `defining' power," the United States submits, "would be a virtual nullity were the SEC not permitted to go beyond common law fraud (which is separately prohibited in the first [self-operative] sentence of Section 14(e))." Brief for United States 11; see id., at 37.

      82

      In maintaining that the Commission's power to define fraudulent acts under § 14(e) is broader than its rulemaking power under § 10(b), the United States questions the Court of Appeals' reading of Schreiber. See Brief for United States 38-40. Parenthetically, the United States notes that the word before the Schreiber Court was "manipulative"; unlike "fraudulent," the United States observes, "`manipulative' . . . is `virtually a term of art when used in connection with the securities markets.' " Brief for United States 38, n. 20 (quoting Schreiber, 472 U. S., at 6). Most tellingly, the United States submits, Schreiber involved acts alleged to violate the self-operative provision in § 14(e)'s first sentence, a sentence containing language similar to § 10(b). But § 14(e)'s second sentence, containing the rulemaking authorization, the United States points out, does not track § 10(b), which simply authorizes the SEC to proscribe "manipulative or deceptive device[s] or contrivance[s]." Brief for United States 38. Instead, § 14(e)'s rulemaking prescription tracks § 15(c)(2)(D) of the Exchange Act, 15 U. S. C. § 78o (c)(2)(D), [672] which concerns the conduct of broker-dealers in over-thecounter markets. See Brief for United States 38-39. Since 1938, see 52 Stat. 1075, § 15(c)(2) has given the Commission authority to "define, and prescribe means reasonably designed to prevent, such [broker-dealer] acts and practices as are fraudulent, deceptive, or manipulative." 15 U. S. C. § 78o (c)(2)(D). When Congress added this same rulemaking language to § 14(e) in 1970, the Government states, the Commission had already used its § 15(c)(2) authority to reach beyond common-law fraud. See Brief for United States 39, n. 22.[17]

      83

      We need not resolve in this case whether the Commission's authority under § 14(e) to "define . . . such acts and practices as are fraudulent" is broader than the Commission's frauddefining authority under § 10(b), for we agree with the United States that Rule 14e—3(a), as applied to cases of this genre, qualifies under § 14(e) as a "means reasonably designed to prevent" fraudulent trading on material, nonpublic information in the tender offer context.[18] A prophylactic [673] measure, because its mission is to prevent, typically encompasses more than the core activity prohibited. As we noted in Schreiber, § 14(e)'s rulemaking authorization gives the Commission "latitude," even in the context of a term of art like "manipulative," "to regulate nondeceptive activities as a `reasonably designed' means of preventing manipulative acts, without suggesting any change in the meaning of the term `manipulative' itself." 472 U. S., at 11, n. 11. We hold, accordingly, that under § 14(e), the Commission may prohibit acts not themselves fraudulent under the common law or § 10(b), if the prohibition is "reasonably designed to prevent. . . acts and practices [that] are fraudulent." 15 U. S. C. § 78n(e).[19]

      84

      Because Congress has authorized the Commission, in § 14(e), to prescribe legislative rules, we owe the Commission's judgment "more than mere deference or weight." Batterton v. Francis, 432 U. S. 416, 424-426 (1977). Therefore, in determining whether Rule 14e—3(a)'s "disclose or abstain from trading" requirement is reasonably designed to prevent fraudulent acts, we must accord the Commission's assessment "controlling weight unless [it is] arbitrary, capricious, or manifestly contrary to the statute." Chevron U. S. A. Inc. v. Natural Resources Defense Council, Inc. , 467 U. S. 837, 844 (1984). In this case, we conclude, the Commission's assessment is none of these.[20]

      85

      [674] In adopting the "disclose or abstain" rule, the SEC explained:

      86
      "The Commission has previously expressed and continues to have serious concerns about trading by persons in possession of material, nonpublic information relating to a tender offer. This practice results in unfair disparities in market information and market disruption. Security holders who purchase from or sell to such persons are effectively denied the benefits of disclosure and the substantive protections of the Williams Act. If furnished with the information, these security holders would be able to make an informed investment decision, which could involve deferring the purchase or sale of the securities until the material information had been disseminated or until the tender offer had been commenced or terminated." 45 Fed. Reg. 60412 (1980) (footnotes omitted).
      87

      The Commission thus justified Rule 14e—3(a) as a means necessary and proper to assure the efficacy of Williams Act protections.

      88

      The United States emphasizes that Rule 14e—3(a) reaches trading in which "a breach of duty is likely but difficult to prove." Reply Brief 16. "Particularly in the context of a tender offer," as the Tenth Circuit recognized, "there is a fairly wide circle of people with confidential information," Peters, 978 F. 2d, at 1167, notably, the attorneys, investment [675] bankers, and accountants involved in structuring the transaction. The availability of that information may lead to abuse, for "even a hint of an upcoming tender offer may send the price of the target company's stock soaring." SEC v. Materia, 745 F. 2d 197, 199 (CA2 1984). Individuals entrusted with nonpublic information, particularly if they have no long-term loyalty to the issuer, may find the temptation to trade on that information hard to resist in view of "the very large short-term profits potentially available [to them]." Peters, 978 F. 2d, at 1167.

      89

      "[I]t may be possible to prove circumstantially that a person [traded on the basis of material, nonpublic information], but almost impossible to prove that the trader obtained such information in breach of a fiduciary duty owed either by the trader or by the ultimate insider source of the information." Ibid. The example of a "tippee" who trades on information received from an insider illustrates the problem. Under Rule 10b—5, "a tippee assumes a fiduciary duty to the shareholders of a corporation not to trade on material nonpublic information only when the insider has breached his fiduciary duty to the shareholders by disclosing the information to the tippee and the tippee knows or should know that there has been a breach." Dirks , 463 U. S., at 660. To show that a tippee who traded on nonpublic information about a tender offer had breached a fiduciary duty would require proof not only that the insider source breached a fiduciary duty, but that the tippee knew or should have known of that breach. "Yet, in most cases, the only parties to the [information transfer] will be the insider and the alleged tippee." Peters, 978 F. 2d, at 1167.[21]

      90

      [676] In sum, it is a fair assumption that trading on the basis of material, nonpublic information will often involve a breach of a duty of confidentiality to the bidder or target company or their representatives. The SEC, cognizant of the proof problem that could enable sophisticated traders to escape responsibility, placed in Rule 14e—3(a) a "disclose or abstain from trading" command that does not require specific proof of a breach of fiduciary duty. That prescription, we are satisfied, applied to this case, is a "means reasonably designed to prevent" fraudulent trading on material, nonpublic information in the tender offer context. See Chestman, 947 F. 2d, at 560 ("While dispensing with the subtle problems of proof associated with demonstrating fiduciary breach in the problematic area of tender offer insider trading, [Rule 14e— 3(a)] retains a close nexus between the prohibited conduct and the statutory aims."); accord, Maio, 51 F. 3d, at 635, and n. 14; Peters, 978 F. 2d, at 1167.[22] Therefore, insofar as it serves to prevent the type of misappropriation charged against O'Hagan, Rule 14e—3(a) is a proper exercise of the Commission's prophylactic power under § 14(e).[23]

      91

      As an alternate ground for affirming the Eighth Circuit's judgment, O'Hagan urges that Rule 14e—3(a) is invalid because [677] it prohibits trading in advance of a tender offer—when "a substantial step . . . to commence" such an offer has been taken—while § 14(e) prohibits fraudulent acts "in connection with any tender offer." See Brief for Respondent 41-42. O'Hagan further contends that, by covering pre-offer conduct, Rule 14e—3(a) "fails to comport with due process on two levels": The Rule does not "give fair notice as to when, in advance of a tender offer, a violation of § 14(e) occurs," id., at 42; and it"disposes of any scienter requirement," id., at 43. The Court of Appeals did not address these arguments, and O'Hagan did not raise the due process points in his briefs before that court. We decline to consider these contentions in the first instance.[24] The Court of Appeals may address on remand any arguments O'Hagan has preserved.

      92
      IV
      93

      Based on its dispositions of the securities fraud convictions, the Court of Appeals also reversed O'Hagan's convictions, under 18 U. S. C. § 1341, for mail fraud. See 92 F. 3d, at 627-628. Reversal of the securities convictions, the Court of Appeals recognized, "d[id] not as a matter of law require that the mail fraud convictions likewise be reversed." Id., at 627 (citing Carpenter, 484 U. S., at 24, in which this Court unanimously affirmed mail and wire fraud convictions based on the same conduct that evenly divided the Court on the defendants' securities fraud convictions). But in this case, the Court of Appeals said, the indictment was so structured that the mail fraud charges could not be disassociated from the securities fraud charges, and absent any securities [678] fraud, "there was no fraud upon which to base the mail fraud charges." 92 F. 3d, at 627-628.[25]

      94

      The United States urges that the Court of Appeals' position is irreconcilable with Carpenter: Just as in Carpenter, so here, the "mail fraud charges are independent of [the] securities fraud charges, even [though] both rest on the same set of facts." Brief for United States 46-47. We need not linger over this matter, for our rulings on the securities fraud issues require that we reverse the Court of Appeals judgment on the mail fraud counts as well.[26]

      95

      O'Hagan, we note, attacked the mail fraud convictions in the Court of Appeals on alternate grounds; his other arguments, not yet addressed by the Eighth Circuit, remain open for consideration on remand.

      96
      * * *
      97

      The judgment of the Court of Appeals for the Eighth Circuit is reversed, and the case is remanded for further proceedings consistent with this opinion.

      98

      It is so ordered.

      99
      [679] Justice Scalia, concurring in part and dissenting in part.
      100

      I join Parts I, III, and IV of the Court's opinion. I do not agree, however, with Part II of the Court's opinion, containing its analysis of respondent's convictions under § 10(b) and Rule 10b—5.

      101

      I do not entirely agree with Justice Thomas's analysis of those convictions either, principally because it seems to me irrelevant whether the Government's theory of why respondent's acts were covered is "coherent and consistent," post, at 691. It is true that with respect to matters over which an agency has been accorded adjudicative authority or policymaking discretion, the agency's action must be supported by the reasons that the agency sets forth, SEC v. Chenery Corp., 318 U. S. 80, 94 (1943); see also SEC v. Chenery Corp., 332 U. S. 194, 196 (1947), but I do not think an agency's unadorned application of the law need be, at least where (as here) no Chevron deference is being given to the agency's interpretation, see Chevron U. S. A. Inc. v. Natural Resources Defense Council, Inc., 467 U. S. 837 (1984). In point of fact, respondent's actions either violated § 10(b) and Rule 10b—5, or they did not—regardless of the reasons the Government gave. And it is for us to decide.

      102

      While the Court's explanation of the scope of § 10(b) and Rule 10b—5 would be entirely reasonable in some other context, it does not seem to accord with the principle of lenity we apply to criminal statutes (which cannot be mitigated here by the Rule, which is no less ambiguous than the statute). See Reno v. Koray, 515 U. S. 50, 64-65 (1995) (explaining circumstances in which rule of levity applies); United States v. Bass, 404 U. S. 336, 347-348 (1971) (discussing policies underlying rule of lenity). In light of that principle, it seems to me that the unelaborated statutory language: "[t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance," § 10(b), must be construed to require the manipulation or deception of a party to a securities transaction.

      103
      [680] Justice Thomas, with whom The Chief Justice joins, concurring in the judgment in part and dissenting in part.
      104

      Today the majority upholds respondent's convictions for violating § 10(b) of the Securities Exchange Act of 1934, and Rule 10b—5 promulgated thereunder, based upon the Securities and Exchange Commission's "misappropriation theory." Central to the majority's holding is the need to interpret § 10(b)'s requirement that a deceptive device be "use[d] or employ[ed], in connection with the purchase or sale of any security." 15 U. S. C. § 78j(b). Because the Commission's misappropriation theory fails to provide a coherent and consistent interpretation of this essential requirement for liability under § 10(b), I dissent.

      105

      The majority also sustains respondent's convictions under § 14(e) of the Securities Exchange Act, and Rule 14e—3(a) promulgated thereunder, regardless of whether respondent violated a fiduciary duty to anybody. I dissent too from that holding because, while § 14(e) does allow regulations prohibiting nonfraudulent acts as a prophylactic against certain fraudulent acts, neither the majority nor the Commission identifies any relevant underlying fraud against which Rule 14e—3(a) reasonably provides prophylaxis. With regard to respondent's mail fraud convictions, however, I concur in the judgment of the Court.

      106
      I
      107

      I do not take issue with the majority's determination that the undisclosed misappropriation of confidential information by a fiduciary can constitute a "deceptive device" within the meaning of § 10(b). Nondisclosure where there is a preexisting duty to disclose satisfies our definitions of fraud and deceit for purposes of the securities laws. See Chiarella v. United States, 445 U. S. 222, 230 (1980).

      108

      Unlike the majority, however, I cannot accept the Commission's interpretation of when a deceptive device is "use[d] . . . in connection with" a securities transaction. Although the Commission and the majority at points seem to suggest that [681] any relation to a securities transaction satisfies the "in connection with" requirement of § 10(b), both ultimately reject such an overly expansive construction and require a more integral connection between the fraud and the securities transaction. The majority states, for example, that the misappropriation theory applies to undisclosed misappropriation of confidential information "for securities trading purposes," ante, at 652, thus seeming to require a particular intent by the misappropriator in order to satisfy the "in connection with" language. See also ante, at 656 (the "misappropriation theory targets information of a sort that misappropriators ordinarily capitalize upon to gain no-risk profits through the purchase or sale of securities" (emphasis added)); ante, at 656-657 (distinguishing embezzlement of money used to buy securities as lacking the requisite connection). The Commission goes further, and argues that the misappropriation theory satisfies the "in connection with" requirement because it "depends on an inherent connection between the deceptive conduct and the purchase or sale of a security." Brief for United States 21 (emphasis added); see also ibid. (the "misappropriated information had personal value to respondent only because of its utility in securities trading" (emphasis added)).

      109

      The Commission's construction of the relevant language in § 10(b), and the incoherence of that construction, become evident as the majority attempts to describe why the fraudulent theft of information falls under the Commission's misappropriation theory, but the fraudulent theft of money does not. The majority correctly notes that confidential information "qualifies as property to which the company has a right of exclusive use." Ante, at 654. It then observes that the "undisclosed misappropriation of such information, in violation of a fiduciary duty, . . . constitutes fraud akin to embezzlement—the fraudulent appropriation to one's own use of the money or goods entrusted to one's care by another." [682] Ibid. (citations and internal quotation marks omitted).[27] So far the majority's analogy to embezzlement is well taken, and adequately demonstrates that undisclosed misappropriation can be a fraud on the source of the information.

      110

      What the embezzlement analogy does not do, however, is explain how the relevant fraud is "use[d] or employ[ed], in connection with" a securities transaction. And when the majority seeks to distinguish the embezzlement of funds from the embezzlement of information, it becomes clear that neither the Commission nor the majority has a coherent theory regarding § 10(b)'s "in connection with" requirement.

      111

      Turning first to why embezzlement of information supposedly meets the "in connection with" requirement, the majority asserts that the requirement

      112
      "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 securities transaction and the breach of duty thus coincide." Ante, at 656.
      113

      The majority later notes, with apparent approval, the Government's contention that the embezzlement of funds used to purchase securities would not fall within the misappropriation theory. Ante, at 656-657 (citing Brief for United States 24, n. 13). The misappropriation of funds used for a securities transaction is not covered by its theory, the Government explains, because "the proceeds would have value to the malefactor apart from their use in a securities transaction, and the fraud would be complete as soon as the money was [683] obtained." Brief for United States 24, n. 13; see ante, at 656 (quoting Government's explanation).

      114

      Accepting the Government's description of the scope of its own theory, it becomes plain that the majority's explanation of how the misappropriation theory supposedly satisfies the "in connection with" requirement is incomplete. The touchstone required for an embezzlement to be "use[d] or employ[ed], in connection with" a securities transaction is not merely that it "coincide" with, or be consummated by, the transaction, but that it is necessarily and only consummated by the transaction. Where the property being embezzled has value "apart from [its] use in a securities transaction"— even though it is in fact being used in a securities transaction—the Government contends that there is no violation under the misappropriation theory.

      115

      My understanding of the Government's proffered theory of liability, and its construction of the "in connection with" requirement, is confirmed by the Government's explanation during oral argument:

      116
      "[Court]: What if I appropriate some of my client's money in order to buy stock?
      117

      . . . . .

      118

      "[Court]: Have I violated the securities laws?

      119

      "[Counsel]: I do not think that you have.

      120
      "[Court]: Why not? Isn't that in connection with the purchase of securit[ies] just as much as this one is?
      121
      "[Counsel]: It's not just as much as this one is, because in this case it is the use of the information that enables the profits, pure and simple. There would be no opportunity to engage in profit—
      122
      "[Court]: Same here. I didn't have the money. The only way I could buy this stock was to get the money.
      123

      . . . . .

      124
      "[Counsel]: The difference . . . is that once you have the money you can do anything you want with it. In a sense, the fraud is complete at that point, and then you [684] go on and you can use the money to finance any number of other activities, but the connection is far less close than in this case, where the only value of this informa- tion for personal profit for respondent was to take it and profit in the securities markets by trading on it.
      125

      . . . . .

      126
      "[Court]: So what you're saying is, is in this case the misappropriation can only be of relevance, or is of substantial relevance, is with reference to the purchase of securities.
      127

      "[Counsel]: Exactly.

      128
      "[Court]: When you take the money out of the accounts you can go to the racetrack, or whatever.
      129
      "[Counsel]: That's exactly right, and because of that difference, [there] can be no doubt that this kind of misappropriation of property is in connection with the purchase or sale of securities.
      130
      "Other kinds of misappropriation of property may or may not, but this is a unique form of fraud, unique to the securities markets, in fact, because the only way in which respondent could have profited through this in- formation is by either trading on it or by tipping somebody else to enable their trades." Tr. of Oral Arg. 16-19 (emphases added).
      131

      As the above exchange demonstrates, the relevant distinction is not that the misappropriated information was used for a securities transaction (the money example met that test), but rather that it could only be used for such a transaction. See also id., at 6-7 (Government contention that the misappropriation theory satisfies "the requisite connection between the fraud and the securities trading, because it is only in the trading that the fraud is consummated" (emphasis added)); id., at 8 (same).

      132

      The Government's construction of the "in connection with" requirement—and its claim that such requirement precludes coverage of financial embezzlement—also demonstrates how [685] the majority's described distinction of financial embezzlement is incomplete. Although the majority claims that the fraud in a financial embezzlement case is complete as soon as the money is obtained, and before the securities transaction is consummated, that is not uniformly true, and thus cannot be the Government's basis for claiming that such embezzlement does not violate the securities laws. It is not difficult to imagine an embezzlement of money that takes place via the mechanism of a securities transaction—for example where a broker is directed to purchase stock for a client and instead purchases such stock—using client funds—for his own account. The unauthorized (and presumably undisclosed) transaction is the very act that constitutes the embezzlement and the "securities transaction and the breach of duty thus coincide." What presumably distinguishes monetary embezzlement for the Government is thus that it is not necessarily coincident with a securities transaction, not that it never lacks such a "connection."

      133

      Once the Government's construction of the misappropriation theory is accurately described and accepted—along with its implied construction of § 10(b)'s "in connection with" language—that theory should no longer cover cases, such as this one, involving fraud on the source of information where the source has no connection with the other participant in a securities transaction. It seems obvious that the undisclosed misappropriation of confidential information is not necessarily consummated by a securities transaction. In this case, for example, upon learning of Grand Met's confidential takeover plans, O'Hagan could have done any number of things with the information: He could have sold it to a newspaper for publication, see id., at 36; he could have given or sold the information to Pillsbury itself, see id., at 37; or he could even have kept the information and used it solely for his personal amusement, perhaps in a fantasy stock trading game.

      134

      Any of these activities would have deprived Grand Met of its right to "exclusive use," ante, at 654, of the information [686] and, if undisclosed, would constitute "embezzlement" of Grand Met's informational property. Under any theory of liability, however, these activities would not violate § 10(b) and, according to the Commission's monetary embezzlement analogy, these possibilities are sufficient to preclude a violation under the misappropriation theory even where the informational property was used for securities trading. That O'Hagan actually did use the information to purchase securities is thus no more significant here than it is in the case of embezzling money used to purchase securities. In both cases the embezzler could have done something else with the property, and hence the Commission's necessary "connection" under the securities laws would not be met.[28] If the relevant test under the "in connection with" language is whether the fraudulent act is necessarily tied to a securities transaction, then the misappropriation of confidential information used to trade no more violates § 10(b) than does the misappropriation of funds used to trade. As the Commission concedes that the latter is not covered under its theory, I am at a loss to see how the same theory can coherently be applied to the former.[29]

      135

      [687] The majority makes no attempt to defend the misappropriation theory as set forth by the Commission. Indeed, the majority implicitly concedes the indefensibility of the Commission's theory by acknowledging that alternative uses of misappropriated information exist that do not violate the securities laws and then dismissing the Government's repeated explanations of its misappropriation theory as mere "overstatement." Ante, at 657. Having rejected the Government's description of its theory, the majority then engages in the "imaginative" exercise of constructing its own misappropriation theory from whole cloth. Thus, we are told, if we merely "[s]ubstitute `ordinarily' for `only' " when describing the degree of connecteness between a misappropriation and a securities transaction, the Government would have a winner. Ibid. Presumably, the majority would similarly edit the Government's brief to this Court to argue for only an "ordinary," rather than an "inherent connection between the deceptive conduct and the purchase or sale of a security." Brief for United States 21 (emphasis added).

      136

      I need not address the coherence, or lack thereof, of the majority's new theory, for it suffers from a far greater, and dispositive, flaw: It is not the theory offered by the Commission. Indeed, as far as we know from the majority's opinion, this new theory has never been proposed by the Commission, much less adopted by rule or otherwise. It is a fundamental proposition of law that this Court "may not supply a reasoned basis for the agency's action that the agency itself has not given." Motor Vehicle Mfrs. Assn. of United States, Inc. v. State Farm Mut. Automobile Ins. Co., 463 U. S. 29, 43 (1983). We do not even credit a "post hoc rationalizatio[n]" of counsel for the agency, id., at 50, so one is left to wonder how we could possibly rely on a post hoc rationalization [688] invented by this Court and never even presented by the Commission for our consideration.

      137

      Whether the majority's new theory has merit, we cannot possibly tell on the record before us. There are no findings regarding the "ordinary" use of misappropriated information, much less regarding the "ordinary" use of other forms of embezzled property. The Commission has not opined on the scope of the new requirement that property must "ordinarily" be used for securities trading in order for its misappropriation to be "in connection with" a securities transaction. We simply do not know what would or would not be covered by such a requirement, and hence cannot evaluate whether the requirement embodies a consistent and coherent interpretation of the statute.[30] Moreover, persons subject to [689] this new theory, such as respondent here, surely could not and cannot regulate their behavior to comply with the new theory because, until today, the theory has never existed. In short, the majority's new theory is simply not presented by this case, and cannot form the basis for upholding respondent's convictions.

      138

      In upholding respondent's convictions under the new and improved misappropriation theory, the majority also points to various policy considerations underlying the securities laws, such as maintaining fair and honest markets, promoting investor confidence, and protecting the integrity of the securities markets. Ante, at 657, 658-659. But the repeated reliance on such broad-sweeping legislative purposes reaches too far and is misleading in the context of the misappropriation theory. It reaches too far in that, regardless of the overarching purpose of the securities laws, it is not illegal to run afoul of the "purpose" of a statute, only its letter. The majority's approach is misleading in this case because it glosses over the fact that the supposed threat to fair and honest markets, investor confidence, and market integrity comes not from the supposed fraud in this case, but from the mere fact that the information used by O'Hagan was nonpublic.

      139

      As the majority concedes, because "the deception essential to the misappropriation theory involves feigning fidelity to the source of information, if the fiduciary discloses to the source that he plans to trade on the nonpublic information, there is no `deceptive device' and thus no § 10(b) violation." Ante, at 655 (emphasis added). Indeed, were the source expressly to authorize its agents to trade on the confidential information—as a perk or bonus, perhaps—there would likewise be no § 10(b) violation.[31] Yet in either case—disclosed [690] misuse or authorized use—the hypothesized "inhibiting impact on market participation," ante, at 659, would be identical to that from behavior violating the misappropriation theory: "Outsiders" would still be trading based on nonpublic information that the average investor has no hope of obtaining through his own diligence.[32]

      140

      The majority's statement that a "misappropriator who trades on the basis of material, nonpublic information, in short, gains his advantageous market position through deception; he deceives the source of the information and simultaneously harms members of the investing public, " ante, at 656 (emphasis added), thus focuses on the wrong point. Even if it is true that trading on nonpublic information hurts the public, it is true whether or not there is any deception of the source of the information.[33] Moreover, as [691] we have repeatedly held, use of nonpublic information to trade is not itself a violation of § 10(b). E. g., Chiarella, 445 U. S., at 232-233. Rather, it is the use of fraud "in connection with" a securities transaction that is forbidden. Where the relevant element of fraud has no impact on the integrity of the subsequent transactions as distinct from the nonfraudulent element of using nonpublic information, one can reasonably question whether the fraud was used in connection with a securities transaction. And one can likewise question whether removing that aspect of fraud, though perhaps laudable, has anything to do with the confidence or integrity of the market.

      141

      The absence of a coherent and consistent misappropriation theory and, by necessary implication, a coherent and consistent application of the statutory "use or employ, in connection with" language, is particularly problematic in the context of this case. The Government claims a remarkable breadth to the delegation of authority in § 10(b), arguing that "the very aim of this section was to pick up unforeseen, cunning, deceptive devices that people might cleverly use in the securities markets." Tr. of Oral Arg. 7. As the Court aptly queried, "[t]hat's rather unusual, for a criminal statute to be that open-ended, isn't it?" Ibid. Unusual indeed. Putting aside the dubious validity of an open-ended delegation to an independent agency to go forth and create regulations criminalizing "fraud," in this case we do not even have a formal regulation embodying the agency's misappropriation theory. Certainly Rule 10b—5 cannot be said to embody the theory— although it deviates from the statutory language by the addition of the words "any person," it merely repeats, unchanged, § 10(b)'s "in connection with" language. Given that the validity of the misappropriation theory turns on the construction [692] of that language in § 10(b), the regulatory language is singularly uninformative.[34]

      142

      Because we have no regulation squarely setting forth some version of the misappropriation theory as the Commission's interpretation of the statutory language, we are left with little more than the Commission's litigating position or the majority's completely novel theory that is not even acknowledged, much less adopted, by the Commission. As we have noted before, such positions are not entitled to deference and, at most, get such weight as their persuasiveness warrants. Metropolitan Stevedore Co. v. Rambo, ante, at 138, n. 9, 140, n. 10. Yet I find wholly unpersuasive a litigating position by the Commission that, at best, embodies an inconsistent and incoherent interpretation of the relevant statutory language and that does not provide any predictable guidance as to what behavior contravenes the statute. That position is no better than an ad hoc interpretation of statutory language and in my view can provide no basis for liability.

      143
      II
      144

      I am also of the view that O'Hagan's conviction for violating Rule 14e—3(a) cannot stand. Section 14(e) of the Exchange Act provides, in relevant part:

      145
      "It shall be unlawful for any person . . . to engage in any fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer . . . . The Commission shall, for the purposes of this subsection, by rules and regulations define, and prescribe means [693] reasonably designed to prevent, such acts and practices as are fraudulent, deceptive, or manipulative." 15 U. S. C. § 78n(e).
      146

      Pursuant to the rulemaking authority conferred by this section, the Commission has promulgated Rule 14e—3(a), which provides, in relevant part:

      147
      "(a) If any person has taken a substantial step or steps to commence, or has commenced, a tender offer (the `offering person'), it shall constitute a fraudulent, deceptive or manipulative act or practice within the meaning of section 14(e) of the [Securities Exchange] Act for any other person who is in possession of material information relating to such tender offer which information he knows or has reason to know is nonpublic and which he knows or has reason to know has been acquired directly or indirectly from:

      "(1) The offering person,

      "(2) The issuer of the securities sought or to be sought by such tender offer, or

      "(3) [Any person acting on behalf of the offering person or such issuer], to purchase or sell [any such securities or various instruments related to such securities], unless within a reasonable time prior to any purchase or sale such information and its source are publicly disclosed by press release or otherwise." 17 CFR § 240.14e—3(a) (1996).

      148

      As the majority acknowledges, Rule 14e—3(a) prohibits a broad range of behavior regardless of whether such behavior is fraudulent under our precedents. See ante, at 669 (Rule applies "`without regard to whether the trader owes a preexisting fiduciary duty to respect the confidentiality of the information' " (emphasis deleted)) (quoting United States v. Chestman, 947 F. 2d 551, 557 (CA2 1991) (en banc), cert. denied, 503 U. S. 1004 (1992)).

      149

      [694] The Commission offers two grounds in defense of Rule 14e—3(a). First, it argues that § 14(e) delegates to the Commission the authority to "define" fraud differently than that concept has been defined by this Court, and that Rule 14e— 3(a) is a valid exercise of that "defining" power. Second, it argues that § 14(e) authorizes the Commission to "prescribe means reasonably designed to prevent" fraudulent acts, and that Rule 14e—3(a) is a prophylactic rule that may prohibit nonfraudulent acts as a means of preventing fraudulent acts that are difficult to detect or prove.

      150

      The majority declines to reach the Commission's first justification, instead sustaining Rule 14e—3(a) on the ground that

      151
      "under § 14(e), the Commission may prohibit acts not themselves fraudulent under the common law or § 10(b), if the prohibition is `reasonably designed to prevent . . . acts and practices [that] are fraudulent.' " Ante, at 673 (quoting 15 U. S. C. § 78n(e)).
      152

      According to the majority, prohibiting trading on nonpublic information is necessary to prevent such supposedly hardto-prove fraudulent acts and practices as trading on information obtained from the buyer in breach of a fiduciary duty, ante, at 675, and possibly "warehousing," whereby the buyer tips allies prior to announcing the tender offer and encourages them to purchase the target company's stock, ante, at 672-673, n. 17.[35]

      153

      I find neither of the Commission's justifications for Rule 14e—3(a) acceptable in misappropriation cases. With regard to the Commission's claim of authority to redefine the concept of fraud, I agree with the Eighth Circuit that the Commission misreads the relevant provision of § 14(e).

      154
      [695] "Simply put, the enabling provision of § 14(e) permits the SEC to identify and regulate those `acts and practices' which fall within the § 14(e) legal definition of `fraudulent,' but it does not grant the SEC a license to redefine the term." 92 F. 3d 612, 624 (1996).
      155

      This conclusion follows easily from our similar statement in Schreiber v. Burlington Northern, Inc., 472 U. S. 1, 11, n. 11 (1985), that § 14(e) gives the "Commission latitude to regulate nondeceptive activities as a `reasonably designed' means of preventing manipulative acts, without suggesting any change in the meaning of the term `manipulative' itself."

      156

      Insofar as the Rule 14e—3(a) purports to "define" acts and practices that "are fraudulent," it must be measured against our precedents interpreting the scope of fraud. The majority concedes, however, that Rule 14e—3(a) does not prohibit merely trading in connection with fraudulent nondisclosure, but rather it prohibits trading in connection with any nondisclosure, regardless of the presence of a pre-existing duty to disclose. Ante, at 669. The Rule thus exceeds the scope of the Commission's authority to define such acts and practices as "are fraudulent."[36]

      157

      [696] Turning to the Commission's second justification for Rule 14e—3(a), although I can agree with the majority that § 14(e) authorizes the Commission to prohibit nonfraudulent acts as a means reasonably designed to prevent fraudulent ones, I cannot agree that Rule 14e—3(a) satisfies this standard. As an initial matter, the Rule, on its face, does not purport to be an exercise of the Commission's prophylactic power, but rather a redefinition of what "constitute[s] a fraudulent, deceptive, or manipulative act or practice within the meaning of § 14(e)." That Rule 14e—3(a) could have been "conceived and defended, alternatively, as definitional or preventive," ante, at 674, n. 19, misses the point. We evaluate regulations not based on the myriad of explanations that could have been given by the relevant agency, but on those explanations and justifications that were, in fact, given. See State Farm, 463 U. S., at 43, 50. Rule 14e—3(a) may not be "[s]ensibly read" as an exercise of "preventive" authority, ante, at 674, n. 19; it can only be differently so read, contrary to its own terms.

      158

      Having already concluded that the Commission lacks the power to redefine fraud, the regulation cannot be sustained on its own reasoning. This would seem a complete answer to whether the Rule is valid because, while we might give deference to the Commission's regulatory constructions of § 14(e), the reasoning used by the regulation itself is in this instance contrary to law and we need give no deference to the Commission's post hoc litigating justifications not reflected in the regulation.

      159

      Even on its own merits, the Commission's prophylactic justification fails. In order to be a valid prophylactic regulation, Rule 14e—3(a) must be reasonably designed not merely to prevent any fraud, but to prevent persons from engaging in "fraudulent, deceptive, or manipulative acts or practices, in connection with any tender offer." 15 U. S. C. § 78n(e) (emphasis added). Insofar as Rule 14e—3(a) is designed to prevent the type of misappropriation at issue in this case, such acts are not legitimate objects of prevention because [697] the Commission's misappropriation theory does not represent a coherent interpretation of the statutory "in connection with" requirement, as explained in Part I, supra. Even assuming that a person misappropriating information from the bidder commits fraud on the bidder, the Commission has provided no coherent or consistent explanation as to why such fraud is "in connection with" a tender offer, and thus the Commission may not seek to prevent indirectly conduct which it could not, under its current theory, prohibit directly.[37]

      160

      Finally, even further assuming that the Commission's misappropriation theory is a valid basis for direct liability, I fail to see how Rule 14e—3(a)'s elimination of the requirement of a breach of fiduciary duty is "reasonably designed" to prevent the underlying "fraudulent" acts. The majority's primary argument on this score is that in many cases "`a breach of duty is likely but difficult to prove.' " Ante, at 674 (quoting Reply Brief for United States 16). Although the majority's hypothetical difficulties involved in a tipper-tippee situation might have some merit in the context of "classical" insider trading, there is no reason to suspect similar difficulties in "misappropriation" cases. In such cases, Rule 14e— 3(a) requires the Commission to prove that the defendant "knows or has reason to know" that the nonpublic information upon which trading occurred came from the bidder or an agent of the bidder. Once the source of the information has been identified, it should be a simple task to obtain proof of any breach of duty. After all, it is the bidder itself that was defrauded in misappropriation cases, and there is no reason [698] to suspect that the victim of the fraud would be reluctant to provide evidence against the perpetrator of the fraud.[38] There being no particular difficulties in proving a breach of duty in such circumstances, a rule removing the requirement of such a breach cannot be said to be "reasonably designed" to prevent underlying violations of the misappropriation theory.

      161

      What Rule 14e—3(a) was in fact "designed" to do can be seen from the remainder of the majority's discussion of the Rule. Quoting at length from the Commission's explanation of the Rule in the Federal Register, the majority notes the Commission's concern with "`unfair disparities in market information and market disruption.' " Ante, at 674 (quoting 45 Fed. Reg. 60412 (1980)). In the Commission's further explanation of Rule 14e—3(a)'s purpose—continuing the paragraph partially quoted by the majority—an example of the problem to be addressed is the so-called "stampede effect" [699] based on leaks and rumors that may result from trading on material, nonpublic information. Id., at 60413. The majority also notes (but does not rely on) the Government's contention that it would not be able to prohibit the supposedly problematic practice of "warehousing"—a bidder intentionally tipping allies to buy stock in advance of a bid announcement—if a breach of fiduciary duty were required. Ante, at 672-673, n.17 (citing Reply Brief for United States 17). Given these policy concerns, the majority notes with seeming approval the Commission's justification of Rule 14e—3(a) "as a means necessary and proper to assure the efficacy of Williams Act protections." Ante, at 674.

      162

      Although this reasoning no doubt accurately reflects the Commission's purposes in adopting Rule 14e—3(a), it does little to support the validity of that Rule as a means designed to prevent such behavior: None of the above-described acts involve breaches of fiduciary duties, hence a Rule designed to prevent them does not satisfy § 14(e)'s requirement that the Commission's Rules promulgated under that section be "reasonably designed to prevent" acts and practices that "are fraudulent, deceptive, or manipulative." As the majority itself recognizes, there is no "`general duty between all participants in market transactions to forgo actions based on material, nonpublic information,' " and such duty only "`arises from a specific relationship between two parties.' " Ante, at 661 (quoting Chiarella, 445 U. S., at 233). Unfair disparities in market information, and the potential "stampede effect" of leaks, do not necessarily involve a breach of any duty to anyone, and thus are not proper objects for regulation in the name of "fraud" under § 14(e). Likewise (as the Government concedes, Reply Brief for United States 17), "warehousing" is not fraudulent given that the tippees are using the information with the express knowledge and approval of the source of the information. There simply would be no deception in violation of a duty to disclose under such circumstances. Cf. ante, at 654-655 (noting Government's concession [700] that use of bidder's information with bidder's knowledge is not fraudulent under misappropriation theory).

      163

      While enhancing the overall efficacy of the Williams Act may be a reasonable goal, it is not one that may be pursued through § 14(e), which limits its grant of rulemaking authority to the prevention of fraud, deceit, and manipulation. As we have held in the context of § 10(b), "not every instance of financial unfairness constitutes fraudulent activity." Chiarella, supra, at 232. Because, in the context of misappropriation cases, Rule 14e—3(a) is not a means "reasonably designed" to prevent persons from engaging in fraud "in connection with" a tender offer, it exceeds the Commission's authority under § 14(e), and respondent's conviction for violation of that Rule cannot be sustained.

      164
      III
      165

      With regard to respondent's convictions on the mail fraud counts, my view is that they may be sustained regardless of whether respondent may be convicted of the securities fraud counts. Although the issue is highly fact bound, and not independently worthy of plenary consideration by this Court, we have nonetheless accepted the issue for review and therefore I will endeavor to resolve it.

      166

      As I read the indictment, it does not materially differ from the indictment in Carpenter v. United States, 484 U. S. 19 (1987). There, the Court was unanimous in upholding the mail fraud conviction, id., at 28, despite being evenly divided on the securities fraud counts, id., at 24. I do not think the wording of the indictment in the current case requires a finding of securities fraud in order to find mail fraud. Certainly the jury instructions do not make the mail fraud count dependent on the securities fraud counts. Rather, the counts were simply predicated on the same factual basis, and just because those facts are legally insufficient to constitute securities fraud does not make them legally insufficient [701] to constitute mail fraud.[39] I therefore concur in the judgment of the Court as it relates to respondent's mail fraud convictions.

      167

      ----------

      168

      [1] Briefs of amici curiae urging reversal were filed for the American Institute of Certified Public Accountants by Louis A. Craco, Richard I. Miller, and David P. Murray; for the Association for Investment Management and Research by Stuart H. Singer; and for the North American Securities Administrators Association, Inc., et al. by Karen M. O'Brien, Meyer Eisenberg, Louis Loss, and Donald C. Langevoort.

      169

      Briefs of amici curiae urging affirmance were filed for Law Professors and Counsel by Richard W. Painter and Douglas W. Dunham; and for the National Association of Criminal Defense Lawyers by Arthur F. Mathews, David M. Becker, Andrew B. Weissman, Robert F. Hoyt, Lisa Kemler, Milton V. Freeman, and Elkan Abramowitz.

      170

      [2] As evidence that O'Hagan traded on the basis of nonpublic information misappropriated from his law firm, the Government relied on a conversation between O'Hagan and the Dorsey & Whitney partner heading the firm's Grand Met representation. That conversation allegedly took place shortly before August 26, 1988. See Brief for United States 4. O'Hagan urges that the Government's evidence does not show he traded on the basis of nonpublic information. O'Hagan points to news reports on August 18 and 22, 1988, that Grand Met was interested in acquiring Pillsbury, and to an earlier, August 12, 1988, news report that Grand Met had put up its hotel chain for auction to raise funds for an acquisition. See Brief for Respondent 4 (citing App. 73-74, 78-80). O'Hagan's challenge to the sufficiency of the evidence remains open for consideration on remand.

      171

      [3] O'Hagan was convicted of theft in state court, sentenced to 30 months' imprisonment, and fined. See State v. O'Hagan, 474 N. W. 2d 613, 615, 623 (Minn. App. 1991). The Supreme Court of Minnesota disbarred O'Hagan from the practice of law. See In re O'Hagan, 450 N. W. 2d 571 (1990).

      172

      [4] See, e. g., United States v. Chestman, 947 F. 2d 551, 566 (CA2 1991) (en banc), cert. denied, 503 U. S. 1004 (1992); SEC v. Cherif, 933 F. 2d 403, 410 (CA7 1991), cert. denied, 502 U. S. 1071 (1992); SEC v. Clark, 915 F. 2d 439, 453 (CA9 1990).

      173

      [5] Twice before we have been presented with the question whether criminal liability for violation of § 10(b) may be based on a misappropriation theory. In Chiarella v. United States, 445 U. S. 222, 235-237 (1980), the jury had received no misappropriation theory instructions, so we declined to address the question. See infra, at 661. In Carpenter v. United States, 484 U. S. 19, 24 (1987), the Court divided evenly on whether, under the circumstances of that case, convictions resting on the misappropriation theory should be affirmed. See Aldave, The Misappropriation Theory: Carpenter and Its Aftermath, 49 Ohio St. L. J. 373, 375 (1988) (observing that "Carpenter was, by any reckoning, an unusual case," for the information there misappropriated belonged not to a company preparing to engage in securities transactions, e. g., a bidder in a corporate acquisition, but to the Wall Street Journal).

      174

      [6] The Government could not have prosecuted O'Hagan under the classical theory, for O'Hagan was not an "insider" of Pillsbury, the corporation in whose stock he traded. Although an "outsider" with respect to Pillsbury, O'Hagan had an intimate association with, and was found to have traded on confidential information from, Dorsey & Whitney, counsel to tender offer or Grand Met. Under the misappropriation theory, O'Hagan's securities trading does not escape Exchange Act sanction, as it would under Justice Thomas' dissenting view, simply because he was associated with, and gained nonpublic information from, the bidder, rather than the target.

      175

      [7] Under the misappropriation theory urged in this case, the disclosure obligation runs to the source of the information, here, Dorsey & Whitney and Grand Met. Chief Justice Burger, dissenting in Chiarella, advanced a broader reading of § 10(b) and Rule 10b—5; the disclosure obligation, as he envisioned it, ran to those with whom the misappropriator trades. 445 U. S., at 240 ("a person who has misappropriated nonpublic information has an absolute duty to disclose that information or to refrain from trading"); see also id., at 243, n. 4. The Government does not propose that we adopt a misappropriation theory of that breadth.

      176

      [8] Where, however, a person trading on the basis of material, nonpublic information owes a duty of loyalty and confidentiality to two entities or persons—for example, a law firm and its client—but makes disclosure to only one, the trader may still be liable under the misappropriation theory.

      177

      [9] Justice Thomas' evident struggle to invent other uses to which O'Hagan plausibly might have put the nonpublic information, see post, at 685, is telling. It is imaginative to suggest that a trade journal would have paid O'Hagan dollars in the millions to publish his information. See Tr. of Oral Arg. 36-37. Counsel for O'Hagan hypothesized, as a nontrading use, that O'Hagan could have "misappropriat[ed] this information of [his] law firm and its client, deliver[ed] it to [Pillsbury], and suggest[ed] that [Pillsbury] in the future . . . might find it very desirable to use [O'Hagan] for legal work." Id., at 37. But Pillsbury might well have had large doubts about engaging for its legal work a lawyer who so stunningly displayed his readiness to betray a client's confidence. Nor is the Commission's theory "incoherent" or "inconsistent," post, at 680, 692, for failing to inhibit use of confidential information for "personal amusement . . . in a fantasy stock trading game," post, at 685.

      178

      [10] As noted earlier, however, see supra, at 654-655, the textual requirement of deception precludes § 10(b) liability when a person trading on the basis of nonpublic information has disclosed his trading plans to, or obtained authorization from, the principal—even though such conduct may affect the securities markets in the same manner as the conduct reached by the misappropriation theory. Contrary to Justice Thomas' suggestion, see post, at 689-691, the fact that § 10(b) is only a partial antidote to the problems it was designed to alleviate does not call into question its prohibition of conduct that falls within its textual proscription. Moreover, once a disloyal agent discloses his imminent breach of duty, his principal may seek appropriate equitable relief under state law. Furthermore, in the context of a tender offer, the principal who authorizes an agent's trading on confidential information may, in the Commission's view, incur liability for an Exchange Act violation under Rule 14e—3(a).

      179

      [11] The Eighth Circuit's conclusion to the contrary was based in large part on Dirks `s reiteration of the Chiarella language quoted and discussed above. See 92 F. 3d 612, 618-619 (1996).

      180

      [12] The United States additionally argues that Congress confirmed the validity of the misappropriation theory in the Insider Trading and Securities Fraud Enforcement Act of 1988 (ITSFEA), § 2(1), 102 Stat. 4677, note following 15 U. S. C. § 78u—1. See Brief for United States 32-35. ITSFEA declares that "the rules and regulations of the Securities and Exchange Commission under the Securities Exchange Act of 1934 . . . governing trading while in possession of material, nonpublic information are, as required by such Act, necessary and appropriate in the public interest and for the protection of investors." Note following 15 U. S. C. § 78u—1. ITSFEA also includes a new § 20A(a) of the Exchange Act expressly providing a private cause of action against persons who violate the Exchange Act "by purchasing or selling a security while in possession of material, nonpublic information"; such an action may be brought by "any person who, contemporaneously with the purchase or sale of securities that is the subject of such violation, has purchased . . . or sold . . . securities of the same class." 15 U. S. C. § 78t—1(a). Because we uphold the misappropriation theory on the basis of § 10(b) itself, we do not address ITSFEA's significance for cases of this genre.

      181

      [13] In relevant part, § 32 of the Exchange Act, as set forth in 15 U. S. C. § 78ff(a), provides:

      182

      "Any person who willfully violates any provision of this chapter . . . or any rule or regulation thereunder the violation of which is made unlawful or the observance of which is required under the terms of this chapter . . . shall upon conviction be fined not more than $1,000,000, or imprisoned not more than 10 years, or both . . . ; but no person shall be subject to imprisonment under this section for the violation of any rule or regulation if he proves that he had no knowledge of such rule or regulation."

      183

      [14] The statute provides no such defense to imposition of monetary fines. See ibid.

      184

      [15] In addition to § 14(e), the Williams Act and the 1970 amendments added to the Exchange Act the following provisions concerning disclosure: § 13(d), 15 U. S. C. § 78m(d) (disclosure requirements for persons acquiring more than five percent of certain classes of securities); § 13(e), 15 U. S. C. § 78m(e) (authorizing Commission to adopt disclosure requirements for certain repurchases of securities by issuer); § 14(d), 15 U. S. C. § 78n(d) (disclosure requirements when tender offer results in offer or owning more than five percent of a class of securities); § 14(f),15 U. S. C. § 78n(f) (disclosure requirements when tender offer results in new corporate directors constituting a majority).

      185

      [16] The Rule thus adopts for the tender offer context a requirement resembling the one Chief Justice Burger would have adopted in Chiarella for misappropriators under § 10(b). See supra, at 655, n. 6.

      186

      [17] The Government draws our attention to the following measures: 17 CFR § 240.15c2-1 (1970) (prohibiting a broker-dealer's hypothecation of a customer's securities if hypothecated securities would be commingled with the securities of another customer, absent written consent); § 240.15c2-3 (prohibiting transactions by broker-dealers in unvalidated German securities); § 240.15c2-4 (prohibiting broker-dealers from accepting any part of the sale price of a security being distributed unless the money received is promptly transmitted to the persons entitled to it); § 240.15c2-5 (requiring broker-dealers to provide written disclosure of credit terms and commissions in connection with securities sales in which broker-dealers extend credit, or participate in arranging for loans, to the purchasers). See Brief for United States 39, n. 22.

      187

      [18] We leave for another day, when the issue requires decision, the legitimacy of Rule 14e—3(a) as applied to "warehousing," which the Government describes as "the practice by which bidders leak advance information of a tender offer to allies and encourage them to purchase the target company's stock before the bid is announced." Reply Brief 17. As we observed in Chiarella, one of the Commission's purposes in proposing Rule 14e—3(a) was "to bar warehousing under its authority to regulate tender offers." 445 U. S., at 234. The Government acknowledges that trading authorized by a principal breaches no fiduciary duty. See Reply Brief 17. The instant case, however, does not involve trading authorized by a principal; therefore, we need not here decide whether the Commission's proscription of warehousing falls within its § 14(e) authority to define or prevent fraud.

      188

      [19] The Commission's power under § 10(b) is more limited. See supra, at 651 (Rule 10b—5 may proscribe only conduct that § 10(b) prohibits).

      189

      [20] Justice Thomas' dissent urges that the Commission must be precise about the authority it is exercising—that it must say whether it is acting to "define" or to "prevent" fraud—and that in this instance it has purported only to define, not to prevent. See post, at 696. Justice Thomas sees this precision in Rule 14e—3(a)'s words: "it shall constitute a fraudulent . . . act . . . within the meaning of section 14(e) . . . ." We do not find the Commission's Rule vulnerable for failure to recite as a regulatory preamble: We hereby exercise our authority to "define, and prescribe means reasonably designed to prevent, . . . [fraudulent] acts." Sensibly read, the Rule is an exercise of the Commission's full authority. Logically and practically, such a rule may be conceived and defended, alternatively, as definitional or preventive.

      190

      [21] Justice Thomas opines that there is no reason to anticipate difficulties in proving breach of duty in "misappropriation" cases. "Once the source of the [purloined] information has been identified," he asserts, "it should be a simple task to obtain proof of any breach of duty." Post, at 697. To test that assertion, assume a misappropriating partner at Dorsey & Whitney told his daughter or son and a wealthy friend that a tender for Pillsbury was in the offing, and each tippee promptly purchased Pillsbury stock, the child borrowing the purchase price from the wealthy friend. Justice Thomas' confidence, post, at 698, n. 12, that "there is no reason to suspect that the tipper would gratuitously protect the tippee," seems misplaced.

      191

      [22] Justice Thomas insists that even if the misappropriation of information from the bidder about a tender offer is fraud, the Commission has not explained why such fraud is "in connection with" a tender offer. Post, at 697, 698. What else, one can only wonder, might such fraud be "in connection with"?

      192

      [23] Repeating the argument it made concerning the misappropriation theory, see supra, at 665, n. 11, the United States urges that Congress confirmed Rule 14e—3(a)'s validity in ITSFEA, 15 U. S. C. § 78u—1. See Brief for United States 44-45. We uphold Rule 14e—3(a) on the basis of § 14(e) itself and need not address ITSFEA's relevance to this case.

      193

      [24] As to O'Hagan's scienter argument, we reiterate that 15 U. S. C. § 78ff(a)requires the Government to prove "willful[l]violat[ion]" of the securities laws, and that lack of knowledge of the relevant rule is an affirmative defense to a sentence of imprisonment. See supra, at 665-666.

      194

      [25] The Court of Appeals reversed respondent's money laundering convictions on similar reasoning. See 92 F. 3d, at 628. Because the United States did not seek review of that ruling, we leave undisturbed that portion of the Court of Appeals' judgment.

      195

      [26] Justice Thomas finds O'Hagan's convictions on the mail fraud counts, but not on the securities fraud counts, sustainable. Post, at 700-701. Under his view, securities traders like O'Hagan would escape SEC civil actions and federal prosecutions under legislation targeting securities fraud, only to be caught for their trading activities in the broad mail fraud net. If misappropriation theory cases could proceed only under the federal mail and wire fraud statutes, practical consequences for individual defendants might not be large, see Aldave, 49 Ohio St. L. J., at 381, and n. 60; however, "proportionally more persons accused of insider trading [might] be pursued by a U. S. Attorney, and proportionally fewer by the SEC," id., at 382. Our decision, of course, does not rest on such enforcement policy considerations.

      196

      [27] Of course, the "use" to which one puts misappropriated property need not be one designed to bring profit to the misappropriator: Any "fraudulent appropriation to one's own use" constitutes embezzlement, regardless of what the embezzler chooses to do with the money. See, e. g., Logan v. State, 493 P. 2d 842, 846 (Okla. Crim. App. 1972) ("Any diversion of funds held in trust constitutes embezzlement whether there is direct personal benefit or not as long as the owner is deprived of his money").

      197

      [28] Indeed, even if O'Hagan or someone else thereafter used the information to trade, the misappropriation would have been complete before the trade and there should be no § 10(b) liability. The most obvious realworld example of this scenario would be if O'Hagan had simply tipped someone else to the information. The mere act of passing the information along would have violated O'Hagan's fiduciary duty and, if undisclosed, would be an "embezzlement" of the confidential information, regardless of whether the tippee later traded on the information.

      198

      [29] The majority is apparently unimpressed by the example of a misappropriator using embezzled information for personal amusement in a fantasy stock trading game, finding no need for the Commission to "inhibit" such recreational uses. Ante, at 657, n. 8. This argument, of course, misses the point of the example. It is not that such a use does or should violate the securities laws yet is not covered by the Commission's theory; rather, the example shows that the misappropriation of information is not "only" or "inherently" tied to securities trading, and hence the misappropriation of information, whatever its ultimate use, fails the Commission's own test under the "in connection with" requirement of § 10(b) and Rule 10b—5.

      199

      [30] Similarly, the majority's assertion that the alternative uses of misappropriated information are not as profitable as use in securities trading, ante, at 657, n. 8, is speculative at best. We have no idea what is the best or most profitable use of misappropriated information, either in this case or generally. We likewise have no idea what is the best use of other forms of misappropriated property, and it is at least conceivable that the best use of embezzled money, or securities themselves, is for securities trading. If the use of embezzled money to purchase securities is "sufficiently detached," ante, at 657, from a securities transaction, then I see no reason why the non-"inherent" use of information for securities trading is not also "sufficiently detached" under the Government's theory. In any event, I am at a loss to find in the statutory language any hint of a "best-use" requirement for setting the requisite connection between deception and the purchase or sale of securities.

      200

      The majority's further claim that it is unremarkable that "a rule suitably applied to the fraudulent uses of certain kinds of information would be stretched beyond reason were it applied to the fraudulent use of money," ibid., is itself remarkable given that the only existing "rule" is Rule 10b—5, which nowhere confines itself to information and, indeed, does not even contain the word. And given that the only "reason" offered by the Government in support of its misappropriation theory applies (or fails to apply) equally to money or to information, the application of the Government's theory in this case is no less "beyond reason" than it would be as applied to financial embezzlement.

      201

      [31] See Tr. of Oral Arg. 9 (Government conceding that, "just as in [Carpenter v. United States, 484 U. S. 19 (1987)], if [the defendant] had gone to the Wall Street Journal and said, look, you know, you're not paying me very much. I'd like to make a little bit more money by buying stock, the stocks that are going to appear in my Heard on the Street column, and the Wall Street Journal said, that's fine, there would have been no deception of the Wall Street Journal").

      202

      [32] That the dishonesty aspect of misappropriation might be eliminated via disclosure or authorization is wholly besides the point. The dishonesty in misappropriation is in the relationship between the fiduciary and the principal, not in any relationship between the misappropriator and the market. No market transaction is made more or less honest by disclosure to a third-party principal, rather than to the market as a whole. As far as the market is concerned, a trade based on confidential information is no more "honest" because some third party may know of it so long as those on the other side of the trade remain in the dark.

      203

      [33] The majority's statement, by arguing that market advantage is gained "through" deception, unfortunately seems to embrace an error in logic: Conflating causation and correlation. That the misappropriator may both deceive the source and "simultaneously" hurt the public no more shows a causal "connection" between the two than the fact that the sun both gives some people a tan and "simultaneously" nourishes plants demonstrates that melanin production in humans causes plants to grow. In this case, the only element common to the deception and the harm is that both are the result of the same antecedent cause—namely, using nonpublic information. But such use, even for securities trading, is not illegal, and the consequential deception of the source follows an entirely divergent branch of causation than does the harm to the public. The trader thus "gains his advantageous market position through " the use of nonpublic information, whether or not deception is involved; the deception has no effect on the existence or extent of his advantage.

      204

      [34] That the Commission may purport to be interpreting its own Rule, rather than the statute, cannot provide it any greater leeway where the Rule merely repeats verbatim the statutory language on which the entire question hinges. Furthermore, as even the majority recognizes, Rule 10b—5 may not reach beyond the scope of § 10(b), ante, at 651, and thus the Commission is obligated to explain how its theory fits within its interpretation of § 10(b) even if it purports to be interpreting its own derivative rule.

      205

      [35] Although the majority leaves open the possibility that Rule 14e—3(a) may be justified as a means of preventing "warehousing," it does not rely on that justification to support its conclusion in this case. Suffice it to say that the Commission itself concedes that warehousing does not involve fraud as defined by our cases, see Reply Brief for United States 17, and thus preventing warehousing cannot serve to justify Rule 14e—3(a).

      206

      [36] Even were § 14(e)'s defining authority subject to the construction given it by the Commission, there are strong constitutional reasons for not so construing it. A law that simply stated "it shall be unlawful to do 'X', however 'X' shall be defined by an independent agency," would seem to offer no "intelligible principle" to guide the agency's discretion and would thus raise very serious delegation concerns, even under our current jurisprudence, J. W. Hampton, Jr., & Co. v. United States, 276 U. S. 394, 409 (1928). See also Field v. Clark, 143 U. S. 649, 693-694 (1892) (distinguishing between making the law by determining what it shall be, and executing the law by determining facts on which the law's operation depends). The Commission's interpretation of § 14(e) would convert it into precisely the type of law just described. Thus, even if that were a plausible interpretation, our usual practice is to avoid unnecessary interpretations of statutory language that call the constitutionality of the statute into further serious doubt.

      207

      [37] I note that Rule 14e—3(a) also applies to persons trading upon information obtained from an insider of the target company. Insofar as the Rule seeks to prevent behavior that would be fraudulent under the "classical theory" of insider trading, this aspect of my analysis would not apply. As the majority notes, however, the Government "could not have prosecuted O'Hagan under the classical theory," ante, at 653, n. 5, hence this proviso has no application to the present case.

      208

      [38] Even where the information is obtained from an agent of the bidder, and the tippee claims not to have known that the tipper violated a duty, there is still no justification for Rule 14e—3(a). First, in such circumstances the tipper himself would have violated his fiduciary duty and would be liable under the misappropriation theory, assuming that theory were valid. Facing such liability, there is no reason to suspect that the tipper would gratuitously protect the tippee. And if the tipper accurately testifies that the tippee was (falsely) told that the information was passed on without violating the tipper's own duties, one can question whether the tippee has in fact done anything illegal, even under the Commission's misappropriation theory. Given that the fraudulent breach of fiduciary duty would have been complete at the moment of the tip, the subsequent trading on that information by the tippee might well fail even the Commission's own construction of the "in connection with" requirement. See supra, at 683-687. Thus, even if the tipper might, in some circumstances, be inclined to protect the tippee, see ante, at 675-676, n. 20, it is doubtful that the tippee would have violated the misappropriation theory in any event, and thus preventing such nonviolations cannot justify Rule 14e— 3(a). Second, even were this scenario a legitimate concern, it would at most justify eliminating the requirement that the tippee "know" about the breach of duty. It would not explain Rule 14e—3(a)'s elimination of the requirement that there be such a breach.

      209

      [39] While the majority may find it strange that the "mail fraud net" is broader reaching than the securities fraud net, ante, at 678, n. 25, any such supposed strangeness—and the resulting allocation of prosecutorial responsibility between the Commission and the various United States Attorneys—is no business of this Court, and can be adequately addressed by Congress if it too perceives a problem regarding jurisdictional boundaries among the Nation's prosecutors. That the majority believes that, upon shifting from securities fraud to mail fraud prosecutions, the "practical consequences for individual defendants might not be large," ibid., both undermines the supposed policy justifications for today's decision and makes more baffling the majority's willingness to go to such great lengths to save the Commission from itself.

    • 4.2 SEC v. Dorozhko

      Limits of misappropriation and the level playing field …

      1
      574 F.3d 42 (2009)
      2
      SECURITIES AND EXCHANGE COMMISSION, Plaintiff-Appellant,
      v.
      Oleksandr DOROZHKO, Defendant-Appellee.
      3
      Docket No. 08-0201-cv.
      United States Court of Appeals, Second Circuit.
      Argued: April 3, 2009.
      Decided: July 22, 2009.
      4

      [43] Mark Pennington, Assistant General Counsel (Brian G. Cartwright, General Counsel, Andrew N. Vollmer, Deputy General Counsel, Jacob H. Stillman, Solicitor, and David Lisitza, Attorney, on the brief), Washington, D.C.

      5

      Charles A. Ross (Christopher L. Padurano and Stephanie M. Carvlin, on the brief) Charles A. Ross & Assoc., LLC, New York, NY.

      6

      Before: CABRANES, HALL, Circuit Judges, and SULLIVAN, District Judge.[*]

      7
      JOSÉ A. CABRANES, Circuit Judge:
      8

      We are asked to consider whether, in a civil enforcement lawsuit brought by the United States Securities and Exchange Commission ("SEC") under Section 10(b) [44] of the Securities Exchange Act of 1934 ("Section 10(b)"), computer hacking may be "deceptive" where the hacker did not breach a fiduciary duty in fraudulently obtaining material, nonpublic information used in connection with the purchase or sale of securities. For the reasons stated herein, we answer the question in the affirmative.

      9
      BACKGROUND
      10

      In early October 2007, defendant Oleksandr Dorozhko, a Ukranian national and resident, opened an online trading account with Interactive Brokers LLC ("Interactive Brokers") and deposited $42,500 into that account. At about the same time, IMS Health, Inc. ("IMS") announced that it would release its third-quarter earnings during an analyst conference call scheduled for October 17, 2007 at 5 p.m.—that is, after the close of the securities markets in New York City. IMS had hired Thomson Financial, Inc. ("Thomson") to provide investor relations and web-hosting services, which included managing the online release of IMS's earnings reports.

      11

      Beginning at 8:06 a.m. on October 17, and continuing several times during the morning and early afternoon, an anonymous computer hacker attempted to gain access to the IMS earnings report by hacking into a secure server at Thomson prior to the report's official release. At 2:15 p.m.—minutes after Thomson actually received the IMS data—that hacker successfully located and downloaded the IMS data from Thomson's secure server.

      12

      Beginning at 2:52 p.m., defendant—who had not previously used his Interactive Brokers account to trade—purchased $41,670.90 worth of IMS "put" options that would expire on October 25 and 30, 2007.[1] These purchases represented approximately 90% of all purchases of "put" options for IMS stock for the six weeks prior to October 17. In purchasing these options, which the SEC describes as "extremely risky," defendant was betting that IMS's stock price would decline precipitously (within a two-day expiration period) and significantly (by greater than 20%). Appellant's Br. 2.

      13

      At 4:33 p.m.—slightly ahead of the analyst call—IMS announced that its earnings per share were 28% below "Street" expectations, i.e., the expectations of many Wall Street analysts. When the market opened the next morning, October 18, at 9:30 a.m., IMS's stock price sank approximately 28% almost immediately—from $29.56 to $21.20 per share. Within six minutes of the market opening, defendant had sold all of his IMS options, realizing a net profit of $286,456.59 overnight.

      14

      Interactive Brokers noticed the irregular trading activity and referred the matter to the SEC, which now alleges that defendant was the hacker. See SEC v. Dorozhko, 606 F.Supp.2d 321, 323 (S.D.N.Y.2008) (explaining that the SEC's theory rests on "two undisputed events: (1) the fact of the hack, and (2) the proximity to the hack of the trades by [defendant,] who was the only individual to trade heavily in IMS Health put options subsequent to the hack"). On October 29, 2007, the SEC sought and received from the United States District Court for the Southern District of New York (Naomi Reice Buchwald, Judge) a temporary restraining order freezing the proceeds of the "put" option transactions in defendant's brokerage [45] account. The District Court held a preliminary injunction hearing on the matter on November 28, 2007, at which it heard testimony and considered various affidavits.

      15

      On January 8, 2008, in a thoughtful and careful opinion, the District Court denied the SEC's request for a preliminary injunction because the SEC had not shown a likelihood of success. Specifically, the District Court ruled that computer hacking was not "deceptive" within the meaning of Section 10(b) as defined by the Supreme Court. According to the District Court, "a breach of a fiduciary duty of disclosure is a required element of any `deceptive' device under § 10b." Dorozhko, 606 F.Supp.2d at 330. The District Court reasoned that since defendant was a corporate outsider with no special relationship to IMS or Thomson, he owed no fiduciary duty to either. Although computer hacking might be fraudulent and might violate a number of federal and state criminal statutes, the District Court concluded that this behavior did not violate Section 10(b) without an accompanying breach of a fiduciary duty.

      16

      This appeal followed. On appeal, the SEC maintains its theory that the fraud in this case consists of defendant's alleged computer hacking, which involves various misrepresentations. The SEC does not argue that defendant breached any fiduciary duties as part of his scheme. In this critical regard, we recognize that the SEC's claim against defendant—a corporate outsider who owed no fiduciary duties to the source of the information—is not based on either of the two generally accepted theories of insider trading. See United States v. Cusimano, 123 F.3d 83, 87 (2d Cir.1997) (distinguishing "the traditional theory of insider trading, under which a corporate insider trades in the securities of his own corporation on the basis of material, non-public information," from "the misappropriation theory, [under which] § 10(b) and Rule 10b-5 are violated whenever a person trades while in knowing possession of material, non-public information that has been gained in violation of a fiduciary duty to its source"). The SEC's claim is nonetheless based on a claim of fraud, and we turn our attention to whether this fraud is "deceptive" within the meaning of Section 10(b).

      17
      DISCUSSION
      18
      Standard of Review
      19

      We review the grant or denial of a preliminary injunction for abuse of discretion. E.g., Kickham Hanley P.C. v. Kodak Retirement Income Plan, 558 F.3d 204, 209 (2d Cir.2009) ("[A]buse of discretion. . . occurs when (1) its decision rests on an error of law or a clearly erroneous factual finding, or (2) its decision—though not necessarily the product of a legal error or a clearly erroneous factual finding—cannot be located within the range of permissible decisions." (internal citations, parentheticals, and quotation marks omitted)); Davis v. New York, 316 F.3d 93, 102 (2d Cir. 2002).

      20
      "Deceptive Device"
      21

      "Section 10(b) prohibits the use or employ, in connection with the purchase or sale of any security . . ., [of] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe." 15 U.S.C. § 78j(b)[2] The instant case requires us to [46] decide whether the "device" in this case— computer hacking—could be "deceptive."[3]

      22

      In construing the text of any federal statute, we first consider the precedents that bind us as an intermediate appellate court—namely, the holdings of the Supreme Court and those of prior panels of this Court, which provide definitive interpretations of otherwise ambiguous language. Insofar as those precedents fail to resolve an apparent ambiguity, we examine the text of the statute itself, interpreting provisions in light of their ordinary meaning and their contextual setting. See United States v. Magassouba, 544 F.3d 387, 404 (2d Cir.2008) ("In determining whether statutory language is ambiguous, we `reference . . . the language itself, the specific context in which that language is used, and the broader context of the statute as a whole.'" (quoting Robinson v. Shell Oil Co., 519 U.S. 337, 341, 117 S.Ct. 843, 136 L.Ed.2d 808 (1997))). Where the statutory language remains ambiguous, "we resort to canons of construction and, if the meaning still remains ambiguous, to legislative history." Magassouba, 544 F.3d at 404 (internal alterations and quotation marks omitted).

      23

      The District Court determined that the Supreme Court has interpreted the "deceptive" element of Section 10(b) to require a breach of a fiduciary duty. See Dorozhko, 606 F.Supp.2d at 338 ("[T]he Supreme Court has in a number of opinions carefully established that the essential component of a § 10(b) violation is a breach of a fiduciary duty to disclose or abstain that coincides with a securities transaction."). The District Court reached this conclusion by relying principally on three Supreme Court opinions: Chiarella v. United States, 445 U.S. 222, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), United States v. O'Hagan, 521 U.S. 642, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997), and SEC v. Zandford, 535 U.S. 813, 122 S.Ct. 1899, 153 L.Ed.2d 1 (2002). We consider each of these cases in turn.

      24

      In Chiarella, the defendant was employed by a financial printer and used information passing through his office to trade securities offered by acquiring and target companies. In a criminal prosecution, [47] the government alleged that the defendant committed fraud by not disclosing to the market that he was trading on the basis of material, nonpublic information. The Supreme Court held that defendant's "silence," or nondisclosure, was not fraud because he was under no obligation to disclose his knowledge of inside information. "When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak. We hold that a duty to disclose under § 10(b) does not arise from the mere possession of nonpublic market information." 445 U.S. at 235, 100 S.Ct. 1108; see also United States v. Chestman, 947 F.2d 551, 575 (2d Cir. 1991) (Winter, J., concurring in part and dissenting in part) (stating that, after Chiarella, "silence cannot constitute a fraud absent a duty to speak owed to those who are injured"). Justice Blackmun, joined by Justice Marshall, dissented. In their view, stealing information from an employer was fraudulent within the meaning of Section 10(b) because the statute was designed as a "catchall" provision to protect investors from unknown risks. Id. at 246, 100 S.Ct. 1108 (Blackmun, J., dissenting). According to Justice Blackmun, the majority had "confine[d]" the meaning of fraud "by imposition of a requirement of a `special relationship' akin to fiduciary duty before the statute gives rise to a duty to disclose or to abstain from trading upon material, nonpublic information." Id.[4]

      25

      In O'Hagan, the defendant was an attorney who traded in securities based on material, nonpublic information regarding his firm's clients. As in Chiarella, the government alleged that the defendant had committed fraud through "silence" because the defendant had a duty to disclose to the source of the information (his client) that he would trade on the information. The Supreme Court agreed, noting that "[d]eception through nondisclosure is central to the theory of liability for which the Government seeks recognition." 521 U.S. at 654, 117 S.Ct. 2199. "[I]f the fiduciary discloses to the source that he plans to trade on the nonpublic information, there is no `deceptive device' and thus no § 10(b) violation—although the fiduciary-turned-trader may remain liable under state law for breach of a duty of loyalty." Id. at 655, 117 S.Ct. 2199.

      26

      In Zandford, the defendant was a securities broker who traded under a client's account and transferred the proceeds to his own account. The Fourth Circuit held that the defendant's fraud was not "in connection with" the purchase or sale of a security because it was mere theft that happened to involve securities, rather than true securities fraud. The Supreme Court reversed in a unanimous opinion, observing that Section 10(b) "should be construed not technically and restrictively, but flexibly to effectuate its remedial purposes." 535 U.S. at 819, 122 S.Ct. 1899. Although the Court warned that not "every common-law fraud that happens to involve securities [is] a violation of § 10(b)," id. at 820, 122 S.Ct. 1899, the defendant's scheme was a single plan to deceive, rather than a series of independent frauds, and was therefore "in connection with" the purchase or sale of a security, id. at 825, 122 S.Ct. 1899. In a final footnote, the Court offered the following observation: "[I]f the [48] broker told his client he was stealing the client's assets, that breach of fiduciary duty might be in connection with a sale of securities, but it would not involve a deceptive device or fraud." 535 U.S. at 825 n. 4, 122 S.Ct. 1899. In the instant case, the District Court interpreted the Zandford footnote as an "explicit[ ] acknowledg[ment] that Zandford would not be liable under § 10(b) if he had disclosed to Wood that he was planning to steal his money." Dorozhko, 606 F.Supp.2d at 338.

      27

      The District Court concluded that in Chiarella, O'Hagan, and Zandford, the Supreme Court developed a requirement that any "deceptive device" requires a breach of a fiduciary duty. In applying that interpretation to the instant case, the District Court ruled that "[a]lthough [defendant] may have broken the law, he is not liable in a civil action under § 10(b) because he owed no fiduciary or similar duty either to the source of his information or to those he transacted with in the market." Dorozhko, 606 F.Supp.2d at 324.[5] At least one of our sister circuits has made the same observation relying on the same precedent. See Regents of the Univ. of Cal. v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372, 389 (5th Cir.2007) (discussing Chiarella and O'Hagan, and stating that "the [Supreme] Court . . . has established that a device, such as a scheme, is not `deceptive' unless it involves breach of some duty of candid disclosure").

      28

      In our view, none of the Supreme Court opinions relied upon by the District Court—much less the sum of all three opinions — establishes a fiduciary-duty requirement as an element of every violation of Section 10(b). In Chiarella, O'Hagan, and Zandford, the theory of fraud was silence or nondisclosure, not an affirmative misrepresentation. The Supreme Court held that remaining silent was actionable only where there was a duty to speak, arising from a fiduciary relationship. In Chiarella, the Supreme Court held that there was no deception in an employee's silence because he did not have duty to speak. See 445 U.S. at 226, 100 S.Ct. 1108 ("This case concerns the legal effect of the petitioner's silence." (emphasis added)); see also id. at 227-28, 100 S.Ct. 1108 ("At common law, misrepresentation made for the purpose of inducing reliance upon the false statement is fraudulent. But one who fails to disclose material information prior to the consummation of a transaction commits fraud only when he is under a duty to do so." (emphasis added)). In O'Hagan, an attorney who traded on client secrets had a fiduciary duty to inform his firm that he was trading on the basis of the confidential information. See 521 U.S. at 653, 117 S.Ct. 2199 (noting that a "breach of a duty of trust and confidence. . . to his law firm" was conduct that "satisfies § 10(b)'s requirement that chargeable conduct involve a `deceptive device or contrivance'"); see also id. at 654, 117 S.Ct. 2199 ("Deception through nondisclosure is central to the theory of liability [49] for which the Government seeks recognition." (emphasis added)). Even in Zandford, which dealt principally with the statutory requirement that a deceptive device be used "in connection with" the purchase or sale of a security, the defendant's fraud consisted of not telling his brokerage client—to whom he owed a fiduciary duty—that he was stealing assets from the account. See 535 U.S. at 822, 122 S.Ct. 1899 ("[Defendant's brokerage clients] were injured as investors through [defendant's] deceptions, which deprived them of any compensation for the sale of their valuable securities."); see also id. at 823, 122 S.Ct. 1899 ("[A]ny distinction between omissions and misrepresentations is illusory in the context of a broker who has a fiduciary duty to her clients.").

      29

      Chiarella, O'Hagan, and Zandford all stand for the proposition that nondisclosure in breach of a fiduciary duty "satisfies § 10(b)'s requirement . . . [of] a `deceptive device or contrivance,'" O'Hagan, 521 U.S. at 653, 117 S.Ct. 2199. However, what is sufficient is not always what is necessary, and none of the Supreme Court opinions considered by the District Court require a fiduciary relationship as an element of an actionable securities claim under Section 10(b). While Chiarella, O'Hagan, and Zandford all dealt with fraud qua silence, an affirmative misrepresentation is a distinct species of fraud. Even if a person does not have a fiduciary duty to "disclose or abstain from trading," there is nonetheless an affirmative obligation in commercial dealings not to mislead. See, e.g., Basic Inc. v. Levinson, 485 U.S. 224, 240 n. 18, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988) (distinguishing "situations where insiders have traded in abrogation of their duty to disclose or abstain," from "affirmative misrepresentations by those under no duty to disclose (but under the ever-present duty not to mislead)").

      30

      In this case, the SEC has not alleged that defendant fraudulently remained silent in the face of a "duty to disclose or abstain" from trading. Rather, the SEC argues that defendant affirmatively misrepresented himself in order to gain access to material, nonpublic information, which he then used to trade. We are aware of no precedent of the Supreme Court or our Court that forecloses or prohibits the SEC's straightforward theory of fraud.[6] Absent a controlling precedent that "deceptive" has a more limited meaning than its ordinary meaning, we see no reason to complicate the enforcement of Section 10(b) by divining new requirements. In reaching this conclusion, we are mindful of the Supreme Court's oft-repeated instruction that Section 10(b) "should be construed not technically and restrictively, but flexibly to effectuate its remedial purposes." Zandford, 535 U.S. [50] at 819, 122 S.Ct. 1899 (internal quotation marks omitted).[7] Accordingly, we adopt the SEC's proposed interpretation of Chiarella and its progeny: "misrepresentations are fraudulent, but . . . silence is fraudulent only if there is a duty to disclose." Appellant's Br. 44.

      31

      Having denied the SEC's application for a preliminary injunction freezing defendant's trading account on the basis of a perceived fiduciary duty requirement stemming from the Chiarella line of insider trading cases, the District Court did not decide whether the ordinary meaning of "deceptive" covers the computer hacking in this case—or, indeed, whether the computer hacking in this case involved any misrepresentation at all. Defendant invites us to remand both questions so that the District Court may decide in the first instance.

      32

      In its ordinary meaning, "deceptive" covers a wide spectrum of conduct involving cheating or trading in falsehoods. See Webster's International Dictionary 679 (2d ed.1934) (defining "deceptive" as "tending to deceive," and defining "deceive" as "[t]o cause to believe the false, or to disbelieve the true" or "[t]o impose upon; to deal treacherously with; cheat"). Cf. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199 n. 20, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976) (consulting the 1934 edition of Webster's International Dictionary to define other relevant terms in Section 10(b)); In re Parmalat Sec. Litig., 376 F.Supp.2d 472, 502 n. 152 (S.D.N.Y.2005) (consulting the 1934 edition of Webster's International Dictionary to define "deceptive"). In light of this ordinary meaning, it is not at all surprising that Rule 10b-5 equates "deceit" with "fraud." See 17 C.F.R. § 240.10b-5 (prohibiting "any untrue statement of a material fact . . . or . . . any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security" (emphases added)). Indeed, we have previously observed that the conduct prohibited by Section 10(b) and Rule 10b-5 "irreducibly entails some act that gives the victim a false impression." United States v. Finnerty, 533 F.3d 143, 148 (2d Cir. 2008).

      33

      The District Court—summarizing the SEC's allegations—described the computer hacking in this case as "employ[ing] electronic means to trick, circumvent, or bypass computer security in order to gain unauthorized access to computer systems, networks, and information . . . and to steal such data." Dorozhko, 606 F.Supp.2d at 329. On appeal, the SEC adds a further gloss, arguing that, in general, "[computer [51] h]ackers either (1) `engage in false identification and masquerade as another user[']. . . or (2) `exploit a weakness in [an electronic] code within a program to cause the program to malfunction in a way that grants the user greater privileges.'" Appellant's Br. 22-23 (quoting Orin S. Kerr, Cybercrime Scope: Interpreting "Access" and "Authorization" in Computer Misuse Statutes, 78 N.Y.U. L.Rev. 1596, 1645 (2003)). In our view, misrepresenting one's identity in order to gain access to information that is otherwise off limits, and then stealing that information is plainly "deceptive" within the ordinary meaning of the word. It is unclear, however, that exploiting a weakness in an electronic code to gain unauthorized access is "deceptive," rather than being mere theft. Accordingly, depending on how the hacker gained access, it seems to us entirely possible that computer hacking could be, by definition, a "deceptive device or contrivance" that is prohibited by Section 10(b) and Rule 10b-5.

      34

      However, we are hesitant to move from this general principle to a particular application without the benefit of the District Court's views as to whether the computer hacking in this case—as opposed to computer hacking in general—was "deceptive." Our caution is counseled by the considerable and careful efforts the District Court has already devoted to this case, including hearing live testimony from witnesses at a preliminary injunction hearing that covered, among other topics, how Thomson's secure servers were infiltrated. See, e.g., J.A. 848 Tr. of Preliminary Injunction Hearing at 40-41, Dorozkho, 606 F.Supp.2d. 321 (No. 07 civ 9606). Having established that the SEC need not demonstrate a breach of fiduciary duty, we now remand to the District Court to consider, in the first instance, whether the computer hacking in this case involved a fraudulent misrepresentation that was "deceptive" within the ordinary meaning of Section 10(b). The District Court may, in its informed discretion, enter a new order on the basis of the existing record or reopen the preliminary injunction hearing to consider such additional testimony regarding the nature of the hacking in this particular case as it deems appropriate in the circumstances.

      35
      CONCLUSION
      36

      For the foregoing reasons, the District Court's January 8, 2008 order denying the SEC's motion for a preliminary injunction is VACATED. The cause is REMANDED for further proceedings consistent with this opinion.

      37

      [*] The Honorable Richard J. Sullivan, of the United States District Court for the Southern District of New York, sitting by designation.

      38

      [1] A "put" is "[a]n option that conveys to its holder the right, but not the obligation, to sell a specific asset at a predetermined price until a certain date. . . . Investors purchase puts in order to take advantage of a decline in the price of the asset." David L. Scott, Wall Street Words 295 (2003).

      39

      [2] The regulation promulgated by the SEC pertinent to the instant case is Rule 10b-5, which provides, in relevant part:

      40

      It shall be unlawful for any person, directly or indirectly . . .

      (a) To employ any device, scheme, or artifice to defraud,

      (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

      (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

      in connection with the purchase or sale of any security.

      41

      17 C.F.R. § 240.10b-5.

      42

      [3] In the District Court's view, "the alleged `hacking and trading' was a `device or contrivance' within the meaning of the statute." Dorozhko, 606 F.Supp.2d at 328. The District Court further observed that the scheme was "in connection with" the purchase or sale of securities because the close temporal proximity of the hacking to the trading (everything occurred in less than twenty-four hours) and the cohesiveness of the scheme (establishing the trading account, stealing the confidential information within minutes of its availability, and trading on it within minutes of the next day's opening bell) suggest that hacking into the Thomson computers was part of a single scheme to commit securities fraud. See id. at 328-29; see also SEC v. Zandford, 535 U.S. 813, 822, 122 S.Ct. 1899, 153 L.Ed.2d 1 (2002) (holding that "in connection with" means "to coincide"). The District Court also concluded that the alleged hacking was not "manipulative" because the Supreme Court has defined that word to cover exclusively practices "intended to mislead investors by artificially affecting market activity." See Dorozhko, 606 F.Supp.2d at 329 (quoting Santa Fe Indus. v. Green, 430 U.S. 462, 476, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977)). The parties do not challenge these conclusions in this appeal.

      43

      [4] Although the District Court construed Justice Blackmun's dissent to suggest that "no breach of fiduciary duty should be required to uphold a conviction under § 10(b)," Dorozhko, 606 F.Supp.2d at 333, we read this dissent in light of the circumstances of Chiarella, which only considered a fraud based on nondisclosure, not an affirmative misrepresentation. See 445 U.S. at 247, 100 S.Ct. 1108 (Blackmun, J., dissenting) ("I do not agree that a failure to disclose violates . . . Rule [10b-5] only when the responsibilities of a [fiduciary] relationship . . . have been breached." (emphasis added)).

      44

      [5] Some commentators grudgingly have acknowledged that the District Court's conclusion would be compelled under a narrow reading of Section 10(b) that covers only the "disclose or abstain" requirement for corporate insiders other than fiduciaries. See, e.g., Robert A. Prentice, The Internet and Its Challenges for the Future of Insider Trading Regulation, 12 Harv. J.L. & Tech. 263, 297-98 (1999) (acknowledging that, "[t]o the extent that misappropriation liability is based solely on a breach of fiduciary duty, thieves unrelated to the source of the information could steal the information without being in violation of existing federal securities laws"); but see id. at 300 (arguing that "to hold that hackers are misappropriators is consistent with the pre-1934 common law upon which Section 10(b) was based [and] is consonant with the underlying policy of Section 10(b)—investor protection" (internal footnote omitted)).

      45

      [6] The District Court found it "noteworthy" that in the over seventy years since the enactment of the Securities Exchange Act of 1934, "no federal court has ever held that those who steal material nonpublic information and then trade on it violate § 10(b)," even though "traditional theft (e.g. breaking into an investment bank and stealing documents) is hardly a new phenomenon, and involves similar elements for purposes of our analysis here." Dorozhko, 606 F.Supp.2d at 339. The District Court suggested that "hacking and trading" schemes have been and ought to be prosecuted under "any number of federal and/or state criminal statutes," rather than through civil enforcement actions. Id. at 323; see also id. at 324 (listing applicable federal criminal statutes). At the preliminary injunction hearing, the District Court stated that it was "very disturbing" that this case was not a federal prosecution, J.A. 889 Tr. of Preliminary Injunction Hearing at 129:20, SEC v. Dorozhko, 606 F.Supp.2d. 321 (S.D.N.Y. Nov. 28, 2007)(No. 07 civ 9606). We intimate no view on that question. It is enough to say that we deal with the facts presented, which in our view are sufficient to maintain a civil enforcement claim.

      46

      [7] We are further counseled by the observations of Judge Augustus N. Hand, who reasoned over fifty years ago that had Congress intended to impose a fiduciary-duty requirement on Section 10(b) liability, it would have said so. See Birnbaum v. Newport Steel Corp., 193 F.2d 461, 464 (2d Cir.1952) (A. Hand, J.) ("When Congress intended to protect the stockholders of a corporation against a breach of fiduciary duty by corporate insiders, it left no doubt as to its meaning. Thus Section 16(b) of the Act of 1934 . . . expressly gave the corporate issuer or its stockholders a right of action against corporate insiders using their position to profit in the sale or exchange of corporate securities. The absence of a similar provision in Section 10(b) strengthens the conclusion that [Section 10(b)] was directed solely at that type of misrepresentation or fraudulent practice usually associated with the sale or purchase of securities rather than at fraudulent mismanagement of corporate affairs, and that Rule [10b-5] extended protection only to the defrauded purchaser or seller." (internal citation omitted)). We recognize that in the instant case, the SEC is neither a purchaser nor a seller, but brings this suit in its regulatory capacity in order to "ensure honest securities markets and . . . promote investor confidence," Zandford, 535 U.S. at 819, 122 S.Ct. 1899.

    • 4.3 SEC v. Cuban

      Limits on misappropriation theory – is a state-based fiduciary duty still required to establish liability?

      1
      634 F.Supp.2d 713 (2009)
      2
      SECURITIES AND EXCHANGE COMMISSION, Plaintiff,
      v.
      Mark CUBAN, Defendant.
      3
      Civil Action No. 3:08-CV-2050-D.
      United States District Court, N.D. Texas, Dallas Division.
      4
      July 17, 2009.
      5
      Opinion Dismissing Action With Prejudice August 13, 2009.
      6

      [716] Kevin P. O'Rourke (argued), Adam S. Aderton, and Julie M. Riewe, U.S. Securities and Exchange Commission, Washington, DC, and Toby M. Galloway, U.S. Securities and Exchange Commission, Fort Worth, TX, for plaintiff.

      7

      Lyle Roberts, Ralph C. Ferrara (argued), Stephen A. Best, and Henry W. Asbill, Dewey & LeBoeuf LLP, Washington, DC, Christopher J. Clark, Dewey & LeBoeuf LLP, New York City, and Stephen M. Ryan, Dewey & LeBoeuf LLP, Houston, TX, and Paul E. Coggins and Kip Mendrygal, Fish & Richardson PC, Dallas, TX, for defendant.

      8

      Allen Ferrell, Harvard Law School, Cambridge, MA, Stephen Bainbridge, UCLA Law School, Los Angeles, CA, M. Todd Henderson, University of Chicago Law School, Chicago, IL, Alan R. Bromberg, SMU Dedman School of Law, Dallas, TX, and Jonathan R. Macey, Yale Law School, New Haven, CT, amici curiae in support of defendant.

      9
      [717] MEMORANDUM OPINION AND ORDER
      10
      SIDNEY A. FITZWATER, Chief Judge.
      11

      The dispositive question presented by defendant Mark Cuban's ("Cuban's") motion to dismiss is whether plaintiff Securities and Exchange Commission ("SEC") has adequately alleged that Cuban undertook a duty of non-use of information required to establish liability under the misappropriation theory of insider trading. Concluding that it has not, the court grants Cuban's motion to dismiss, but it also allows the SEC to replead.

      12
      I
      13
      A
      14

      This is a suit brought by the SEC against Cuban under the misappropriation theory of insider trading. The SEC alleges that, after Cuban agreed to maintain the confidentiality of material, nonpublic information concerning a planned private investment in public equity ("PIPE") offering by Mamma.com Inc. ("Mamma.com"),[1] he sold his stock in the company without first disclosing to Mamma.com that he intended to trade on this information, thereby avoiding substantial losses when the stock price declined after the PIPE was publicly announced. The SEC maintains that Cuban is liable for violating § 17(a) of the Securities Act of 1933 ("Securities Act"), § 10(b) of the Securities Exchange Act of 1934 ("Exchange Act"), and Rule 10b-5 promulgated thereunder.[2]

      15

      According to the SEC's complaint, in March 2004 Cuban purchased 600,000 shares, or a 6.3% stake, in Mamma.com, a Canadian company that operated an Internet search engine and traded on the NASDAQ. In the spring of 2004, Mamma.com decided to raise capital through a PIPE offering. As the PIPE offering progressed toward closing, the company decided to inform Cuban, its then-largest known shareholder, of the offering and to invite him to participate. The CEO of Mamma.com spoke with Cuban by telephone.

      16
      The CEO prefaced the call by informing Cuban that he had confidential information to convey to him, and Cuban agreed that he would keep whatever information the CEO intended to share with him confidential. The CEO, in reliance on Cuban's agreement to keep the information confidential, proceeded to tell Cuban about the PIPE offering.
      17

      Compl. ¶ 14. As Mamma.com "anticipated," Cuban reacted angrily to this news, stating that he did not like PIPE offerings because they dilute the existing shareholders. Id. at ¶ 15. At the end of the call Cuban said: "Well, now I'm screwed. I can't sell." Id. at ¶ 14. Two internal company emails quoted in the complaint indicate that the executive chairman of Mamma.com may have expected that Cuban would not sell his shares until after the PIPE was announced. See id. at ¶ 15 ("[Cuban] said he would sell his shares (recognizing that he was not able to do anything until we announce the equity)[.]"); id. at ¶ 20 ("[Cuban's] answers were: he would not invest, he does not want the company to make acquisitions, he will sell his shares which he can not [sic] do until after we announce.").

      18

      [718] Several hours after they spoke by telephone, the CEO sent Cuban a follow-up email in which he provided contact information for the investment bank conducting the offering, in case Cuban wanted more information about the PIPE. Cuban then contacted the sales representative, who "supplied Cuban with additional confidential details about the PIPE." Id. at ¶ 17. One minute after ending this call, Cuban telephoned his broker and directed the broker to sell all 600,000 of his Mamma.com shares. The broker sold a small amount of the shares during after-hours trading on June 28, 2004, and sold the remainder during regular trading hours on June 29, 2004. Cuban did not inform Mamma.com of his intention to trade on the information that he had been given in confidence and that he had agreed to keep confidential. See id. at ¶ 25 ("Cuban never disclosed to Mamma.com that he was going to sell his shares prior to the public announcement of the PIPE."). After the markets had closed on June 29, 2004, Mamma.com publicly announced the PIPE offering. Trading in the company's stock opened substantially lower the next day and continued to decline in the days following. Cuban avoided losses in excess of $750,000 by selling his shares prior to the public announcement of the PIPE. After the sale, Cuban filed the required disclosure statement with the SEC and "publicly stated that he had sold his Mamma.com shares because the company was conducting a PIPE[.]" Id.

      19

      Based on Cuban's alleged violation of § 17(a) of the Securities Act, § 10(b) of the Exchange Act, and Rule 10b-5, the SEC seeks a permanent injunction against future violations, disgorgement of losses avoided, prejudgment interest, and imposition of a civil monetary penalty.

      20
      B
      21

      Cuban, supported by five law professors as amici curiae, moves to dismiss the complaint under Fed.R.Civ.P. 12(b)(6) for failure to state a claim on which relief can be granted, and under Rule 9(b) for failing to plead fraud with particularity.[3] Cuban maintains that, to establish liability for insider trading, the SEC must demonstrate that his conduct was deceptive under § 10(b), which he asserts the SEC has not done under the facts pleaded. Specifically, Cuban contends that the SEC has alleged merely that he entered into a confidentiality agreement, which is of itself insufficient to establish misappropriation theory liability because the agreement must arise in the context of a preexisting fiduciary or fiduciary-like relationship, or create a relationship that bears all the hallmarks of a traditional fiduciary relationship; the existence of a fiduciary or fiduciary-like relationship is governed exclusively by state law and, under Texas law, the facts pleaded do not demonstrate that he had such a relationship with Mamma.com; even if the court applies federal common law, the facts pleaded still fail to show such a relationship; and the SEC cannot rely on Rule 10b5-2(b)(1) to supply [719] the requisite duty because the Rule applies only in the context of family or personal relationships, and, if the Rule does create liability in the absence of a preexisting fiduciary or fiduciary-like relationship, it exceeds the SEC's § 10(b) rulemaking authority and cannot be applied against him.

      22
      II
      23

      Under Rule 8(a)(2), a pleading must contain "a short and plain statement of the claim showing that the pleader is entitled to relief." While "the pleading standard Rule 8 announces does not require `detailed factual allegations,'" it demands more than "`labels and conclusions.'" Ashcroft v. Iqbal, ___ U.S. ___, 129 S.Ct. 1937, 1949, 173 L.Ed.2d 868 (2009) (quoting Bell Atl. Corp. v. Twombly, 550 U.S. 544, 555, 127 S.Ct. 1955, 167 L.Ed.2d 929 (2007)). And "`a formulaic recitation of the elements of a cause of action will not do.'" Id. (quoting Bell Atl., 550 U.S. at 555, 127 S.Ct. 1955).

      24

      In deciding a Rule 12(b)(6) motion to dismiss for failure to state a claim, "[t]he `court accepts all well-pleaded facts as true, viewing them in the light most favorable to the plaintiff.'" In re Katrina Canal Breaches Litig., 495 F.3d 191, 205 (5th Cir.2007) (internal quotation marks omitted) (quoting Martin K. Eby Constr. Co. v. Dallas Area Rapid Transit, 369 F.3d 464, 467 (5th Cir.2004)). To survive the motion, a plaintiff must plead "enough facts to state a claim to relief that is plausible on its face." (Bell Atl., 550 U.S. at 570, 127 S.Ct. 1955). "A claim has facial plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable inference that the defendant is liable for the misconduct alleged." Iqbal, 129 S.Ct. at 1949. "The plausibility standard is not akin to a `probability requirement,' but it asks for more than a sheer possibility that a defendant has acted unlawfully." Id.; see also Bell Atl., 550 U.S. at 555, 127 S.Ct. 1955 ("Factual allegations must be enough to raise a right to relief above the speculative level[.]"). "[W]here the well-pleaded facts do not permit the court to infer more than the mere possibility of misconduct, the complaint has alleged—but it has not `shown'—that the pleader is entitled to relief." Iqbal, 129 S.Ct. at 1950 (quoting Rule 8(a)(2) (alteration omitted)).

      25
      III
      26
      A
      27

      Section 10(b) of the Exchange Act makes it unlawful

      28
      for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange—... [t]o use or employ, in connection with the purchase or sale of any security ... any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.
      29

      15 U.S.C. § 78j(b).

      30

      Rule 10b-5, promulgated pursuant to the SEC's § 10(b) rulemaking authority, provides:

      31
      It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
      32
      (a) To employ any device, scheme, or artifice to defraud,
      33
      (b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
      34
      [720] (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
      35
      in connection with the purchase or sale of any security.
      36

      17 C.F.R. § 240.10b-5 (2009).

      37

      The law of insider trading is not based on a federal statute expressly prohibiting the practice; it has instead developed through SEC and judicial interpretations of § 10(b)'s prohibition of "deceptive"[4] conduct and Rule 10b-5's antifraud provisions. The SEC, in In re Cady, Roberts & Co., 40 S.E.C. 907, 1961 WL 60638 (1961), and the Supreme Court, in Chiarella v. United States, 445 U.S. 222, 227-30, 100 S.Ct. 1108, 63 L.Ed.2d 348 (1980), first recognized the "traditional" or "classical" theory of insider trading liability. Under this theory, "§ 10(b) and Rule 10b-5 are violated when a corporate insider trades in the securities of his corporation on the basis of material, nonpublic information." United States v. O'Hagan, 521 U.S. 642, 651-52, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997) (citing Chiarella, 445 U.S. at 228, 100 S.Ct. 1108). Liability is premised on the "relationship of trust and confidence between the shareholders of a corporation and those insiders who have obtained confidential information by reason of their position with that corporation." Chiarella, 445 U.S. at 228, 100 S.Ct. 1108. This relationship gives rise to a "duty to disclose" confidential information prior to trading. Id.

      38

      In O'Hagan the Supreme Court expanded the scope of insider trading liability by recognizing the "misappropriation theory," which had been the subject of disagreement among lower courts. "The `misappropriation theory' holds that a person commits fraud `in connection with' a securities transaction, and thereby violates § 10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information." O'Hagan, 521 U.S. at 652, 117 S.Ct. 2199. The "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." Id. "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." Id.

      39
      The two theories are complementary, each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities. The classical theory targets a corporate insider's breach of duty to shareholders with whom the insider transacts; the misappropriation theory outlaws trading on the basis of nonpublic information by a corporate "outsider" in breach of a duty owed not to a trading party, but to the source of the information.
      40

      Id. at 652-53, 117 S.Ct. 2199.

      41

      The nature of the duty required to support misappropriation theory liability is at the heart of the present case and Cuban's motion to dismiss. In 2000 the SEC adopted Rule 10b5-2, which delineates certain [721] circumstances that will give rise to a "duty of trust or confidence" for purposes of the misappropriation theory. Rule 10b5-2(b)(1) provides that "a `duty of trust or confidence' exists ... [w]henever a person agrees to maintain information in confidence[.]"

      42
      B
      43

      The SEC argues that, under Rule 10b5-2(b)(1) and the facts pleaded in the complaint, it has stated a claim on which relief can be granted. According to the SEC, Cuban is liable under the misappropriation theory based on a duty created by his agreement to keep confidential the information that Mamma. com's CEO provided him about the impending PIPE offering. It posits that Cuban breached this duty when, without disclosing to Mamma. com his intent to trade in its stock based on the information, he sold his shares in the company.

      44

      Cuban maintains that he is entitled to dismissal of this suit because, to establish liability for insider trading, the SEC must demonstrate that his conduct was deceptive under § 10(b), as construed by the Supreme Court in Chiarella and O'Hagan, which Cuban maintains the SEC has not done under the facts pleaded. Cuban argues that the SEC has alleged merely that he entered into a confidentiality agreement, and he posits that such an agreement is of itself inadequate to establish misappropriation theory liability. To be sufficient, he contends, the agreement must arise in the context of a preexisting fiduciary or fiduciary-like relationship, or create a relationship that bears all the hallmarks of a traditional fiduciary relationship. He further maintains that the existence of a fiduciary or fiduciary-like relationship is governed exclusively by state law; that, under applicable Texas law, the facts pleaded do not demonstrate that he had such a relationship with Mamma.com; and that even if the court applies federal common law, the facts pleaded still fail to show such a relationship. Finally, Cuban argues that the SEC cannot rely on Rule 10b5-2(b)(1) to supply the requisite duty because, first, the Rule applies only in the context of family or personal relationships, and, second, if the Rule does create liability based on a mere confidentiality agreement in the absence of a preexisting fiduciary or fiduciary-like relationship, it exceeds the SEC's § 10(b) rulemaking authority and cannot be applied against him.

      45
      IV
      46

      Because it affects the resolution of Cuban's other arguments, the court turns first to his contention that his liability under the misappropriation theory depends on the existence of a preexisting fiduciary or fiduciary-like relationship, as determined exclusively under applicable state law.

      47
      A
      48

      Cuban relies on this court's opinion in Southwest Realty, Ltd. v. Daseke, 1992 WL 373166, at *9-*10 (N.D.Tex. May 21, 1992) (Fitzwater, J.), to support his contention that state law regarding fiduciary and fiduciary-like relationships is the exclusive source of the predicate duty for misappropriation theory liability. He also posits that, unless the court derives the duty from state law alone, its decision will violate the general rule—applied in cases like Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 478-80, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977)—against the creation of federal common law.

      49

      The SEC counters that no federal court has relied exclusively on state law to determine whether a duty sufficient to support misappropriation theory liability exists. It contends that were the court to adopt a state-specific standard for deriving the [722] duty, the decision would balkanize the misappropriation theory and lead to divergent outcomes under the federal securities laws depending on the state of jurisdiction in a particular insider trading case.

      50
      B
      51

      The court rejects Cuban's contention that Southwest Realty compels the conclusion that the existence of a duty sufficient to support misappropriation theory liability is determined exclusively under state law. In Southwest Realty the court followed the conclusions of several appellate courts that "the federal securities laws themselves are not the source of a duty of disclosure. `Rather the duty to disclose material facts arises only where there is some basis outside the securities laws, such as state law, for finding a fiduciary or other confidential relationship.'" Sw. Realty, 1992 WL 373166, at *10 (quoting Fortson v. Winstead, McGuire, Sechrest & Minick, 961 F.2d 469 (4th Cir.1992)). Southwest Realty did not address insider trading or the misappropriation theory, which the Supreme Court did not adopt until several years later. Thus the court had no occasion to hold that state law regarding fiduciary or similar relationships was the only source of a duty to support liability under this theory. Rather, in the factual and legal context presented, the court simply followed settled precedent that provided that the federal securities laws are not the source of a duty of disclosure, and that such a duty must be found elsewhere, such as in state law.

      52

      Moreover, although the source of a duty adequate to support insider trading liability can be found in state law—this certainly appears to be the case, for example, in O'Hagan, 521 U.S. at 652-53, 117 S.Ct. 2199 (relying on attorney's fiduciary duty to client)—it may be located elsewhere without violating the general rule against creating federal common law. The SEC can promulgate a rule that imposes such a duty, provided the rule conforms with the SEC's rulemaking powers, such as those found in § 10(b) of the Exchange Act. In doing so, the SEC does not create federal general common law. "Common law," when discussed in cases that hold there is no federal general common law, see, e.g., O'Melveny & Myers v. FDIC, 512 U.S. 79, 83, 114 S.Ct. 2048, 129 L.Ed.2d 67 (1994) (citing Erie R.R. Co. v. Tompkins, 304 U.S. 64, 78, 58 S.Ct. 817, 82 L.Ed. 1188 (1938)), means judge-made law. See Black's Law Dictionary 293 (8th ed.) ("The body of law derived from judicial decisions, rather than from statutes or constitutions[.]"). An agency regulation promulgated under authority conferred by Congress is not judge-made law. And in concluding below that an agreement with the proper components can establish the duty necessary to support liability under the misappropriation theory, the court is not creating federal general common law. Because all states recognize and enforce duties created by agreement, the court is essentially relying on the state law of contracts to supply the requisite duty.

      53

      Finally, for reasons the court will explain in the next section, it rejects Cuban's contention that liability under the misappropriation theory depends on the existence of a preexisting fiduciary or fiduciary-like relationship.

      54
      V
      55

      The court now considers whether, under the Supreme Court's precedents, breach of a legal duty arising by agreement can be the basis for misappropriation theory liability, and, if so, what are the essential components of the agreement.

      56
      A
      57

      In Chiarella the Court recognized the classical theory of insider trading and explained that because insider trading [723] essentially involves the nondisclosure of information, it falls within § 10(b)'s requirement of deception only if there is a duty to disclose. See Chiarella, 445 U.S. at 231, 100 S.Ct. 1108 (reasoning that trading on material, nonpublic information is "not a fraud under § 10(b)" unless the trader is under a duty to disclose); id. at 228, 100 S.Ct. 1108 ("But one who fails to disclose material information prior to the consummation of a transaction commits fraud only when he is under a duty to do so."); id. at 235, 100 S.Ct. 1108 ("When an allegation of fraud is based upon nondisclosure, there can be no fraud absent a duty to speak."). Further, the duty is not a general one but must arise from "a specific relationship between two parties." Id. at 233, 100 S.Ct. 1108. Chiarella unequivocally rejects a "parity-of-information" principle, under which a disclosure duty would arise based on the mere possession of material, nonpublic information. Id.

      58

      Building on Chiarella, the Supreme Court concluded in O'Hagan that, like the classical theory, the misappropriation theory also involves deception within the meaning of § 10(b). O'Hagan teaches that the essence of the misappropriation theory is the trader's undisclosed use of material, nonpublic information that is the property of the source, in breach of a duty owed to the source to keep the information confidential and not to use it for personal benefit. See O'Hagan, 521 U.S. at 652, 117 S.Ct. 2199 ("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."); id. at 656, 117 S.Ct. 2199 ("[T]he 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."); see also id. at 655, 117 S.Ct. 2199 (contrasting government's allegations in O'Hagan with Santa Fe because, in Santa Fe, "all pertinent facts were disclosed by the persons charged with violating § 10(b) and Rule 10b-5; therefore, there was no deception through nondisclosure to which liability under those provisions could attach" (citation omitted)). Under the misappropriation theory of insider trading, the deception flows from the undisclosed, duplicitous nature of the breach. See id. at 653-54, 117 S.Ct. 2199 ("A fiduciary who `[pretends] loyalty to the principal while secretly converting the principal's information for personal gain' `dupes' or defrauds the principal." (quoting Brief for United States 17)); id. at 655, 117 S.Ct. 2199 ("[T]he deception essential to the misappropriation theory involves feigning fidelity to the source of information[.]").

      59

      O'Hagan states unmistakably that "[d]eception through nondisclosure is central to [this] theory[.]" Id. at 654, 117 S.Ct. 2199. And by providing that a person can avoid misappropriation theory liability by disclosing his intention to use confidential information, it confirms that the deception inheres in the undisclosed use of information, in breach of a duty not to do so.

      60
      [F]ull disclosure forecloses liability under the misappropriation theory.... [I]f the fiduciary discloses to the source that he plans to trade on the nonpublic information, there is no "deceptive device" and thus no § 10(b) violation—although the fiduciary-turned-trader may remain liable under state law for breach of a duty of loyalty.
      61

      Id. at 655, 117 S.Ct. 2199; see also id. at 659 n. 9, 117 S.Ct. 2199 ("[T]he textual requirement of deception precludes § 10(b) liability when a person trading on the basis of nonpublic information has disclosed his trading plans to, or obtained [724] authorization from, the principal—even though such conduct may affect the securities markets in the same manner as the conduct reached by the misappropriation theory."). In simple terms, the misappropriator acts deceptively, not merely because he uses the source's material, nonpublic information for personal benefit, in breach of a duty not to do so, but because he does not disclose to the source that he intends to trade on or otherwise use the information.

      62
      B
      63

      In the context of the misappropriation theory, therefore, trading on the basis of material, nonpublic information cannot be deceptive unless the trader is under a legal duty to refrain from trading on or otherwise using it for personal benefit. Where the trader and the information source are in a fiduciary relationship, this obligation arises by operation of law upon the creation of the relationship. As O'Hagan makes clear, a fiduciary is bound to act loyally toward the principal, and as a part of the duty of loyalty, to use property that has been entrusted to him— including confidential information—to benefit only the principal and not himself. See O'Hagan, 521 U.S. at 652, 117 S.Ct. 2199 ("[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."). The deception inheres in the fiduciary's undisclosed breach of this duty. Specifically, the fiduciary deceives the principal by acting the part of a faithful agent in other respects while secretly appropriating the principal's confidential information for his own use. Because of the fiduciary's duty of loyalty, the principal has a right to expect that the fiduciary is not trading on or otherwise using the principal's confidential information. The fiduciary's duplicitous conduct confirms that expectation while the fiduciary is contemporaneously and secretly violating his duty. Thus the fiduciary's trading violates the principal's legitimate and justifiable expectation that the fiduciary is using the information only for the principal's benefit.

      64

      Because under O'Hagan the deception that animates the misappropriation theory involves at its core the undisclosed breach of a duty not to use another's information for personal benefit, there is no apparent reason why that duty cannot arise by agreement.[5] Further, recognizing that a duty analogous to the fiduciary's duty of "loyalty and confidentiality" can be created by agreement fully comports with [725] Chiarella's teaching that the duty must arise out of a relationship between specific parties and not the mere possession of confidential information. The court therefore concludes that a duty sufficient to support liability under the misappropriation theory can arise by agreement absent a preexisting fiduciary or fiduciary-like relationship.

      65

      Indeed, the duty that arises by agreement can be seen as conferring a stronger footing for imposing liability for deceptive conduct than does the existence, without more, of a fiduciary or similar relationship of trust and confidence. In the context of an agreement, the misappropriator has committed to refrain from trading on material, nonpublic information. The duty is thus created by conduct that captures the person's obligation with greater acuity than does a duty that flows more generally from the nature of the parties' relationship. The misappropriator is held to terms created by his own agreement rather than to a duty triggered merely by operation of law due to his relationship with the information source.

      66

      The agreement, however, must consist of more than an express or implied promise merely to keep information confidential. It must also impose on the party who receives the information the legal duty to refrain from trading on or otherwise using the information for personal gain. With respect to confidential information, nondisclosure[6] and non-use are logically distinct. A person who receives material, nonpublic information may in fact preserve the confidentiality of that information while simultaneously using it for his own gain. Indeed, the nature of insider trading is such that one who trades on material, nonpublic information refrains from disclosing that information to the other party to the securities transaction. To do so would compromise his advantageous position. See O'Hagan, 521 U.S. at 656, 117 S.Ct. 2199 ("The misappropriation theory targets information of a sort that misappropriators ordinarily capitalize upon to gain no-risk profits through the purchase or sale of securities."). But although conceptually separate, both nondisclosure and non-use comprise part of the duty that arises by operation of law when a fiduciary relationship is created. Where misappropriation theory liability is predicated on an agreement, however, a person must undertake, either expressly or implicitly, both obligations. He must agree to maintain the confidentiality of the information and not to trade on or otherwise use it. Absent a duty not to use the information for personal benefit, there is no deception in doing so. As in the fiduciary context, the deception occurs when a person secretly trades on confidential information in violation of the source's legitimate and justifiable expectation that the recipient will not do so. Id. at 654, 117 S.Ct. 2199 ("Deception through nondisclosure is central to [this] theory[.]"). This expectation can be created where the source entrusts a person with confidential information in reliance on the recipient's agreement not to disclose the information and not to use it for personal gain. The expectation is not unilateral, arising merely from the source's subjective belief that the recipient will not trade on the information. It rests on the recipient's undertaking of a duty to refrain from doing so as well. Cf. United States v. Chestman, 947 F.2d 551, 567 (2d Cir.1991) (noting, in context of insider trading suit, that "a fiduciary duty cannot be imposed unilaterally by entrusting a person with confidential information"); United States v. Reed, 601 F.Supp. 685, 715 (S.D.N.Y.) [726] (reasoning, in same context, that "[t]he mere unilateral investment of confidence by one party in the other ordinarily will not suffice to saddle the parties with the obligations and duties of a confidential relationship"), rev'd on other grounds, 773 F.2d 477 (2d Cir.1985). For the recipient then to exploit the information's value in the securities markets, without disclosing to the source his intent to do so, violates the source's legitimate and justifiable expectation and deceives him. In short, the recipient's agreement not to use the source's information for personal benefit, combined with his subsequent undisclosed use of the information for securities trading purposes, makes his conduct deceptive under § 10(b) and Rule 10b-5.[7]

      67

      Although the court therefore agrees with Cuban that an agreement must contain more than a promise of confidentiality, the court disagrees with his contention that, for a person to be held liable under the misappropriation theory, he must enter into an agreement that creates a relationship bearing all the hallmarks of a traditional fiduciary relationship. And the court respectfully declines to follow the case Cuban cites in support of this proposition: United States v. Kim, 184 F.Supp.2d 1006 (N.D.Cal.2002). See id. at 1011 (holding that "a similar relationship of trust and confidence must be characterized by superiority, dominance, or control"); id. at 1015 ("In the Court's opinion ... an express agreement can provide the basis for misappropriation liability only if the express agreement sets forth a relationship with the hallmarks of a fiduciary relationship detailed above."). Although no court appears to have analyzed the precise question that this court examines above—i.e., the nature of an agreement that can give rise to misappropriation theory liability— some have disagreed with Kim's holding that a relationship marked by factors such as superiority, dominance, or control is required. See, e.g., SEC v. Nothern, 598 F.Supp.2d 167, 176 (D.Mass.2009) ("[A] `similar relationship of trust and confidence' [may] exist[ ] even in the absence of a scintilla of superiority or dominance[.]"); SEC v. Kirch, 263 F.Supp.2d 1144, 1150 (N.D.Ill.2003) ("[T]he `duty of loyalty and [727] confidentiality' owed by the outsider ... to the person ... who shared confidential information with him or her ... is not limited to fiduciary relationships in the limited sense that requires such factors as control and dominance on the part of the fiduciary.").[8] Moreover, if an agreement has the elements necessary to conform to the principles of the misappropriation theory liability recognized in O'Hagan, it should not be determinative whether the agreement creates a relationship in which one party is superior to, or exercises control or dominance over, the other.

      68
      C
      69

      The conclusion that an agreement imposing duties of nondisclosure and non-use can support liability under the misappropriation theory is supported by its consistency with the purpose of the theory. The misappropriation theory "address[es] efforts to capitalize on nonpublic information through the purchase or sale of securities." O'Hagan, 521 U.S. at 652, 117 S.Ct. 2199. It is "designed to `protec[t] the integrity of the securities markets against abuses by "outsiders" to a corporation who have access to confidential information that will affect th[e] corporation's security price when revealed, but who owe no fiduciary or other duty to that corporation's shareholders.'" Id. at 653, 117 S.Ct. 2199 (quoting Brief for United States 14). "The theory is ... well tuned to an animating purpose of the Exchange Act: to insure honest securities markets and thereby promote investor confidence." Id. at 658, 117 S.Ct. 2199. "Although informational disparity is inevitable in the securities markets, investors likely would hesitate to venture their capital in a market where trading based on misappropriated nonpublic information is unchecked by law." Id. The goal of protecting the integrity of the securities markets and promoting investor confidence would be achieved just as effectively by enforcing duties of nondisclosure and non-use that arise by agreement as by enforcing duties that flow from the nature of the relationship between the information source and the misappropriator. In fact, the converse is also true: investors likely would hesitate to venture their capital if they knew that while a corporate outsider in a fiduciary relationship could not trade based on misappropriated nonpublic information, an outsider who had actually agreed with the source not to trade on such information, but was not a fiduciary, could do so.

      70
      VI
      71

      The court next addresses whether the SEC has adequately alleged that Cuban entered into an agreement sufficient to create the duty necessary to establish misappropriation theory liability. State common law can impose such a duty, provided Cuban entered into an express or implied agreement with Mamma. com not to disclose material, nonpublic information about the PIPE offering and not to trade on or otherwise use the information. The court concludes that the SEC's complaint is deficient in this critical respect.

      72

      [728] Regarding the telephone call during which the alleged agreement was made, the SEC merely alleges that Cuban "agreed that he would keep whatever information the CEO intended to share with him confidential"; that in reliance on that agreement, the CEO informed him of the PIPE offering; and that Cuban expressed displeasure at this news and, at the end of the call, stated "Well, now I'm screwed. I can't sell." Compl. ¶ 14. Thus while the SEC adequately pleads that Cuban entered into a confidentiality agreement, it does not allege that he agreed, expressly or implicitly, to refrain from trading on or otherwise using for his own benefit the information the CEO was about to share. Although at one point Cuban allegedly stated that he was "screwed" because he "[could not] sell," this appears to express his belief, at least at that time, that it would be illegal for him to sell his Mamma.com shares based on the information the CEO had provided. This statement, however, cannot reasonably be understood as an agreement not to sell based on the information. Further, the complaint asserts no facts that reasonably suggest that the CEO intended to obtain from Cuban an agreement to refrain from trading on the information as opposed to an agreement merely to keep it confidential.

      73

      Nor is it sufficient that the complaint indicates that the executive chairman of Mamma. com may have expected that Cuban would not sell until the PIPE was publicly announced. See id. at ¶ 15 ("`[Cuban] said he would sell his shares (recognizing that he was not able to do anything until we announce the equity)[.]'" (quoting email of executive chairman to Mamma.com board)); id. at ¶ 20 ("`[Cuban's] answers were: he would not invest, he does not want the company to make acquisitions, he will sell his shares which he can not [sic] do until after we announce.'" (quoting second email of executive chairman to board)). Outside a fiduciary or fiduciary-like relationship, a mere unilateral expectation on the part of the information source—one that is not based on the other party's agreement to refrain from trading on the information—cannot create the predicate duty for misappropriation theory liability.

      74
      VII
      75

      Having determined that the SEC's complaint is insufficient to plead a duty arising by agreement, the court turns finally to the parties' arguments regarding whether the SEC can rely on Rule 10b5-2(b)(1) to impose the required duty.[9]

      76
      A
      77

      The SEC's rulemaking authority under § 10(b) is bounded by the statute's proscription of conduct that is manipulative or deceptive. The SEC cannot by rule make unlawful conduct that does not fall into one of these categories. See O'Hagan, 521 U.S. at 651, 117 S.Ct. 2199 ("Liability under Rule 10b-5, our precedent indicates, does not extend beyond conduct encompassed by § 10(b)'s prohibition.") (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 214, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976); Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 173, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994)); id. at 655, 117 S.Ct. 2199 ("[Section] 10(b) is not an all-purpose breach of fiduciary duty ban; rather, it [729] trains on conduct involving manipulation or deception." (citing Santa Fe Indus., 430 U.S. at 473-76, 97 S.Ct. 1292)). In the context of the misappropriation theory, the SEC cannot by rule predicate liability on an agreement that lacks the necessary component of an obligation not to trade on or otherwise use confidential information for personal benefit. As the court has explained, it is the undisclosed use of such information, in breach of a duty not to use it for personal benefit, that makes the conduct deceptive under § 10(b) and Rule 10b-5.

      78
      B
      79

      In considering whether Rule 10b5-2(b)(1) can serve as the basis for misappropriation theory liability, the court first examines its plain meaning. Courts in the Fifth Circuit "interpret regulations in the same manner as statutes, looking first to the regulation's plain language. Where the language is unambiguous, [courts] do not look beyond the plain wording of the regulation to determine meaning." Anthony v. United States, 520 F.3d 374, 380 (5th Cir.2008). "The appropriate starting point when interpreting any statute is its plain meaning." United States v. Elrawy, 448 F.3d 309, 315 (5th Cir.2006) (citing United States v. Ron Pair Enters., Inc., 489 U.S. 235, 242, 109 S.Ct. 1026, 103 L.Ed.2d 290 (1989)). "The plain meaning of legislation should be conclusive, except in the `rare cases [in which] the literal application of a statute will produce a result demonstrably at odds with the intentions of its drafters.'" Ron Pair Enters., 489 U.S. at 242, 109 S.Ct. 1026 (quoting Griffin v. Oceanic Contractors, Inc., 458 U.S. 564, 571, 102 S.Ct. 3245, 73 L.Ed.2d 973 (1982)).

      80

      To determine "the plain meaning of the statute, the court must look to the particular statutory language at issue, as well as the language and design of the statute as a whole." K Mart Corp. v. Cartier, Inc., 486 U.S. 281, 291, 108 S.Ct. 1811, 100 L.Ed.2d 313 (1988) (citing Bethesda Hosp. Ass'n v. Bowen, 485 U.S. 399, 403-05, 108 S.Ct. 1255, 99 L.Ed.2d 460 (1988); Offshore Logistics, Inc. v. Tallentire, 477 U.S. 207, 220-21, 106 S.Ct. 2485, 91 L.Ed.2d 174 (1986)). "It is `a cardinal principle of statutory construction' that `a statute ought, upon the whole, to be so construed that, if it can be prevented, no clause, sentence, or word shall be superfluous, void, or insignificant.'" TRW Inc. v. Andrews, 534 U.S. 19, 31, 122 S.Ct. 441, 151 L.Ed.2d 339 (2001) (quoting Duncan v. Walker, 533 U.S. 167, 174, 121 S.Ct. 2120, 150 L.Ed.2d 251 (2001)). The court "must, if possible, construe a statute to give every word some operative effect." Cooper Indus., Inc. v. Aviall Servs., Inc., 543 U.S. 157, 167, 125 S.Ct. 577, 160 L.Ed.2d 548 (2004) (citing United States v. Nordic Vill., Inc., 503 U.S. 30, 35-36, 112 S.Ct. 1011, 117 L.Ed.2d 181 (1992)).

      81
      C
      82

      Rule 10b5-2 provides:

      83
      Preliminary Note to § 240.10b5-2: This section provides a non-exclusive definition of circumstances in which a person has a duty of trust or confidence for purposes of the "misappropriation" theory of insider trading under Section 10(b) of the Act and Rule 10b-5. The law of insider trading is otherwise defined by judicial opinions construing Rule 10b-5, and Rule 10b5-2 does not modify the scope of insider trading law in any other respect.
      84
      (a) Scope of Rule. This section shall apply to any violation of Section 10(b) of the Act (15 U.S.C. § 78j(b)) and § 240.10b-5 thereunder that is based on the purchase or sale of securities on the basis of, or the communication of, material nonpublic information misappropriated [730] in breach of a duty of trust or confidence.
      85
      (b) Enumerated "duties of trust or confidence." For purposes of this section, a "duty of trust or confidence" exists in the following circumstances, among others:
      86
      (1) Whenever a person agrees to maintain information in confidence;
      87
      (2) Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality; or
      88
      (3) Whenever a person receives or obtains material nonpublic information from his or her spouse, parent, child, or sibling; provided, however, that the person receiving or obtaining the information may demonstrate that no duty of trust or confidence existed with respect to the information, by establishing that he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties' history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information.
      89

      17 C.F.R. § 240.10b5-2 (2009).

      90

      The court concludes that, by its terms, Rule 10b5-2(b)(1) attempts to base misappropriation theory liability on an agreement that lacks an obligation not to trade on or otherwise use confidential information. The agreement specified in the Rule—"to maintain information in confidence"—relates merely to preserving the confidentiality of the information. The word "maintain" captures the obligation to keep the information in its existing state, and the modifying phrase "in confidence" indicates that the state to be preserved is its confidentiality. Nothing in Rule 10b5-2(b)(1) requires that the agreement encompass an obligation not to trade on or otherwise use the information.

      91

      That Rule 10b5-2(b)(1) relates to an agreement to preserve confidentiality is supported by the language and design of Rule 10b5-2 as a whole. It accords with the interpretation of Rule 10b5-2(b)(2) and (b)(3), which, like (b)(1), specify circumstances in which a duty of trust or confidence exists. Rule 10b5-2(b)(2) creates the duty based on a history, pattern, or practice of sharing confidences if "the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality." Rule 10b5-2(b)(3) creates a rebuttable rule that a duty of trust or confidence exists in certain enumerated family relationships, unless the person demonstrates that "he or she neither knew nor reasonably should have known that the person who was the source of the information expected that the person would keep the information confidential, because of the parties' history, pattern, or practice of sharing and maintaining confidences, and because there was no agreement or understanding to maintain the confidentiality of the information." Thus Rule 10b5-2(b)(2) and (b)(3) also base misappropriation theory liability on an undertaking, express or implied, to maintain confidentiality of information, but they do not require an undertaking not to trade on or otherwise use the information for personal benefit.

      92

      Because Rule 10b5-2(b)(1) attempts to predicate misappropriation theory liability on a mere confidentiality agreement lacking [731] a non-use component, the SEC cannot rely on it to establish Cuban's liability under the misappropriation theory. To permit liability based on Rule 10b5-2(b)(1) would exceed the SEC's § 10(b) authority to proscribe conduct that is deceptive. See O'Hagan, 521 U.S. at 651, 117 S.Ct. 2199 ("Liability under Rule 10b-5, our precedent indicates, does not extend beyond conduct encompassed by § 10(b)'s prohibition."). This is because, as the court has explained, under the misappropriation theory of liability, it is the undisclosed use of confidential information for personal benefit, in breach of a duty not to do so, that constitutes the deception.

      93
      VIII
      94

      Because the SEC has failed to allege that Cuban undertook a duty to refrain from trading on information about the impending PIPE offering, and because the SEC cannot rely on the duty imposed by Rule 10b5-2(b)(1) alone, Cuban cannot be held liable under the misappropriation theory of insider trading liability, even accepting all well-pleaded facts as true and viewing them in the light most favorable to the SEC. The court therefore grants Cuban's motion to dismiss the complaint under Rule 12(b)(6).

      95

      The court will allow the SEC 30 days from the date of this memorandum opinion and order to file an amended complaint, if the SEC can allege that Cuban undertook a duty, expressly or implicitly, not to trade on or otherwise use material, nonpublic information about the PIPE offering.

      96
      [I]n view of the consequences of dismissal on the complaint alone, and the pull to decide cases on the merits rather than on the sufficiency of pleadings, district courts often afford plaintiffs at least one opportunity to cure pleading deficiencies before dismissing a case, unless it is clear that the defects are incurable or the plaintiffs advise the court that they are unwilling or unable to amend in a manner that will avoid dismissal.
      97

      In re Am. Airlines, Inc., Privacy Litig., 370 F.Supp.2d 552, 567-68 (N.D.Tex.2005) (Fitzwater, J.) (quoting Great Plains Trust Co. v. Morgan Stanley Dean Witter & Co., 313 F.3d 305, 329 (5th Cir.2002)). If the SEC cannot replead as required by today's decision, it may so inform the court, and this case will be dismissed with prejudice.

      98
      * * *
      99

      Cuban's January 14, 2009 motion to dismiss is granted. The SEC is granted 30 days from the date of this memorandum opinion and order to file an amended complaint.

      100

      SO ORDERED.

      101
      MEMORANDUM OPINION AND ORDER
      102

      In a memorandum opinion and order filed July 17, 2009, the court granted defendant Mark Cuban's ("Cuban's") motion to dismiss under Fed.R.Civ.P. 12(b)(6), but it also gave plaintiff Securities and Exchange Commission ("SEC") 30 days to file an amended complaint. 634 F.Supp.2d at 713. The court concluded that "Cuban cannot be held liable under the misappropriation theory of insider trading liability, even accepting all well-pleaded facts as true and viewing them in the light most favorable to the SEC." Id. "The court [allowed] the SEC 30 days from the date of th[e] memorandum opinion and order to file an amended complaint, if the SEC can allege that Cuban undertook a duty, expressly or implicitly, not to trade on or otherwise use material, nonpublic information about the PIPE offering." Id. It stated that "[i]f the SEC cannot replead as required by today's decision, it may so inform the court, and this case will be dismissed with prejudice." Id.

      103

      [732] On August 12, 2009 the SEC timely filed a "Notice and Request Pursuant to the Court's July 17, 2009 Memorandum Opinion and Order." In its notice and request, the SEC "states that it does not intend to file an amended complaint and respectfully requests that the Court enter the final judgment against it to initiate the time for consideration of an appeal." Notice and Request 1.

      104

      Accordingly, for the reasons stated in the court's memorandum opinion and order filed July 17, 2009, and in the absence of an amended complaint, the court grants Cuban's January 14, 2009 motion to dismiss and dismisses this action with prejudice by judgment filed today.

      105

      SO ORDERED.

      106

      ----------

      107

      [1] In June 2007 Mamma.com changed its name to Copernic Inc. The court will refer to the company as Mamma.com, by which it was known at all times relevant to this litigation.

      108

      [2] The court will focus its discussion and analysis on § 10(b) and Rule 10b-5 because the parties agree that § 17(a) is "routinely examined... under the same standards" as these provisions. D. Br. 7 n. 6. See, e.g., Landry v. All Am. Assurance Co., 688 F.2d 381, 386 (5th Cir.1982) ("Rule 10b-5, adopted under § 10(b) of the Securities and Exchange Act of 1934, is substantially identical to § 17(a).").

      109

      [3] Although Cuban moves to dismiss under Rule 9(b) and addresses that standard in his brief, he does not specify how the SEC's complaint is deficient under Rule 9(b) in any respect that is distinct from what he asserts to be lacking under Rule 12(b)(6). To the extent his Rule 12(b)(6) and Rule 9(b) arguments merge, they are discussed together infra. Assuming arguendo that Cuban relies on a distinct argument to contend that the complaint lacks the particularity that Rule 9(b) requires, the court rejects the argument. Rule 9(b) requires that fraud be pleaded "with particularity," which requires specification of facts analogous to those in "the first paragraph of any newspaper story, namely the who, what, when, where, and how." Melder v. Morris, 27 F.3d 1097, 1100 n. 5 (5th Cir.1994). The court holds that the complaint is sufficiently particular to satisfy Rule 9(b).

      110

      [4] "Manipulative," as used in § 10(b), is a narrow "`term of art.'" Regents of the Univ. of Ca. v. Credit Suisse First Boston (USA), Inc., 482 F.3d 372, 390 (5th Cir.2007) (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976)). It "refers generally to practices, such as wash sales, matched orders, or rigged prices, that are intended to mislead investors by artificially affecting market activity." Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 476, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977).

      111

      [5] The court disagrees with Cuban's assertion that, in O'Hagan, "[t]he Court [drew] a clear distinction between fiduciaries and non-fiduciaries because only a fiduciary would have a duty to make this disclosure and therefore can be said to have engaged in a `deception' if he does not disclose or abstain from trading." D. Reply Br. 2-3 (citing O'Hagan, 521 U.S. at 655, 117 S.Ct. 2199). Although O'Hagan is written in terms of fiduciaries and fiduciary relationships, duties, and obligations, it is reasonable to infer that this is because O'Hagan was a criminal case that involved the conduct of a fiduciary. "In this case, the indictment alleged that O'Hagan, in breach of a duty of trust and confidence he owed to his law firm, Dorsey & Whitney, and to its client, Grand Met, traded on the basis of nonpublic information regarding Grand Met's planned tender offer for Pillsbury common stock. This conduct, the Government charged, constituted a fraudulent device in connection with the purchase and sale of securities." O'Hagan, 521 U.S. at 653, 117 S.Ct. 2199 (citation omitted). The Court may simply have intended that its opinion decide the case without injecting dicta to cover other circumstances in which the misappropriation theory could apply. But regardless of the reason, there is no indication in O'Hagan that such a fiduciary or fiduciary-like relationship is necessary—as opposed to merely sufficient—to impose the requisite duty, or is otherwise an essential element of the misappropriation theory.

      112

      [6] In this respect, by "nondisclosure" the court means maintaining the confidentiality of information, not the nondisclosure of one's intention to trade on or otherwise use such information.

      113

      [7] Cases decided both before and after O'Hagan have recognized that a duty sufficient to support misappropriation theory liability may arise by agreement. See, e.g., SEC v. Yun, 327 F.3d 1263, 1273 (11th Cir.2003) (stating that "[o]f course, a breach of an agreement to maintain business confidences would also suffice" to yield insider trading liability); United States v. Falcone, 257 F.3d 226, 234 (2d Cir. 2001) (holding that "a fiduciary relationship, or its functional equivalent, exists only where there is explicit acceptance of a duty of confidentiality or where such acceptance may be implied from a similar relationship of trust and confidence between the parties" (citing Chestman, 947 F.2d at 567-68)); Chestman, 947 F.2d at 571 (reasoning that "fiduciary status" could be established by "a pre-existing fiduciary relation or an express agreement of confidentiality"); SEC v. Nothern, 598 F.Supp.2d 167, 175 (D.Mass.2009) (holding that SEC's allegation that person had "expressly agreed to maintain the confidentiality of ... information is sufficient to state a claim that he had a `similar relationship of trust and confidence'"); SEC v. Lyon, 529 F.Supp.2d 444, 452-53 (S.D.N.Y.2008) (holding that SEC had adequately alleged existence of predicate duty for misappropriation theory liability by pleading that purchase agreement and other materials related to PIPE offering contained confidentiality conditions and provisions, including requirements that defendants use information for sole purpose of evaluating possible investment in the offering, and discovery might reveal that defendants had explicitly accepted the conditions or that it was customary practice among participants in private placement market to be bound and abide by such provisions). Because none of these cases analyzes the nature of the agreement that is required for misappropriation theory liability, none is contrary to the court's holding today that an agreement must include both an obligation to maintain the confidentiality of the information and not to trade on or otherwise use it.

      114

      [8] The court notes that, in an insider trading case decided by this court, Judge Lindsay relied in part on the Kim factors to hold that liability existed under the misappropriation theory. See SEC v. Kornman, 391 F.Supp.2d 477, 488-89 (N.D.Tex.2005) (Lindsay, J.). But unlike in Kim, Judge Lindsay was not explicitly addressing whether factors such as superiority, dominance, or control were required for liability under the misappropriation theory. Instead, he relied on Kim and other cases in "consider[ing] the indicia giving rise to a fiduciary or fiduciary-like relationship in the arena of securities fraud." Id. at 486. In other words, he assumed that such a relationship was necessary for misappropriation theory liability, and he relied on Kim and similar cases to determine whether such a relationship had been adequately pleaded.

      115

      [9] In light of the court's conclusion on this issue, it need not address at length Cuban's contention that Rule 10b5-2 (b)(1) applies only to family and other personal relationships, i.e., non-business relationships. Were the court to reach this question, however, it would join the other courts that reject such a limitation on Rule 10b5-2 (b)(1)'s reach. See, e.g., Nothern, 598 F.Supp.2d at 174-75.

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