INTRODUCTION

           In United States v. O'Hagan¹ the United States Supreme Court articulated an apparently expansive definition of insider trading, adopting the "misappropriation theory" of liability.² Only ten years earlier, the Court split evenly on the viability of the misappropriation theory of insider trading liability.³ This article will examine the Court's decision in O'Hagan, attempt to define the scope of the misappropriation theory as adopted by the Supreme Court, and assess O'Hagan's impact on the law of insider trading. Critical to this analysis, this article views the O'Haganopinion in the context of the Supreme Court's other securities law opinions, and the Court's recent pronouncements on the viability of federal common law.
           This article will first assess the degree to which O'Haganis limited by prior Supreme Court precedents defining securities fraud and prior lower court opinions applying the misappropriation theory. Next, this article will attempt to assess insider trading law in the wake of O'Hagan. The article will conclude with an attempt to define the elements of proof necessary to show an insider trading violation under Rule 10b-5 based upon an analysis of the O'Hagandecision and preexisting law. The conclusion of this article is that the misappropriation theory adopted in O'Haganis not nearly as expansive as it initially appears, particularly in the criminal arena where many insider trading cases arise.
           Section 10(b) of the Securities Exchange Act of 1934,⁴ and Rule 10b-5,⁵ promulgated thereunder by the Securities and Exchange Commission, are the foundation of the misappropriation theory. The Supreme Court, in a long line of cases, which included vigorous debate among the Justices, has held that Rule 10b-5 is an "antifraud" provision designed to proscribe fraud in connection with the purchase or sale of a security, including "insider trading."⁶ The controversy over the years has focused on what exactly is "insider trading." The dissenters in the Supreme Court opinions often chastised the majority for its literal reading of §10(b) rather than broadly interpreting it as a license to essentially police business ethics.⁷
           The touchstone of §10(b) liability is "deception" ⁸ "in connection with the purchase or sale of any security."⁹ Although commonly § 10(b) is referred to as the catchall provision,¹⁰ the Supreme Court has made it clear that what § 10(b) catches must be fraud.¹¹ The Court has refused to allow Rule 10b-5 to be read in a manner that is broader than § 10(b): "We have refused to allow Rule 10b-5 challenges to conduct not prohibited by the text of the statute." ¹² In the context of securities transactions in public markets, the Court has held that absent a duty to speak, a supposed "insider" does not engage in fraud, nor violate § 10(b), by failing to disclose material information because a duty to disclose does not arise from the mere possession of nonpublic market information.¹³ Thus, the key issue in defining insider trading is whether the putative defendant has a duty to disclose, arising from some source other than mere possession of material nonpublic information.
           The Supreme Court has changed none of this through its adoption of the misappropriation theory. Pursuant to the O'Haganmisappropriation theory, a person violates Rule 10b-5 when they deceptively misappropriate material nonpublic information in breach of a fiduciary duty and use that information in a securities transaction because the fraud thereby perpetrated upon the source of the information is fraud in connection with a securities transaction. ¹⁴ In O'Hagan, the Court ruled that the misappropriation theory was a valid theory for which liability could be assessed for §10(b) violations. In doing so, the Court did not expressly approve of the application of § 10(b) in every case, or any case, purporting to apply the misappropriation theory. ¹⁵ Indeed, the Court did not even hold that O'Hagan was liable under the misappropriation theory. ¹⁶

UNITED STATES V. O'Hagan: MODEST STEP FORWARD OR LIABILITY RUN AMOK?

           In United States v. O'Hagan,¹⁷ defendant James O'Hagan was a partner in the law firm of Dorsey & Whitney in Minneapolis, Minnesota.¹⁸ In July 1988, Grand Met retained Dorsey & Whitney as local counsel to represent it regarding a potential tender offer for the common stock of Pillsbury Company.¹⁹ O'Hagan, who did not work on the Grand Met project, began purchasing call options for Pillsbury stock in August of 1988.²⁰ By the end of September, O'Hagan owned 2500 unexpired Pillsbury options and some 5000 shares of Pillsbury common stock.²¹ On September 9, 1988, Dorsey & Whitney withdrew from representing Grand Met and less than a month later, Grand Met publicly announced its tender offer for Pillsbury stock. ²² The announcement sent the price of Pillsbury stock to $60 a share, allowing O'Hagan to make a profit of more than $4.3 million from his Pillsbury stock and call options.²³ The SEC initiated an investigation into O'Hagan's transactions, culminating in a 57-count indictment, including allegations of 17 counts of securities fraud.²⁴ A jury convicted O'Haganand a divided panel of the Court of Appeals for the Eighth Circuit reversed all of O'Hagan's convictions.²⁵ 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.²⁶ The Supreme Court granted certiorari to decide whether the misappropriation theory can support §10(b) liability. ²⁷
           The Supreme Court held "in accord with other Courts of Appeals, that criminal liability under §10(b) may be predicated on the misappropriation theory." ²⁸ The Court explained that 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 the insider's own corporation on the basis of material, nonpublic information.²⁹ Trading on such information is a "deceptive device" under § 10(b), 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.³⁰ It is this relationship that gives rise to a duty to disclose publicly the information because of the necessity of preventing a corporate insider from taking unfair advantage of uninformed stockholders.³¹
           The misappropriation theory, according to the Court, holds that a person commits fraud in connection with a securities transaction, and thereby violates §10(b) and Rule 10b-5, when the person deceptively misappropriates confidential information for securities trading purposes, in breach of a fiduciary duty owed to the source of the information. ³² In lieu of premising liability on a fiduciary relationship between a company insider and a purchaser or seller of the company's stock, the misappropriation theory premises liability on a fiduciary deceptively breaching the duty to those entrusting the fiduciary with access to confidential information and personally gaining from such deception.³³ This conduct defrauds the source of the information of the exclusive use of the information.³⁴
           The Court stated that the traditional and misappropriation theories are complementary, each addressing efforts to capitalize on nonpublic information through the purchase or sale of securities.³⁵ 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 fiduciary duty owed not to a trading party, but to the source of the information.³⁶ The Court stated that full disclosure to the source of information forecloses liability under the misappropriation theory because the deception essential to the theory would not be present; therefore there is no fraud and thus no violation of §10(b) if the fiduciary discloses to the source the plans to trade on the nonpublic information.³⁷ According to the Court, this misconduct amounts only to a breach of the duty of loyalty under state law. ³⁸ This duty of disclosure to the source of information is a somewhat more novel approach to insider trading liability, which previously imposed upon a putative inside trader a duty to disclose material information to the market or to abstain from trading.³⁹
           Turning next to the requirement that the deceptive use of information be "in connection with the purchase or sale of a security," the Court stated that this element is satisfied because the fiduciary's fraud is consummated, not when the fiduciary gains the confidential information, but when without disclosure to the principal, the information is used to purchase or sell securities.⁴⁰ Thus, a misappropriator who trades on the basis of material, nonpublic information gains an advantageous market position through deception; the fiduciary deceives the source of the information and simultaneously harms members of the public.⁴¹ According to the Court, "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
           Essentially the Court now requires proof of two different wrongs for liability under the misappropriation theory. First, there must be a breach of a fiduciary duty constituting fraud upon the source of information.⁴³ Second, there must be a violation of Rule 10b-5; that is the use of a deceptive device in connection with the purchase and sale of securities. ⁴⁴ Thus, O'Hagan holds that proof of unlawful insider trading now requires proof of fraud on the source of information, in addition to the traditional elements of a Rule 10b-5 violation. ⁴⁵
           The Court explained that the misappropriation theory is in all respects still limited by the Court's earlier precedents.⁴⁶ According to the Court, its prior insider trading opinions, Chiarella v. United States⁴⁷ and Dirks v. SEC ⁴⁸ both left the door open for the misappropriation theory. ⁴⁹ In Chiarella, the Court did not address the theory because it was not submitted to the jury.⁵⁰ In Dirks, there was no expectation that the defendant in that case would keep the information in confidence and therefore there was no breach of fiduciary duty arising from the undisclosed use of the information.⁵¹ Nor did the defendant in Dirks misappropriate or illegally obtain the information.⁵² Therefore, the case presented no suggestion of the misappropriation of information in the context of a fiduciary relationship.⁵³
           The Court emphasized that there are "two sturdy safeguards" provided by Congress regarding scienter to address any concern that the misappropriation theory is too broad.⁵⁴ To establish a criminal violation of Rule 10b-5, the Government must prove that a person "wilfully" violated the provision.⁵⁵ Furthermore, a defendant may not be convicted for violating Rule 10b-5 if the defendant proves a lack of knowledge of the rule.⁵⁶
           Is the misappropriation theory inherently incoherent and inconsistent as the dissent in O'Hagan and many commentators have charged?⁵⁷ Perhaps so. Indeed, if O'Hagan is read to authorize the federal courts to create a federal common law regarding the use of confidential information, transcending the full gamut of relationships existing in our society, on an ad hoc basis, the misappropriation theory seems to be an overbroad, unpredictable, and ultimately infirm exercise of federal powers.⁵⁸ But, this Article will now demonstrate that because the O'Hagan Court firmly anchored the misappropriation theory in its prior precedents, and the language of § 10(b), the Court has drawn a clear line in the sand for defendants, and that line is fraudulent breach of fiduciary duty as defined by the relevant state law.

THE MEANING OF O'HAGAN AND THE SUPREME COURT'S PRIOR OPINIONS

           The Supreme Court in O'Hagan emphasized the consistency of the misappropriation theory with its prior precedents.⁵⁹ An understanding of the theory, as adopted by the Court, therefore requires an understanding of those precedents.

ERNST & ERNST v. HOCHFELDER⁶⁰

           In Ernst & Ernst customers of a brokerage firm charged an accounting firm with negligence for failing to properly audit the brokerage which had defrauded its customers in an investment scam. Plaintiffs alleged that defendant Ernst & Ernst had aided and abetted violations of §10(b) and Rule 10b-5 by its failure to conduct proper audits of the firm, thereby failing to discover the brokerage's fraud.⁶¹ The issue before the Supreme Court in Ernst & Ernst was whether § 10(b) proscribes only fraudulent conduct.⁶² Courts and commentators had long differed with regard to whether scienter is a necessary element of such a cause of action, or whether negligent conduct alone is sufficient.⁶³ In addressing the question, the Court turned to the language of §10(b). ⁶⁴ The Court reasoned that the words "manipulative or deceptive" used in conjunction with "device or contrivance" strongly suggested that §10(b) was intended to proscribe knowing or intentional misconduct.⁶⁵ The Court concluded that this language connotes intentional or willful conduct designed to deceive or defraud investors.⁶⁶ Despite the clarity of the statute, the Court went further in search of some indication that § 10(b) could be extended to negligent conduct, and reviewed the relevant legislative history.⁶⁷
           Although the extensive legislative history of the 1934 Act is void of any explicit explanation of Congressional intent, the Court concluded that the relevant portions of that history supported the conclusion that §10(b) addressed practices that involve some element of scienter and cannot be read to impose liability for negligent conduct alone.⁶⁸ For example, the Court quoted one of § 10(b)'s key draftsmen who stated that the section's purpose was to make clear that: "Thou shalt not devise any other cunning devices."⁶⁹ The Court concluded that: "There is no indication . . . that § 10(b) was intended to proscribe conduct not involving scienter."⁷⁰ The Court therefore held that liability under Rule 10b-5 requires a showing of an "intent to deceive, manipulate or defraud."⁷¹

SANTA FE INDUSTRIES, INC. v. GREEN⁷²

           In Santa Fe Industries, Inc. v. Green, the parent company of a subsidiary utilized Delaware's short-form merger statute to buy out the minority shareholders of the subsidiary at a per share price that exceeded past purchase prices, but allegedly was less than the stock's fair market value.⁷³ The district court dismissed the complaint, holding that Delaware law governed the dispute, and that Rule 10b-5 did not override substantive state law.⁷⁴ The Second Circuit Court of Appeals' view was that although Rule 10b-5 plainly reached material misrepresentation and non-disclosure in connection with the purchase or sale of securities, neither misrepresentation nor non-disclosure was a necessary element of a Rule 10b-5 action.⁷⁵ The Rule, according to the Second Circuit, reached breaches of fiduciary duty by a majority against minority shareholders without any charge of misrepresentation or lack of disclosure.⁷⁶ The Second Circuit went on to hold that a complaint alleges a claim under Rule 10b-5 when it charges that a majority has committed a breach of its fiduciary duty to deal fairly with minority shareholders by effecting the merger without any justifiable business purpose.⁷⁷
           The Supreme Court first held that the approach of the Court of Appeals to the interpretation of Rule 10b-5 was inconsistent with Ernst & Ernst v. Hochfelder. ⁷⁸ Once again the Court refused to stray from the text of § 10(b) into the realm of general business ethics. The court stated: "the language of §10(b) gives no indication that Congress meant to prohibit any conduct not involving manipulation or deception. Nor have we been cited to any evidence in the legislative history that would support a departure from the language of the statute." ⁷⁹ Although the plaintiffs in Santa Fe Industries claimed the company treated them unfairly and breached their fiduciary duty, the defendant's conduct was neither deceptive nor manipulative and therefore did not violate either §10(b) or Rule 10b-5.⁸⁰
           The Court could have stopped there. Instead, the Santa Fe Industries Court highlighted that corporate standards of conduct are traditionally left to state regulation and that extending the federal securities laws to this arena would interfere with state corporate law. ⁸¹ The Court recognized that allowing federal law to define state fiduciary duties was problematic: "federal courts applying a federal fiduciary principle under Rule 10b-5 could be expected to depart from state fiduciary standards at least to the extent necessary to ensure uniformity within the federal system."⁸² Absent a clear indication of congressional intent, the Court was reluctant to "federalize the substantial portion of the law of corporations that deals with transactions in securities, particularly where established state policies of corporate regulation would be overridden." ⁸³ The Court recognized that when § 10(b) was enacted it was not supposed to cover the "corporate universe."⁸⁴ "Corporations are creatures of state law, and investors commit their funds to corporate directors on the understnding that. . .state law will govern the internal affairs of the corporation."⁸⁵ Simply put, the Court was unwilling to invasively intrude upon state law without explicit congressional directives.⁸⁶
           In sum, the Court held that a breach of fiduciary duty without any deception, misrepresentation or non-disclosure, did not violate §10(b) or Rule 10b-5 which only proscribes the use of deceptive practices.⁸⁷ Second, the Court clearly established that without Congressional intent, it would not federalize the law of fiduciary duty.⁸⁸ Indeed, the Court specifically condemned the Second Circuit's use of a federal common law of fraud and fiduciary duty to expand the meaning of Rule 10b-5.⁸⁹

CHIARELLA v. UNITED STATES⁹⁰

           In Chiarella v. United States, the Supreme Court addressed the issue of an individual's duty to disclose material nonpublic information, in the context of insider trading.⁹¹ The facts of Chiarella are as follows: Chiarella worked for a financial printer that printed corporate legal documents, including documents related to imminent mergers and acquisitions and tender offers.⁹² Chiarella's employer required its employees to maintain the secrecy of information learned throughout their employment. Chiarella dishonored this obligation and figured out how to decode the names of prospective companies which were set to be acquired. With this information, he traded stocks of the targets and managed a profit of $30,000. He was later convicted of violations of § 10(b) and Rule 10b-5 and the Second Circuit affirmed the convictions.⁹³
           The issue in Chiarella was whether a person who learns confidential information violates §10(b), by committing fraud, through a failure to disclose the impending takeover before trading in the target company's securities.⁹⁴ The majority of the Court, adhering to a traditional notion of insider trading, held that when trading on material nonpublic information, failure to disclose that information prior to trading is fraudulent only when there is a duty to disclose.⁹⁵ The Court stated:

we hold that a duty to disclose under §10(b) does not arise from the mere possession of nonpublic market information. The contrary result is without support in the legislative history of §10(b) and would be inconsistent with the careful plan that Congress has enacted for regulation of the securities market.96

           The Court addressed the issue that the Securities and Exchange Commission left open in the case of Cady Roberts & Co.,⁹⁷ of whether a person who is not a corporate insider who possessed material nonpublic information was liable under § 10(b). The Commission, in Cady Roberts & Co., held that corporate insiders must abstain from trading in the shares of their corporation unless they have first disclosed all material inside information known to them. According to Chiarella, the obligation to disclose or abstain derives from a 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.⁹⁸
           The Court noted that "not every instance of financial unfairness constitutes fraudulent activity under § 10(b)."⁹⁹⁾ The Court also noted:

We cannot affirm petitioner's conviction without recognizing a general duty between all participants in market transactions to forgo actions based on material, nonpublic information. Formulation of such a broad duty, which departs radically from the established doctrine that duty arise from a specific relationship between two parties . . ., should not be undertaken absent some explicit evidence of Congressional intent.100

The Court declined to supplement the rule articulated in Cady Roberts & Co. with any broad federal common law notion of fiduciary duty beyond that which corporate insiders owed shareholders.¹⁰¹ The Court refused to expand the holding in Cady Roberts & Co., to individuals who are not corporate insiders. Consequently, the Court held that there is no liability under § 10(b) for failing to disclose material information absent a duty to speak, because a duty to disclose under § 10(b) does not arise from the mere possession of nonpublic material information. ¹⁰²
           The Court expressly left open the question of the validity of the misappropriation theory.¹⁰³ This was the first time the Court actually had the chance to address the misappropriation theory. It refused however to address the misappropriation theory because the jury had not received a misappropriation theory instruction.¹⁰⁴ Therefore, the viability of the misappropriation theory remained unresolved.¹⁰⁵
           Chiarella was clear that although section 10(b) is "aptly described as a catchall provision, . . .what it catches must be fraud."¹⁰⁶ Moreover, the court was unwilling to allow federal common law to operate to provide a broad-based duty to speak, to support a finding of fraud, outside of the limited context of the Cady Roberts & Co. decision relating to corporate insiders.¹⁰⁷ The Supreme Court has subsequently reaffirmed the Chiarella holding limiting the scope of § 10(b) and Rule 10b-5.

DIRKS V. SEC¹⁰⁸

           In Dirks v. SEC, the Court again limited the scope of Rule 10b-5 and §10(b), with respect to instances involving material omissions, to those where a duty to speak exists.¹⁰⁹ Dirks was a securities analyst who was told by a former employee of Equity Funding of America that the company's assets were overinflated as a result of the company's fraudulent practices. Dirks decided to investigate the allegations. Among other things he interviewed officers and employees of Equity Funding who confirmed the allegations against Equity Funding. 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. Dirks also tried to get the Wall Street Journal to write a story on the allegations of fraud, but they did not believe such a massive fraud could go on undetected.¹¹⁰ During the two weeks of Dirk's investigation, 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 27.¹¹¹
           Although Dirks' efforts lead to the conviction or guilty pleas of Equity Funding and 22 persons,¹¹² the SEC brought an action against Dirks because he tipped off certain investors to the fraud.¹¹³ The SEC felt justified pursuing Dirks because: "Where tippees'--regardless of their motivation or occupation--come into possession of material 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."¹¹⁴ Recognizing Dirks played an important role in bringing Equity Funding's massive fraud to light, the SEC only censured him.¹¹⁵ The question before the Court was whether Dirks violated the anti-fraud provisions of the federal securities law through his disclosure to other investors.¹¹⁶ This is exactly the general duty theory of § 10(b) liability that the Supreme Court rejected in Chiarella, where the defendant was a much less sympathetic character than Dirks.¹¹⁷
           The majority followed the holding in Chiarella and 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 by trading without disclosure."¹¹⁸ The Court explained however, that there can be no duty to disclose where the person who 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.¹¹⁹ The Court reaffirmed that a duty to disclose arises from the relationship between parties and not merely from one's ability to acquire information because of one's position in the market.¹²⁰ The Court therefore rejected, as it rejected in Chiarella, a general duty between all market participants to forgo actions based on material, nonpublic information.¹²¹
           Based upon these principles the Court easily resolved this case. No insider of Equity Funding had violated a duty to that corporation's shareholders, and Dirks could not have assumed any "tippee" duty not to disclose as a result of the information that passed from the Equity Funding insiders to him. Also, Dirks did not owe a direct fiduciary duty to the shareholders of Equity Funding, because he had no prior relationship with Equity Funding. ¹²² Moreover, there was no expectation that Dirks would keep the information confidential. ¹²³ The Supreme Court therefore reversed the censure.¹²⁴
           The Court again defined the circumstances under which liability for trading on the basis of material inside information will attach, and limited those situations to instances in which there had been a breach of fiduciary duty to support fraud.¹²⁵ In doing so, the Court has provided clear guidance as to who holds the duty to disclose or abstain from trading in their decisions in Chiarella and Dirks.¹²⁶ Notably, the Court did not rest its tippee liability analysis on any expansive federal common law doctrine.¹²⁷ Instead, the Dirks analysis of tippee liability flowed from the statutory text of the Exchange Act itself, which prohibits direct violation of law, as well as indirect violations of law, "by means of any other person."¹²⁸

CARPENTER V. UNITED STATES¹²⁹

           In Carpenter v. United States, the defendant was the coauthor of a Wall Street Journal investment column, which, because of its perceived quality and integrity, had an impact on the market price of the stocks it discussed.¹³⁰ The Journal had a rule that the column's contents were the Journal's confidential information prior to publication, and could not be used for personal gain. The defendant, Winans, entered into a scheme with Felis and another stockbroker who in exchange for advance information from Winans would share the profits from the stocks they bought and sold based on the information from the column.¹³¹
           The Court in Carpenter recognized that a company's confidential information, qualifies as property to which the company has a right of exclusive use. ¹³² The undisclosed misappropriation of such information, in violation of a fiduciary duty, constitutes fraud akin to embezzlement; "the fraudulent appropriation for one's own use of the money or goods entrusted to one's care by another."¹³³ The decision was split with respect to the application of the misappropriation theory, which in turn had the effect of affirming the securities law convictions.¹³⁴ However, the Court unanimously affirmed the mail fraud and wire fraud convictions. ¹³⁵ This is significant: apparently some part of the Court concluded that proof amounting to mail fraud and wire fraud does not necessarily amount to securities fraud. This suggests that the federal common law definitions of mail fraud and wire fraud do not carry over to define fraud for all purposes of Rule 10b-5.¹³⁶
           The misappropriation theory adopted in O'Hagan, viewed as part of the Court's Rule 10b-5 jurisprudence, is clearly subject to significant limitations. Most importantly: i) there is little basis for a federalized concept of fiduciary duty to override state fiduciary duty concepts; ii) the misappropriation theory only proscribes fraudulent non-disclosure of a prohibited use of information and not just a mere breach of fiduciary duty; and iii) the misappropriation theory relies upon fiduciary principles (including a focus on the expectations of the parties) to impose a duty of disclosure to support fraud on the source of information. These limitations effectively transform the misappropriation theory into a far more narrow theory of insider trading, best termed "fraud-on-the source" of information theory of insider trading.¹³⁷ The next section will highlight specific misappropriation theory cases that seemingly run afoul of these limitations, and apply a broader, more expansive misappropriation theory.

LOWER COURT CASES APPLYING AN EXPANSIVE MISAPPROPRIATION THEORY

           The misappropriation theory holds that a person commits fraud upon the source of confidential non-public material information, by "feigning" fidelity, and using the information in a securities transaction, thereby violating § 10(b) and Rule 10b-5. Under the theory this is fraud in connection with a securities transaction.¹³⁸ 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.¹³⁹ The significance of the fiduciary duty is that it supports a duty to disclose to the source of the information. The misappropriation theory is thus designed to protect the integrity of the securities markets against abuses by outsiders to a corporation who have access to confidential information that will affect the corporation's security price when revealed, but who owe no fiduciary or other duty to that corporation's shareholders.¹⁴⁰ This is the extent of the misappropriation theory adopted in O'Hagan. The misappropriation theory actually adopted by lower courts, before O'Hagan is often vastly more expansive.
           The misappropriation theory was first developed by the Second Circuit in the case of United States v. Newman.¹⁴¹ The Newman court reversed the dismissal of an indictment charging a violation of the misappropriation theory.¹⁴² The indictment charged that the defendants violated fiduciary duties to their employers, an investment banking firm, and the firm's clients, by trading on confidential information belonging to the firm and its clients.¹⁴³ In assessing the sufficiency of the indictment, the court failed to identify what law it was applying to determine whether defendants indeed owed a fiduciary duty that required disclosure of any use of confidential information, or to cite any state law authority in support of its fiduciary duty analysis. ¹⁴⁴ Newman therefore either stands for the proposition that all of these issues are matters of federal common law, or engages in only the most cursory analysis of the issue. This rudderless approach to the issue of fiduciary duty haunts the development of the misappropriation theory throughout its pre-O'Hagan development.
           The Seventh Circuit authored another such case in SEC v. Cherif. ¹⁴⁵ There the SEC brought a civil enforcement action against a former employee of First National Bank of Chicago.¹⁴⁶ After the bank terminated Cherif's employment, he kept his magnetic identification card. ¹⁴⁷ This card allowed Cherif to enter the bank's offices without authorization to obtain confidential information regarding clients' planned tender offers and leveraged buy outs.¹⁴⁸ Unbeknownst to Cherif, the bank's security system automatically recorded his entries and exits.¹⁴⁹ A comparison of the security system's records with Cherif's trading activity revealed that Cherif traded in the stock of four companies about which the bank had obtained confidential information.¹⁵⁰ The district court enjoined Cherif from future trading and froze his assets.¹⁵¹
           The Seventh Circuit had little difficulty concluding that his course of conduct was fraudulent within the meaning of Rule 10b-5.¹⁵² In doing so, the Seventh Circuit expanded the definition of fraud in § 10(b) to include someone who deprived some person of something of value by trick, deceit, or overreaching.¹⁵³ In reality, Cherif's act was common theft by a non-fiduciary.¹⁵⁴ In an attempt to stretch the liability of § 10(b), the Seventh Circuit held that Cherif breached a continuing fiduciary duty to his former employer when he used the key card and used specific confidential knowledge he had learned as an employee earlier to break into the bank and steal inside information about upcoming transactions.¹⁵⁵ But this amounts only to a breach of the duty of loyalty, not "feigning fidelity to the source of information."¹⁵⁶ The Seventh Circuit stated it made no difference that Cherif carried out the thefts after his employment ended. ¹⁵⁷ Basically, Cherif was like any other burglar who breaks into a building and steals property, and he was guilty of theft, not fraud. Cherif cites no Illinois authority regarding the duties of a former employee and not a single case finding a former employee turned thief guilty of fraud.¹⁵⁸ The employer's policy on the use of confidential information specified that it applied only during the time of Cherif's employment.¹⁵⁹ Indeed, in its final analysis, Cherif relies on federal common law standards of fiduciary fraud created from whole cloth.¹⁶⁰
           Another example of the potential liabilities of an unfettered misappropriation theory is United States v. Willis,¹⁶¹ where a psychiatrist was alleged to have taken information gained from a patient and then used this information to trade securities. The court in Willis held that the psychiatrist breached professional duties of confidentiality to a patient and was held accountable under the misappropriation theory.¹⁶² The question in this case is what fiduciary duty did the psychiatrist breach? In order to be held accountable, the psychiatrist would need to defraud the patient by using the information to trade securities. The psychiatrist never breached the confidentiality of the patient; in fact, maintaining the secrecy of the information was the essence of the trading scheme.¹⁶³ As such, he never breached any previously recognized patient-psychiatrist duty. The federal court seemingly redefined the scope of the fiduciary duty to extend beyond maintaining confidences to a promise to refrain from using such information for purposes of securities trading.¹⁶⁴ The court's search for such a duty is revealing; ultimately there is no authority for such a promise. The court starts with the Hippocratic Oath, which says nothing about securities trading.¹⁶⁵ Willis, at least, looks to relevant state law in search of the breach of fiduciary duty. ¹⁶⁶ However, having gone so much further than most misappropriation theory cases, the Willis court misses the point. Willis cites to two cases in support of its fiduciary duty analysis.¹⁶⁷ Unfortunately, neither case holds that a psychiatrist may not profit from trading upon confidential information; indeed, these cases may only be cited for the proposition that a psychiatrist must keep such information confidential.¹⁶⁸ Despite its failure to find any basis for an obligation for a psychiatrist to refrain from securities trading based upon patient information, the court sustained the indictment.¹⁶⁹ Without a knowing breach of the duty of confidentiality, the psychiatrist could not be convicted of fraudulent conduct. Without the fraudulent conduct, a violation of § 10b-5 is impossible. Although not raised on a motion testing the indictment, the court also searched widely for damage to the patient. ¹⁷⁰ Trading is far from tantamount to damaging disclosure, however, and the court's reasoning on this point is also less than satisfying. Similarly, in United States v. Reed,¹⁷¹ the court applied the misappropriation theory in a situation involving an alleged breach of familial duty in a father-son relationship.¹⁷² Is a father-son relationship, a fiduciary relationship? Reed cites no law in support of such a position. The court in Reed just assumed that there was a duty and that duty was breached. Reed focused on whether the defendant had a relationship of trust and confidence with his father. Can this issue be a matter of federal law? Reed fails to answer this question and appears to look only to general common law principles and relies upon no particular state law.¹⁷³ Again, however, Reed loses sight of the real issue: did the son defraud the father by trading securities. Reed is essentially premised on the disclose or abstain duty which O'Hagan rejected.¹⁷⁴ As such the court fails to focus on the question of whether the source of information was defrauded.¹⁷⁵
           To what extent does a fiduciary duty extend to family relationship as Reed suggests? The court in United States v. Chestman¹⁷⁶ declared that the existence of fiduciary duties in other common law settings is anything but clear.¹⁷⁷ Simply entrusting a person with confidential information cannot impose a fiduciary duty.¹⁷⁸ In Chestman, a husband used confidential information he received from his wife to trade in the stock of a company controlled by his in-laws. ¹⁷⁹ The court held that marriage without more does not create a fiduciary relationship.¹⁸⁰ Reversing the jury finding to the contrary, the court stated that the relationship between the husband and wife did not qualify as a fiduciary relationship.¹⁸¹ While it is true that Chestman was decided after a jury trial, and Reed was testing the sufficiency of an indictment, Chestman is simply far more circumspect in assessing the relationship between the source of the information and the trader. Both Reed and Chestman illustrate, however, the necessity for a fact-intensive inquiry on this issue and the need for formal jury-findings.
           In general, Willis, Reed and Cherif are emblematic of a tendency of the lower courts to expand fiduciary duties under the guise of the misappropriation theory and to impose liability with only a tenuous showing of fraud.¹⁸² For example, many lower courts have expanded the applicability of the theory to situations where "a fiduciary duty or other similar relationship of trust and confidence between the parties to the transaction, is sufficient to support a fiduciary relationship."¹⁸³ In O'Hagan, the Supreme Court appears to have put a stop to this expansion by failing to make any reference to any general "relationship of trust and confidence" as a basis for imposing liability under the misappropriation theory. Justice Ginsburg stated the issue as: "Is a person who trades in securities for personal profit, using confidential information misappropriated in a breach of a fiduciary duty to the source of the information, guilty of violating § 10(b) and Rule 10b-5?"¹⁸⁴ The Supreme Court was clear: the misappropriation theory requires a fraudulent breach of the fiduciary duty. The only duties the lower courts should recognize, therefore, are clearly established fiduciary duties.¹⁸⁵
           How do cases such as Reed, Cherif, and Willis, fare under the O'Hagan misappropriation theory?
           Well, O'Hagan is certainly clear that "the misappropriation theory may support criminal liability."¹⁸⁶ But, beyond that O'Hagan is somewhat sketchy regarding the scope of this theory. The next section will try to complete the O'Hagan sketch, and show that these cases are not within the O'Hagan misappropriation theory.

THE QUESTIONS O'HAGAN LEAVES UNANSWERED

           As is readily apparent from the above discussion, the Supreme Court answered the most general and easy question in O'Hagan: it held that the misappropriation theory may support insider trading liability.¹⁸⁷ But the Court virtually ignored some of the more difficult issues raised by the adoption of the misappropriation theory. First, what law forms the source of the fiduciary duty analysis underlying the misappropriation theory, some unarticulated federal common law, or state law, as may be variously defined by the courts of each state? Second, regardless of the source of the fiduciary duty analysis is the precise fiduciary duty owed defined by contract analysis, such that the beneficiary of the fiduciary relationship is in a position, in nearly every case, to waive, directly or indirectly, any Rule 10b-5 violation? Third, what are the elements and quantum of proof required to show an insider trading violation after O'Hagan? Fourth, where does O'Hagan leave those cases based on an expansive misappropriation theory that is both untethered to fraud and breach of fiduciary duty but defined, apparently, based upon the degree of judicial disgust a given use of "confidential" information arouses? This article will now address each of these questions and suggest answers from the O'Hagan opinion and prior law.

WHAT FIDUCIARY DUTY?

           Thus far, the federal courts, in applying the misappropriation theory, appear to have created a scheme of federal fiduciary duty common law on the fly.¹⁸⁸ That is the courts are defining "misappropriation" on an ad hoc basis with little notice to putative insider traders of what conduct is prohibited and what conduct is acceptable.¹⁸⁹ Although the courts invariably claim to define "misappropriation" in accordance with some "fiduciary duty" analysis, most cases never really address where the legal doctrine for this analysis comes from. ¹⁹⁰ No case has yet to address the fact that state fiduciary duty analysis is often a question of fact and often differs from state to state.¹⁹¹ Commentators recognized before O'Hagan that the misappropriation doctrine relies upon a fiduciary duty analysis created from whole cloth as a creature of federal common law.¹⁹² Most decisions do not even address the issue. In one decision, the Second Circuit appears to have looked to Delaware state law to assess fiduciary duties under the misappropriation theory, but the court was anything but clear on this question.¹⁹³ The O'Hagan Court did not directly address this problem, even though the question is at the heart of the doctrine.
           Given the Supreme Court's approach to federal common law, however, it is clear that the lower courts cannot continue on the federal common law trek. For example, in FDIC v. Atherton¹⁹⁴ and FDIC v. O'Melvaney & Meyers,¹⁹⁵ the Supreme Court was emphatic that federal common law could not be used to govern even the duties of directors or professionals serving federally insured banks, even when the existence of those banks was the result of a federal charter. "There is no federal general common law."¹⁹⁶ If there is no federal common law in an area where the funds of the U.S. Treasury are at stake (because of federally guaranteed deposit insurance) it is hard to imagine how it could be deemed to operate in the context of insider trading.¹⁹⁷ Indeed, as important as fair securities markets are to the health of the economy, they take a back seat to the safety and soundness of the banking system. After all, while a banking crisis is a foremost cause of a general economic collapse, no economy fails based upon pervasive insider trading.¹⁹⁸ Moreover, in light of the Supreme Court's skepticism towards federal common law, it is unlikely that it would countenance a wholesale creation of a federal common law of appropriate information use in contexts ranging from physician-patient relationships to father-son relationships, with nary a mention of this issue in the O'Hagan opinion. Such sweeping judicial intrusion upon traditional state powers would mean that the federal courts would be empowered to redefine the duties attendant to virtually every personal and business relationship.¹⁹⁹ Thus, the Supreme Court must have adopted the misappropriation theory in reliance upon the operation of state common law to define the "breach of fiduciary duty" that is the linchpin of the misappropriation theory. ²⁰⁰
           Along these lines, the Supreme Court made very clear that the duty imposed under the misappropriation theory is not the "disclose or abstain" duty which exists as a matter of federal law only, but rather the duty of confidentiality owed to the source of the information which is apparently a product of state law.²⁰¹ The "disclose or abstain" duty is a federal common law construct administratively and judicially developed under Rule 10b-5. ²⁰² The "disclose or abstain" duty requires potential inside traders to either disclose the non-public information they possess to market participants²⁰³ or to abstain from trading.²⁰⁴ This duty is fundamentally at odds with the duty of confidentiality upon which O'Hagan rests. Indeed, the court in O'Hagan stated that consent from the source of the information obviates any violation.²⁰⁵ This result is inconsistent with the federal disclose or abstain duty, and is the product of either whole cloth or state law.
           State law has never imposed the duty to disclose or abstain from trading when a fiduciary relationship is involved. Rather, since Cady Roberts & Co., ²⁰⁶ the duty to disclose or abstain has been a creature of federal common law.²⁰⁷ Since Cady Roberts, courts have consistently held that a person charged with violating Rule 10b-5 can either disclose the material information to the market or abstain from trading in the securities and escape liability. ²⁰⁸ The Supreme Court in O'Hagan expressly rejected the disclose or abstain rule, and held instead that the misappropriation theory requires a defendant to defraud the source of information rather than those with whom the misappropriator trades.²⁰⁹ The Court stated that the use of the "disclose or abstain rule" in the misappropriation context, as advanced by Chief Justice Burger, dissenting in Chiarella, is too broad.²¹⁰ The approach the Court has taken is inconsistent with the pre-existing disclose or abstain rule. "[I]f the fiduciary discloses to the source that he plans to trade on the nonpublic information, there is no...§10(b) violation."²¹¹ The Court noted that liability could still obtain under state law, even in the absence of deception, for breach of the fiduciary duty of loyalty; apparently, the Court is assuming the operation of state common law to define fiduciary relationships for purposes of the misappropriation theory.²¹² By rejecting the disclose or abstain rule and putting nothing in its place, the Court has seemingly directed us towards state law.²¹³
           Santa Fe Industries also counsels strongly against finding that the Court in O'Hagan implicitly authorized the creation of a sweeping federal common law to redefine duties in all relationships: "Absent a clear indication of congressional intent, we are reluctant to federalize the substantial portion of the law of corporations that deals with transactions in securities, particularly where established state policies of corporate regulation would be overridden."²¹⁴ If the misappropriation doctrine were to operate to create a new fiduciary duty defined by federal common law not only a substantial part of corporation law would be overridden, but the law of partnership, agency, trusts, brokers, attorneys, limited liability companies, psychiatry, family relationships, and other fiduciary relationships would be overridden, to the extent conduct that is not unlawful under state law would be criminally sanctioned under federal law. ²¹⁵ Also, the use of information in these wide-ranging relationships would no longer be defined by reference to state law alone, but also be defined based upon federal not state policy considerations. ²¹⁶ The O'Hagan court left the Santa Fe Industries decision intact.²¹⁷ Therefore the Supreme Court would not authorize such free-wheeling federal common law without any express indication that it was doing so, and without reconciling its prior decisions on this point.
           There is yet another reason why the Supreme Court must be allowing state law to operate to define whether information has been misappropriated fraudulently. If the Supreme Court allows state law to define fiduciary duties, a defendant would be hard pressed to argue lack of notice of criminal prohibitions.²¹⁸ Conversely, if federal common law is to operate to define fraud in the context of fiduciary relationships, then where is a putative inside trader to go to learn the content of these criminal provisions. For example, what federal law notified Willis, that he could be federally jailed for misusing, but not disclosing publicly, client information, regardless of injury to the client?²¹⁹ What notice was there for young Reed²²⁰ that it was a federal offense to trade upon information from his father; for Mrs. Lenfest²²¹ to trade upon information from her husband; and even for attorney O'Haganto trade upon client information.²²² Leaving such vast areas to federal common law development is not an appropriate way to define criminal conduct. Reliance on state law to define fraud may be the only way to construe the statutory provision in a manner that avoids the Constitutional issues raised by an undeveloped, unpredictable and perhaps unknowable federal common law.²²³
           There is no doubt that the Court has exercised interstitial federal common law in applying the federal securities laws for decades.²²⁴ But, given the Court's care to reaffirm the Santa Fe Industries doctrine, it would seem that creating a federal law of fiduciary duty, for imposing criminal²²⁵ sanctions in the context of insider trading would be a particularly overbroad, intrusive and, ultimately, unfair means of defining insider trading. ²²⁶ Indeed, to hold otherwise would be to give federal common law an unprecedented sweep, at least since 1938 and the Court's decision in Erie Railroad v. Tompkins.²²⁷ This seems to go far beyond "interstitial" federal common law and towards the judicial creation of special federal fiduciary principles; this is a highly restricted kind of federal common law.²²⁸ If the Supreme Court is serious about giving Rule 10b-5 vitality²²⁹ without unduly expanding the scope of federal common law, it must recognize a clear and relatively predictable source of law to govern the use of material non-public information.²³⁰ The Court should make explicit that state law should operate to define fiduciary duties in traditional ways. The current practice of creating a "breach of fiduciary duty" by judicial fiat is offensive in terms of the exercise of judicial power, and is fundamentally unfair to the extent that a criminal defendant has no notice of where the source of the critical fiduciary duty analysis rests. The state common law of fiduciary duties could operate to lend predictability to insider trading sanctions and to obviate many of the problems identified above. In the meantime, until the Supreme Court resolves this issue, lower courts should resist any temptation to untether Rule 10b-5 liability from state fraud,²³¹ or at least state fiduciary duty principles, through overly expansive interpretations of the misappropriation theory and extravagant definitions of fiduciary obligations. ²³² Given the Supreme Court's prior statements regarding fiduciary duty and federal common law, federal courts cannot continue to create a federal common law of fiduciary obligation on the fly.
           Another alternative, suggested by some commentators, would be for Congress to extensively legislate in this area.²³³ The problem with this approach is that sitting around for Congress to legislate is wishful thinking at best.²³⁴ There is no assurance that Congress would not simply make matters worse. Besides Congress has legislated in this area by broadly prohibiting fraud, deceptive devices and contrivances, and manipulation.²³⁵ This is precisely the way fraud and fiduciary duties have traditionally been regulated-- by broad prohibition -- with judicial definition of the precise conduct that is offensive. At the end of the day, human ingenuity in concocting fraud and oppression will outpace the legislators ability to specifically define illegal conduct.²³⁶
           In sum, it seems extraordinary to conclude that the Court has authorized such an intrusive and sweeping federal common law.²³⁷ If, as seems likely, the Court has anchored the misappropriation theory to state law, many other issues must be addressed before the scope of the theory can be fully defined.

WHICH STATE LAW APPLIES?

           The conclusion that state law applies to define fiduciary duties under the misappropriation theory, in turn raises another conundrum. What state law should apply? The internal affairs doctrine could supply a simple answer in cases involving corporate insiders--the law of the state of incorporation normally defines the obligations of corporate managers to the business entity.²³⁸ Of course, even here, because fraud is essentially tortious, arguments could be made that the place of the wrong should supply the substantive law defining whether given conduct amounts to fraud.²³⁹ Beyond this "easy" scenario, things get murky. Arguably, the definition of a fiduciary relationship so critical to the analysis of fraud is fundamentally contract based, and the law of the location where the contract is formed should apply.²⁴⁰ But generally, when dealing with fraud the substantive law which applies is the law where damage and the misrepresentation occur. ²⁴¹ But what about other sources of fiduciary duty-- such as the obligation of a son to a father? Here, the law of the state of injury could apply to define the duties of a son--i.e., the state where the father is located.²⁴² And what about the duties of a professional like a lawyer, broker or psychiatrist? Some authority suggests that the law of the state of licensing provides the definition of professional duties.²⁴³ So, if a father who is an agent of a Delaware corporation, located in Illinois, "inadvertently" discloses "hot" information to his son in Missouri, and the son trades on the basis of the tip through a broker in New York, and all three are indicted for violating Rule 10b-5, what law applies? So far, no federal court has wrestled with this issue; but in light of O'Hagan this issue is of tremendous importance in determining compliance with Rule 10b-5.
           Courts cannot side step this issue by assuming that fiduciary duty law is essentially the same from jurisdiction to jurisdiction.²⁴⁴ For example, very few jurisdictions have held that a father/son relationship, ordinarily, gives rise to a fiduciary duty,²⁴⁵ and no state has held that psychiatrists owe a fiduciary duty to patients to abstain from securities trading based upon non-public information disclosed to them.²⁴⁶ In fact, it has repeatedly been held that not even controlling shareholders owe fiduciary duties except in specific circumstances.²⁴⁷ The fiduciary duties owed by a broker to a client also differ greatly from state to state.²⁴⁸ Even where the existence of a fiduciary duty is clear, states may define the scope of the duty (specifically with respect to limitations on the handling of information) differently. ²⁴⁹

IS THE MISAPPROPRIATION THEORY CONTRACT BASED?

           Both the government and the Court clarified that the misappropriation theory satisfies Rule 10b-5's requirement of fraudulent conduct only when a fiduciary makes undisclosed and unauthorized use of information gained by virtue of the fiduciary relationship.²⁵⁰ The Court has been clear that "not all breaches of fiduciary duty in connection with a securities transaction. . .come within the ambit of Rule 10b-5. There must also be manipulation or deception."²⁵¹ As early as the Dirks opinion, the Court recognized that expectations of the parties are therefore crucial to the application of the misappropriation theory.²⁵² This is in accord with recent developments in state fiduciary doctrine that view fiduciary duties as fundamentally contract-based.²⁵³ Under the great weight of authority, with respect to nearly all fiduciary relationships, the beneficiary of the relationship may always agree to permit the fiduciary to use information for profit.²⁵⁴ Simply stated, the scope of fiduciary duties are a function of the understandings of the parties.²⁵⁵ There are some limits to this: first, the Exchange Act requires certain entities to implement policies to stem insider trading;²⁵⁶ and second, this rule does not change the principle that an individual cannot profit indirectly from conduct that they are directly prohibited from undertaking.²⁵⁷ Nevertheless, in a very real sense this means that the beneficiary of the fiduciary relationship holds the keys to the jailhouse door.
           This reality underscores the potential arbitrary nature of the misappropriation theory.²⁵⁸ Specifically, one should expect very few fathers to render testimony in any way incriminating to sons, and husbands and wives would normally be expected to protect spouses--unless, there are pre-existing marital problems. In this scenario, particularly vindictive spouses may be in a position to deliver the coup de grace. It seems unusual that a criminal conviction would turn so much on the testimony of a interested witness.
           Also, the theory requires (in a criminal case) that the proscription on the use of information for trading be within the scope of the fiduciary duty, beyond a reasonable doubt. This seemingly would preclude prosecutions where the parities to the fiduciary duty are not clear on whether the scope of the duty included a prohibition on trading upon otherwise confidential information. For example, agreeing to keep information confidential seems consistent with trading on the information so long as the information is not disclosed.²⁵⁹ Similarly, the breach of the duty must be shown beyond a reasonable doubt and must be intentional under Ernst & Ernst.²⁶⁰ This necessarily requires that the defendant explicitly understand the prohibition from trading on the information; if the defendant can show some good faith explanation for understanding otherwise it cannot be said that there is an intentional breach of fiduciary duty. This fact is further supported by the requirement in a criminal proceeding that defendant act willfully.²⁶¹ These two burdens of proof will be extraordinarily heavy. If a defendant can in any way show that the conduct was in accord with the understandings of the parties to the fiduciary relationship, they should be acquitted. Even in an SEC enforcement action, the twin burden of showing an intentional breach and defining the scope of the relationship should short-circuit many claims of insider trading. The misappropriation theory essentially requires proving a contract and the intentional breach of that contract, beyond a reasonable doubt.

WHAT PROOF?

           O'Hagan gives little guidance as to the precise elements of insider trading violations, the quantum of proof needed to prove those elements, and no guidance on the procedure to be employed in finding a breach of fiduciary duty.
           Under state law the question of the existence of a fiduciary duty is often a question of fact.²⁶² Even in those situations where a fiduciary duty is found as a matter of law the scope of the fiduciary duty is also a question of fact.²⁶³ The question of whether the specific conduct of the defendant, amounts to a violation of the duty is another question of fact. Traditionally, a cause of action for breach of fiduciary duty was equitable in nature, and the right to a trial by jury was therefore somewhat restricted.²⁶⁴ However, if the breach of fiduciary duty is now an element of a criminal charge the right to a trial by jury becomes compelling.²⁶⁵ Each of these questions should therefore be adjudicated by a jury, beyond a reasonable doubt.²⁶⁶
           With respect to the existence of a fiduciary duty most states recognize two types of fiduciary relationship: those where the fiduciary duty is inherent in the relationship, such as attorney-client; and those where the facts and circumstances give rise to a fiduciary duty because the particular relationship is imbued with a high degree of trust and confidence. ²⁶⁷ This issue is particularly fact driven with respect to the second type of relationship.²⁶⁸ The test is remarkably uniform from state to state.²⁶⁹ The application of the test to specific types of relationships is quite divergent from state to state. One example is shareholders of a corporation. Many cases hold that shareholders do not generally owe their corporation a fiduciary duty.²⁷⁰ Other jurisdictions hold that a fiduciary relationship exists between a shareholder and a corporation in particular circumstances.²⁷¹ Similarly, accountants are sometimes fiduciaries and sometimes not.²⁷² Stockbrokers are fiduciaries with respect to certain issues, but, strangely, not normally fiduciaries with respect to giving investment advice.²⁷³ Much depends upon the understandings of the parties and any fiduciary duty must be voluntarily undertaken by the defendant.²⁷⁴
           Both the existence and scope of a fiduciary relationship is essentially a matter of contract. ²⁷⁵ For example, a stockbroker is normally held to be a fiduciary for purposes of executing trades, but is not always a fiduciary for purposes of assuring that the trades are suitable for the customer. Nor, do industry standards alone always suffice to show that a broker is responsible for the suitability of a customers trading.²⁷⁶ It depends upon the facts of the case.²⁷⁷ In the context of the misappropriation theory, the defendant must breach a fiduciary duty through an undisclosed misuse of information; therefore the government must prove that the parties to the fiduciary duty understood the defendant could not use the information to profit in the securities markets. Simply stated, the scope of the fiduciary duty must extend to the use of information at issue.²⁷⁸
           The government must also prove damage to the source of information, i.e., the beneficiary of the fiduciary relationship.²⁷⁹ Damage is an essential element of both fraud and breach of fiduciary duty.²⁸⁰ Both the government ²⁸¹ and Court²⁸² tacitly acknowledge this requirement by persistently maintaining that conduct must amount to fraud to be within the proscriptions of Rule 10b-5, and by their reliance upon Professor Aldave's seminal work on the misappropriation theory. Professor Aldave states: "damages is an element of common law fraud." ²⁸³ Without some injury to the source of the information, there is no fraud and Rule 10b-5 is not satisfied. This is a noteworthy requirement-- for frequently the alleged misuse of information will not suffer cognizable harm.²⁸⁴ Moreover, there is no authority for the proposition that harm to the investing public suffices to show the requisite damages.²⁸⁵ No case allows a victim of fraud to recover against the fraud-feasor based upon the damages suffered by another.²⁸⁶
           The issue of the state of mind required of the defendant pursuant to the misappropriation theory is another question that is not easily answered. First, the O'Hagan decision left the Ernst & Ernst decision intact: thus no violation of Rule 10b-5 can be proven without scienter, even under the misappropriation theory.²⁸⁷ Second, although a material misrepresentation by a fiduciary can be constructive fraud (where scienter is presumed) a negligent breach of duty cannot support a violation of Rule 10b-5 under Ernst & Ernst and does not amount to fraud under Rule 10b-5.²⁸⁸ Third, as the government has recognized and the Court emphasized there can be no criminal liability for violating Rule 10b-5 without a showing of willfulness.²⁸⁹ Wilfulness requires a showing of "consciousness of wrongdoing."²⁹⁰ Finally, if a criminal defendant proves they had no knowledge of Rule 10b-5 they cannot be convicted.²⁹¹
           Each element of the breach of fiduciary duty and fraud should be shown beyond a reasonable doubt in a criminal action.²⁹² In addition, each element of Rule 10b-5 must also be proved beyond a reasonable doubt.²⁹³ Based upon the foregoing, criminal liability for insider trading under the misappropriation theory appears to require proof of the following: 1) the defendant must trade based upon non-public²⁹⁴ material information;²⁹⁵ 2) the defendant must owe a fiduciary duty to the source of the material non-public information;²⁹⁶ 3) the fiduciary duty must be of sufficient scope to prohibit the use of the information by trading securities;²⁹⁷ 4) the defendant must intentionally breach the fiduciary duty;²⁹⁸ 5) without disclosure to the source;²⁹⁹ and 6) resulting in cognizable damage to the source.³⁰⁰
           Until the uncertain wake of O'Hagan settles, and the Supreme Court clarifies these issues, it would seem that the lower courts and prosecutors would be well advised to proceed cautiously. This would seem to require that cases be meticulously proven beyond a reasonable doubt. Each element of the state definition of a breach of fiduciary duty should be proven. Because the law of fiduciary duty is evolving into a more contract based concept, prosecutors and courts must recognize that these issues are highly fact intensive and will often turn on the understanding of both parties to the putative fiduciary relationship. Those cases that have not shown any degree of precision in this analysis, are inconsistent with O'Hagan.³⁰¹

DOES O'Hagan ROLLBACK THE MISAPPROPRIATION THEORY?

           O'Hagan and the government placed great emphasis on the misappropriation theory's requirement of fraud.³⁰² For example, the government was asked at oral argument whether mere theft of information was within the scope of conduct prohibited by the misappropriation theory. The government responded that it was not.³⁰³ O'Hagan thus approves of a far more narrow misappropriation theory than that which some circuit courts had imposed. Indeed the theory should be renamed: mere misappropriation does not suffice for liability; only a fraud on the source of information triggers liability under Rule 10b-5.³⁰⁴ For example, the Court's insistence on a showing of fraud (and the government's concession that theft is not fraud) amounts to a reversal of several pre-O'Hagan misappropriation cases.³⁰⁵ Because only fiduciary duties will ordinarily require disclosure to the source for a showing of fraud, the Court and the government seemed content to limit the theory's operation to fiduciary duties. Thus, the government declined to argue, as a general proposition that familial relationships give rise to fiduciary obligations.³⁰⁶ This also seemingly rolls back the misappropriation theory.³⁰⁷ Most importantly, those federal courts that carefully read O'Hagan in light of the Supreme Court's other federal common law pronouncements should be "leery" of creating federal fiduciary standards defining the proper use of information in the context of virtually all relationships.³⁰⁸

CONCLUSION

           The Supreme Court in O'Hagan leaves its prior precedents intact. Most particularly, the Supreme Court reaffirmed that Rule 10b-5 catches only fraud, that Rule 10b-5 still requires a showing of scienter, and that the lower federal courts are not to override the primary authority of state law to govern business and fiduciary relationships. Combined with the Court's emphasis on curtailing the operation of any freewheeling federal common law, and the need in a criminal context for defendants to have notice of illegal conduct, O'Hagan may stand only for the modest proposition that perpatrating a fraud upon a source of information, within the meaning of state fiduciary principles, for purposes of entering into securities transactions, is fraud "in connection with" securities transactions for purposes of Rule 10b-5.
           This means that the government must prove both fraud on the source and all other elements of a violation of Rule 10b-5. In a criminal case, each element of this polymorphic crime must be proven beyond a reasonable doubt. The government must prove beyond a reasonable doubt that the source of the information sustained damage from the trading and that the source did not expressly or tacitly consent to using the information for trading. The breach of fiduciary duty must be intentional. In a criminal case the defendant must act willfully. This is a demanding violation to prove. Nevertheless the Supreme Court, when its decision is read in accordance with its prior precedents and without authorizing some undefined federal common law fiduciary principle sweeping virtually all relationships into the federal sphere, has successfully stayed true to the statutory language of § 10-(b) and Rule 10b-5, without subverting the section's fundamental purpose of achieving fairness in the securities markets.

1. United States v. O'Hagan, 117 S. Ct. 2199 (1997) rev'g 92 F.3d 612 (8^th Cir. 1996).

2. See Carol B. Swanson, Reinventing Insider Trading: The Supreme Court Misappropriates the Misappropriation Theory, 32 Wake Forest L. Rev. 1157, 1158 (1997)(reviewing initial reactions to O'Hagan decision).

3. Carpenter v. United States, 484 U.S. 19, 24 (1987). Interestingly, the Court in Carpenter unanimously affirmed mail and wire fraud convictions arising from the same conduct; therefore, the Court found that a "scheme to defraud" under federal wire and mail fraud statutes to be broader than fraud under the federal securities laws.

4. Securities Exchange Act of 1934 §10(b), 15 U.S.C. 78j(b) (1994), provides:

5. 17 C.F.R. § 240.10b-5 (1997) provides:

6. See, e.g., Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201 (1976) (holding "that §10(b) was addressed to practices that involve some element of scienter and cannot be read to impose liability for negligent conduct alone.").

7. See, e.g., Chiarella v. United States, 445 U.S. 222, 243 (1980)(Blackman, J., dissenting); Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 761-771 (1975) (Blackmun, J., dissenting)(confining private actions under Rule 10b-5 to actual purchasers or sellers of securities); Sennott v. Rodman & Renshaw, 414 U.S. 926, 929 (1973)(Douglas, J., dissenting from an order denying certiorari). See also United States v. Newman, 664 F.2d 12, 18 (2d Cir. 1981)(stating that federal securities laws should extend to enforce a "high standard of business ethics.").

8. The statute also prohibits "manipulation". Manipulation is, however, virtually a term of art and has no applicability to "insider trading." It refers to the artificial control of a security's price. It, like fraud, requires intentional or willful conduct. Ernst & Ernst, 425 U.S. at 199.

9. 17 C.F.R. § 240.10b-5 (1997).

10. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 203 (1976) (explaining the comments of the drafters to enable the Commission "to deal with new manipulative (or cunning) devices.")

11. "Section 10(b) is aptly described as a catchall provision, but what it catches must be fraud." Chiarella v. United States, 445 U.S. 222, 234-35 (1980).

12. Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164, 173 (1994).

13. Chiarella, 445 U.S. at 235.

14. O'Hagan, 117 S. Ct. at 2207.

15. See O'Hagan, 117 S. Ct. at 2206 n.3.

16. O'Hagan, 117 S. Ct. at 2214. On remand, the Eighth Circuit summarily ordered O'Hagan to prison. United States v. O'Hagan, Nos. 93-3714, 97-3856, 1997 WL 710347 (8^th Cir., October 27, 1992).

17. United States v. O'Hagan, 117 S. Ct. 2199 (1997).

18. Id. at 2205.

19. Id.

20. Id.

21. Id.

22. Id.

23. Id.

24. Id. The government also indicated O'Haganfor violations of § 14(e) of the Securities Exchange Act of 1934, including SEC Rule 14e-3 thereunder. 117 S. Ct. at 2205. This article does not address insider trading under Rule 14e-3.

25. United States v. O'Hagan, 92 F.3d 612 (8^th Cir. 1996).

26. 117 S. Ct. at 2206.

27. United States v. O'Hagan, 117 S. Ct. 759 (1997).

28. 117 S. Ct. at 2206 (emphasis supplied).

29. Id. at 2207.

30. Id. (quoting Chiarella, 445 U.S. at 228.)

31. Id.

32. Id.

33. Id.

34. Id.

35. Id.

36. Id.

37. Id.

38. Id.

39. Chiarella v. United States, 445 U.S. 222, 226 (1980)(quoting In re Cady Roberts & Co., 40 S.E.C. 907, 911 (1961) for the proposition that a corporate insider owes a duty to disclose information to those "with whom they deal" or to abstain from trading); see also Dirks v. United States, 463 U.S. 646, 666 (1983)(imposing disclose or abstain duty upon certain tippees); William K.S. Wang & Marc I. Steinberg, Insider Trading § 4.3 (1996)("Those persons subject to the disclose or abstain mandate of section 10(b) must refrain from trading. . .until the material information is disseminated and digested by the investing public."). This disclose or abstain duty, and not the O'Hagan Court's duty to refrain from defrauding the source of information, was also the apparent foundation of the misappropriation theory prior to O'Hagan. United States v. Teicher, 987 F.2d 112, 120 (2d Cir. 1993)(fiduciary holding material nonpublic information must either "disclose or abstain"); SEC v. Singer, 786 F. Supp. 1158, 1171 (S.D.N.Y. 1992)("the misappropriation theory holds that the duty to disclose or abstain arises from a relationship of trust and confidence)(citing United States v. Reed, 601 F. Supp. 685, 696 (S.D.N.Y. 1985)). The disclosure aspect of the disclose or abstain rule is satisfied only by "disclosure designed to achieve a broad dissemination to the investing public generally." Dirks, 463 U.S. at 653 n. 12 (quoting In re Faberage, Inc., 45 S.E.C. 249, 256 (1973)). The abandonment of the disclose or abstain duty is quite subtle, but key to understanding O'Hagan's focus on the pre-existing duties between the source of information and the trader. Compare Swanson supra note 2, at 1209 ("although the duty is apparently disclose or abstain, it is unclear how that obligation arises" or how it is discharged with Joel Seligman. A Mature Synthesis: O'Hagan Resolves "Insider Trading's Most Vexing Problems. 23 Del. J. Corp. L. 1, 21 (1998) (disclosure obligation is discharged by disclosure to principals ).

40. Id. at 2207.

41. Id.

42. Id.

43. Id. ("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 information, there is no 'deceptive device' and thus no § 10(b) violation.").

44. Id.

45. Id. at 2206-207.

46. E.g., United States v. O'Hagan, 117 S. Ct. at 2209 ("the misappropriation theory is . . . consistent with Santa Fe Indus. v. Green.")

47. 445 U.S. 222 (1980).

48. 463 U.S. 646 (1983).

49. Id. at 2212.

50. Id.. at 2212.

51. Id. at 2212-13.

52. Id. at 2213 (quoting Dirks, 463 U.S. at 665)("There was no expectation by Dirk's sources that he would keep their information in confidence.").

53. Id.

54. "Vital to decision that criminal liability may be sustained under the misappropriation theory, we emphasize, are two sturdy safeguards Congress has provided regarding scienter." Id. at 2214.

55. Id. (citing 15 U.S.C. § 78ff(a)(1994)).

56. Id. (citing 15 U.S.C. § 78ff(a)(1994)).

57. Id. at 2221 (J. Thomas, dissenting). See David Cowan Bayne, Insider Trading: The Demise of the Misappropriation Theory--and Thereafter, 41 St. Louis U. L. Rev. 625 (1997)("Suddenly and hearteningly new hope has been given to the confused law of Insider Trading. In 1995, out of nowhere came Judge J. Michael Luttig and the Fourth Circuit United States v. Bryan opinion to crack the obstructive monolith of the Misappropriation Theory."); Swanson, supra note 2, at 1209 ("under O'Hagan most of the old misappropriation theory difficulties remain, and a whole host of new concerns emerges."). See also Wang & Steinberg, supra note 39, §5.4 (citing cases in lower courts which have approved or criticized the misappropriation theory, and discussing the legislative history of the 1984 and 1988 Insider Trading Acts.). See generally John R. Beeson, Rounding the Peg to Fit the Hole; A Proposed Regulatory Reform of the Misappropriation Theory, 144 U. Pa. L. Rev. 1077 (1996); Michael P. Kenny & Teresa D.Thebault, Misguided Statutory Construction to cover the Corporate Universe: The Misappropriation Theory of Section 10(b), 59 Alb. L.Rev.139 (1995).

58. In fact, prior to O'Hagan, some federal courts had dismissed indictments based upon the misappropriation theory because of due process concerns. See United States v. Newman, 664 F.2d 12, 14 (2d Cir. 1981)(reversing dismissal of indictment based upon misappropriation theory for lack of "clear and definite" statement that conduct was proscribed).

59. O'Hagan, 117 S. Ct. 2209-14 (reviewing prior Supreme Court cases, in detail, and concluding that "the misappropriation theory is. . .consistent. . .with our prior precedent.").

60. Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976).

61. Id. at 188-89.

62. Id. at 187-88.

63. Id. at 197 n. 17.

64. Id. at 197.

65. Id.

66. Id. at 199. (Citing Webster's International Dictionary (2d ed. 1934) which defines "device" as "that which is devised, or formed by design, a contrivance; an invention; project; scheme; often, a scheme to deceive; a stratagem; an artifice," and defines "manipulation" as "to manage or treat artfully or fraudulently; as to manipulate accounts . . . to force (prices) up or down, as by matched orders, wash sales, fictitious reports...; to rig.")

67. Id. at 201.

68. 425 U.S. at 201.

69. 425 U.S. at 202 (citing Hearings on H.R. 7852 and H.R. 8720 Before the House Committee on Interstate and Foreign Commerce, 73d Cong., 2d Sess., 115 (1934)(Statement of Thomas G. Corcoran)).

70. Id. at 202.

71. Id. at 193.

72. Santa Fe Indus., Inc., v. Green, 430 U.S. 462 (1977).

73. Id. at 465-69.

74. Id. at 469.

75. Id. at 470.

76. Green v. Santa Fe Indus., Inc., 533 F.2d 1283, 1292 (2d Cir. 1976)("there is no need for a showing of misrepresentation or lack of disclosure to make out a 10b-5 case").

77. Id. at 1291.

78. 430 U.S. at 472 (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976)).

79. Santa Fe Indus., Inc., v. Green, 430 U.S. 462, 473 (1977)(citing Ernst & Ernst, 425 U.S. at 202)("Neither the intended scope of 10(b) nor the reasons for the changes in its operative language are revealed explicitly in the legislative history of the 1934 Act, which deals primarily with other aspects of legislation. The only specific reference to §10 in the Senate Report in the 1934 Act merely states that the section was aimed at those manipulative and deceptive practice which have been demonstrated to fulfill no useful function.").

80. 430 U.S. at 474, 476 ("the cases do not support the proposition...that a breach of fiduciary duty... without any deception.... violates the statute and the Rule.").

81. Id. at 478-79. Two of the eight member majority failed to join in this portion of the Court's opinion.

82. Id. at 479.

83. Id. at 479.

84. Id. at 480.

85. Id. at 479 (quoting Cort v. Ash, 422 U.S. 66, 84 (1975)).

86. Id. at 480.

87. Id. at 475-76.

88. Id. at 480.

89. Santa Fe Indus., 430 U.S. at 471-72 n.11 (finding Second Circuit's construction of fraud by reference to federal law inappropriate in absence of Congressional intent to create such federal standards).

90. Chiarella v. United States, 445 U.S. 222 (1980).

91. 445 U.S. at 224.

92. Id. at 224.

93. Id. at 224-25.

94. Id. at 224.

95. Id. at 235.

96. Id.

97. In re Cady Roberts & Co., 40 S.E.C. 907 (1961).

98. United States v. Chiarella, 445 U.S. at 227-29.

99. Id. at 232 (citing Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 474-77(1977)).

100. Chiarella, 445 U.S. at 233.

101. Id. at 230.

102. Id. at 235.

103. Id. at 236-38

104. Chiarella, 445 U.S. at 235-37.

105. Id. at 235-37.

106. Chiarella, 445 U.S. at 234-35.

107. Id. at 226-30.

108. Dirks v. SEC, 463 U.S. 646 (1983).

109. Id. at 654-55.

110. Id. at 649-51.

111. Id. at 650.

112. Id. at 650 n. 4.

113. Id. at 655-56.

114. Id. at 651.

115. Id. at 651-52.

116. Id. at 648.

117. Chiarella, 455 U.S. at 232.

118. Dirks, 463 U.S. at 653.

119. Id. at 654.

120. Id. at 657-658.

121. Id. at 657-58.

122. Id. at 665-666.

123. Id.

124. Id. at 652.

125. Id. at 653.

126. Id.

127. Indeed, the Court carefully refrained from expanding the Cady Roberts & Co. disclose or abstain rule. Dirks, 463 U.S. at 661 ("Tipping thus properly is viewed only as a means of indirectly violating the Cady Roberts disclose or abstain rule.")

128. 463 U.S. at 659 (citing 15 U.S.C. § 78t(b)).

129. Carpenter v. United States, 484 U.S. 19 (1987).

130. Id. at 19.

131. Id.

132. Id. at 25-27.

133. Id. at 27.

134. Id. at 24.

135. Id.

136. See, e.g., United States v. Louderman, 576 F.2d 1383, 1387 (9^th Cir. 1978)("state law is irrelevant" in determining whether a certain course of conduct is violative of the wire fraud or mail fraud statutes). See also Durland v. United States, 161 U.S. 306 (1896)(§ 1341 definition of "defraud" is not limited by common law meaning of term); Virden v. Graphics One, 623 F. Supp. 1417, 1422 (C.D. Cal. 1986).

137. See United States v. Chestman, 947 F.2d 551, 567 (2d Cir. 1991)(calling the misappropriation theory the "fraud-on-the-source" theory). The proof of fraudulent intent required to show a violation of Rule 106-5 was highlighted in a recent insider trading case. SEC v. Adler, 137 F.3d 1325 (11^th Cir. 1998) (requiring that insider trading violation include proof that defendant used information with scienter).

138. See, e.g., O'Hagan, 117 S. Ct. at 2209.

139. O'Hagan, 117 S. Ct. at 2207.

140. O'Hagan v. United States, 117 S. Ct. 2204-2207 (1997).

141. United States v. Newman, 664 F.2d 12 (2d Cir. 1981).

142. Id. at 14.

143. Id. at 15.

144. See id. at 17-18.

145. SEC v. Cherif, 933 F.2d 403 (7th Cir. 1991).

146. Id. at 405-06.

147. Id. at 406.

148. Id.

149. Id.

150. Id.

151. Id. at 407.

152. Id. at 412.

153. Id.

154. The court did not address Illinois law, which holds that an agent's fiduciary duty is limited to actions occurring during the scope of the agency. Martin v. Heinhold Commodities, Inc., 510 N.E.2d 840, 845 (Ill. 1987) ("We agree that as a general rule an agent's fiduciary duty is limited to actions occurring within the scope of the agency.").

155. Id. at 411.

156. O'Hagan, 117 S. Ct. at 2209.

157. Cherif, 933 F.2d at 411; Wang & Steinberg, supra note 39, at §5.4.2 (stating that the holding is unique in that fraud by the employee did not lie in his misappropriation of the confidential information concerning the contemplated acquisitions. Such confidential information was not learned during the course of his employment, and hence was not misappropriated during his employment.)

158. The court seems to have intentionally avoided Illinois law. Martin, 510 N.E.2d 845.

159. Cherif, 933 F.2d at 411.

160. Id. at 412 (citing McNally v. United States, 483 U.S. 350 (1987)).

161. 737 F. Supp. 269 (S.D.N.Y. 1990).

162. Id. at 275.

163. Id. at 271 (the court notes Willis disclosed the information to his broker, in connection with the securities transactions, but no other disclosure occurred).

164. Id. at 272 ("when Dr. Willis purchased. . .securities on the basis of his patient's confidential information, he defrauded his patient.").

165. Id. at 272.

166. Id. at 274.

167. Id.

168. MacDonald v. Clinger, 446 N.Y.S. 2d 801 (N.Y. App. Div. 1982)(holding doctor may not disclose information to patient's wife); Doe v. Roe, 400 N.Y.S.2d 668 (N.Y. App. Div. 1977)(holding that psychiatrist may not publish book disclosing patient information such as emotions and fantasies) See also Hammond v. Aetna Casualty & Sur. Co., 243 F. Supp. 793 (N.D. Ohio 1965)(holding insurance company liable for causing doctor to divulge patient information).

169. Id. at 275.

170. Id. at 274.

171. 601 F. Supp. 685 (S.D.N.Y.) rev'd on other grounds 773 F.2d 477 (2d Cir. 1985).

172. 601 F. Supp. at 704-05.

173. Id. at 704-17.

174. 601 F. Supp. at 696.

175. Instead the court assumes that if there was a fiduciary duty breached, then there must be fraud. Compare 601 F. Supp. at 720 ("It is fundamental that the misappropriation of secret information, in violation of a confidential relationship, constitutes fraud.") with O'Hagan, 117 S. Ct. at 2209 (stating that non-fraudulent, misappropriation of information is possible and is merely a breach of state law duty of loyalty).

176. United States v Chestman, 947 F. 2d 551 (2d. Cir 1991)(en banc).

177. 947 F.2d at 567.

178. Id. at 551 (citing Walton v. Morgan Stanley & Co., 623 F.2d 796, 799 (2d Cir. 1980)). Walton applied Delaware State law to the question of whether a fiduciary duty existed. 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 on a confidential basis for a prospective target. After the relationship between the target and Morgan Stanley broke off, Morgan Stanley was charged with trading in the target stock on the basis of the confidential information. The court held that under Delaware law no fiduciary duty existed between the target and Morgan Stanley. 623 F.2d at 799

179. Id. at 555.

180. Id. at 571.

181. Id.

182. See United States v. Bryan, 58 F.3d 933, 950 (4^th Cir. 1995)("In essence, the misappropriation theory disregards the specific statutory requirement of deception.").

183. United States v. Chestman, 947 F.2d at 551. See also SEC v. Clark, 915 F.2d 439 (9^th Cir, 1990)(stating that "the underlying rationale of the misappropriate theory is that a person who receives secret business information from another because of an established relationship of trust and confidence between them has a duty to keep that information confidential").

184. United States v. O'Hagan, 117 S. Ct at 2205. Throughout the entire opinion the Supreme Court never strayed from stating that a fiduciary duty had to be breached, not a relationship of trust and confidence.

185. O'Hagan, 117 S. Ct. at 2209 (stating that the misappropriation theory is consistent with Santa Fe Industries).

186. O'Hagan, 117 S. Ct. at 2206 (holding in accord with several lower Courts of Appeals that criminal liability under section 10(b) may be predicated on the misappropriation theory).

187. 117 S. Ct. at 2205.

188.

Neither Chiarella nor Dirks... do a very good job of defining the fiduciary duty element. Nor have the lower courts subsequently done much to flesh out the requirement. To the contrary, most decisions treat the fiduciary duty element conclusorily at best. The SEC and the lower courts seem to view the fiduciary duty element as a mere minor inconvenience that should not stand in the way of expansive insider trading liability.

Stephen M. Bainbridge, Incorporating State Law Fiduciary Duties Into the Federal Insider Trading Prohibition, 52 Wash. & Lee L. Rev. 1189, 1201 (1995) (emphasis supplied).

189.

Indeed, although fifteen years have passed since the theory's inception, no court adopting the misappropriation theory has offered a principled basis for distinguishing which types of fiduciary or similar relationships of trust and confidence can give rise to Rule 10b-5 liability and which cannot.

United States v. Bryan, 58 F.3d 933, 951 (4^th Cir. 1995).

190. Courts frequently assume that a breach of fiduciary duty under the Restatements amounts to a breach of fiduciary duty sufficient to show fraud for purposes of Rule 10b-5. United States v. Cherif, 933 F.2d at 412 n. 7 (basing finding of fraud for purposes of Rule 10b-5 in a violation of Restatement (Second) of Agency § 385 (1958)). Courts have found fraud based in part upon violations of a physician's Hippocratic Oath. United States v. Willis, 737 F. Supp. 269, 272 (S.D.N.Y. 1990). Courts also seem to pull the fiduciary duty from thin air, basing their findings on some visceral feeling that a given relationship is one of trust and confidence. SEC v. Lenfest, 949 F. Supp. 341, 346 (E.D. Pa. 1996)(holding that husband-wife relationship can support Rule 10b-5 violation even if not fiduciary in nature). None of these courts discuss whether the fraud and fiduciary duty analysis arises from federal common law or state law. But see Moss v. Morgan Stanley & Co., 719 F.2d 5, 14 (2d Cir. 1983)(citing Walton v. Morgan Stanley & Co., 623 F.2d 796, 799 (2d Cir. 1980)(applying Delaware law to fiduciary issue)).

191. See, e.g., United International Holdings, Inc. v. Wharf (Holdings) Ltd., 946 F.Supp. 861, 871 (D. Colo. 1996)(holding that question of fiduciary relationship is question of fact for jury); MTC Electronic Technologies Co. v. Leung, 889 F. Supp. 396, 402 (C.D.Cal. 1995)(under California law investment broker owes fiduciary duty of care in giving investment advice); Hotmar v. Lowell H. Listrom & Co., 808 F.2d 1384 (10^th Cir. 1987)(holding under Kansas law that broker owed no fiduciary duty). See also United States v. Reed, 601 F. Supp. at 717 (recognizing that fiduciary duty analysis must be preserved for the "trier of fact," but failing to identify source of law on that issue).

192. Steven M. Bainbridge, supra note 188, at 1189 ("what is the precise fiduciary duty at issue? Is the source of that duty federal or state law? Despite over a decade of experience with the fiduciary duty requirement, neither of these questions has a clear and convincing answer.")

193. Moss v. Morgan Stanley & Co., 719 F.2d 5, 14 (2d Cir. 1983)(citing Walton v. Morgan Stanley & Co., 623 F.2d 796, 799 (2d Cir. 1980)). Dirks cited the Walton decision with approval even though it is at best unclear that Rule 10b-5 was an issue in Walton. 463 U.S. at 662 n.22.

194. Atherton v. FDIC, 117 S. Ct. 666, 673 (1997)(holding that there is no federal common law governing conduct of directors of federally insured, federally chartered banks).

195. O'Melveny & Myers v. FDIC, 512 U.S. 79, 87 (1994)(cases warranting federal common law are "few and restricted.").

196. O'Melveny & Myers v. FDIC, 512 U.S. at 83 (citing Erie R. Co. v. Tompkins 304 U.S. 64, 78 (1938)). See also Paul Lund, The Decline of Federal Common Law, 76 Boston Univ. L. Rev. 895 (1996)("This article addresses another way in which the Supreme Court has altered dramatically the balance between state and federal power during the 1990s: by restricting the federal common law making powers of the federal courts.").

197. Steven A. Ramirez, The Chaos of 12 U.S.C. Section 1821(k): Congressional Subsidizing of Negligent Bank Directors and Officers, 65 Fordham L. Rev. 625, 656-675 (1996)(arguing that federal common law should apply to provide the standard of care for directors and officers of federally chartered and insured banks).

198. Although the causes of the Great Depression are the subject of continued debate, the bank crisis of the 1930s is always a usual suspect in either causing or excarerbating this economic catastrophe. See, e.g., Milton I. Friedman and Anna J. Schwartz, A Monetary History of the United States 352-53 (1963).

199. See United States v. Chestman, 947 F.2d 551 (2d Cir. 1991)(assessing husband and wife relationship);SEC v. Cooper, No. 95-8535 (RJK), 1995 WL 739046 (C.D.Cal. December 13, 1995)(psychotherapist); SEC v. Sheinberg, No. 92-7293, 1992 WL 372190 (C.D.Cal. December 10, 1992)(assessing father-son relationship).

Amicus Brief of National Association of Criminal Defense Lawyers at *7-8, United States v. O'Hagan, 117 S. Ct. 2199 (1997)(No. 96-842)(1997 WL 145002). See also United States v. Bryan, 58 F.3d 933, 950 (4^th Cir. 1995)(highlighting the danger that the misappropriation theory may turn Rule 10b-5 into a federal common law governing "all trust relationships.").

200. 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 a person misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. Under this theory, a fiduciary's undisclosed, self-serving use of a principal's information to purchase or sell securities, in breach of a duty of loyalty and confidentiality, defrauds the principal of the exclusive use of that information. O'Hagan, 117 S. Ct. at 2207.

201. United States v. O'Hagan, 117 S. Ct. at 2208 ("deception through non-disclosure is central" to misappropriation theory). Supra note 39.

202. Supra note 39. See generally Thomas Lee Hazen, The Law of Securities Regulation §13.9 (3^rd ed. 1996).

203. See, e.g., United States v. Libera, 989 F.2d 596, 601 (2d. Cir. 1993) (information is not disclosed until is "fully impounded" into the price of the security); In re Smith Barney, Harris, Upham & Co., Exchange Act Release No. 34-21242 [1984 Transfer Binder] Fed. Sec. L. Rep. (CCH ¶ 83, 656 (Aug. 15, 1984) (stating method of satisfying disclosure to market particpants; must give participants sufficient time to receive and digest information).

204. Wang & Steinberg, supra note 39, at § 4.3.

205. O'Hagan, 117 S. Ct. at 2209 (no discussion of effective disclosure to market participants).

206. In re Cady Roberts, & Co., 40 S.E.C. 907, 912 (1961)(where the Commission relied upon two factors to impose the abstain or disclose mandate: (1) access to information intended for a corporate purpose and not for personal benefit, and (2) the inherent unfairness of trading on information that is inacceccible to the other party to the transaction.).

207. See supra note 39.

208. Id.

209. Id.

210. United States v. O'Hagan, 117 S. Ct. 2199, 2208 n.6 (1997).

211. O'Hagan, at 2209.

212. O'Hagan, 117 S. Ct. at 2209.

213. See Santa Fe Indus. v. Green, 430 U.S. 462, 471-472, (refusing to create federal common law absent congressional intent); Atherton v. FDIC, 117 S. Ct. 666, 673 (1997)(holding that there is no federal common law governing conduct of directors of federally insured, federally chartered bands); O'Melveny & Meyers v. FDIC, 512 U.S. 79, 87 (1994)(there are few and restricted cases warranting general common law).

214. Santa Fe Indus., Inc. v. Green, 430 U.S. at 471-474. See also Bainbridge, supra, note 188, at 1268 ("the fiduciary duty element required by the federal definition of insider trading should be supplied solely by state corporate law.").

215. The federal courts have made a dent in this daunting task, but it is clear that any federal common law in this area is in its infancy. See United States v. Re Brook, 837 F. Supp. 162 (S.D.W.Va. 1994) rev'd 58 F.3d 961 (4^th Cir. 1995)(government employee); United States v. Teicher, 987 F.2d 112 (2d Cir. 1993)(arbitrageur); United States v. Grossman, 843 F.2d 78 (2d Cir. 1988)(lawyer); SEC v. Lenfest 949 F. Supp. 341 (E.D.Pa. 1996)(husband/wife); SEC v. Willis, 777 F. Supp. 1165 (S.D.N.Y. 1991)(psychiatrist/patient); United States v. Willis, 737 F. Supp. 269 (S.D.N.Y. 1990)(psychiatrist/patient); SEC v. Peters, 735 F. Supp. 1505 (D.Kan. 1990) rev'd on other grounds, 978 F.2d 1162 (10^th Cir. 1992)(partners); United States v. Reed, 601 F. Supp. 685 (S.D.N.Y.), rev'd on other grounds, 773 F.2d 477 (2d Cir. 1985)(father/son); SEC v. Musella, 578 F. Supp. 425 (S.D.N.Y. 1984)(law firm office manager). See supra notes 178, 190 and 199.

216. Wang & Steinberg, supra note 39 at 354-81 (detailed assessment of the range of relationships federal courts have regulated under the auspices of the misappropriation theory).

217. 117 S. Ct. at 2209. ("The misappropriation theory advanced by the government is consistent with Santa Fe Industries.").

218. Courts have rejected arguments that insider trading prohibitions do not give defendants "fair notice" of illegal conduct because the misappropriation theory is too undefined. United States v. Willis, 737 F. Supp. at 277 (citing Carpenter, 791 F.2d at 1034 and Newman, 664 F.2d at 19.) See also United States v. Bryan, 58 F.3d 933, 951 (4^th Cir. 1995)("It would be difficult to overstate the uncertainty that has been introduced into the already uncertain law governing fraudulent securities transactions through adoption of the misappropriation theory, with its linchpin the breach of a fiduciary duty."); United States v. Chiarella, 588 F.2d 1358, 1377 (2d Cir. 1978)(Meskill, Judge, dissenting)(concluding that there was no "clear and definite statement of conduct proscribed" by insider trading laws) rev'd on other grounds, 445 U.S. 222 (1980).

219. Compare United States v. Willis, 737 F. Supp. 269 (S.D.N.Y. 1990) with Doe v. Roe, 400 N.Y.S.2d 668 (N.Y. Appl.Div. 1982)(holding psychiatrist may not publish book disclosing patient information).

220. Compare United States v. Reed, 601 F. Supp. 685 (S.D.N.Y.), rev'd on other grounds, 773 F.2d 477 (2d Cir. 1985) with Zullig v. Zullig, 502 P.2d 198 (Wyo. 1972)(son owed father no fiduciary duty).

221. Compare SEC v. Lenfest, 949 F. Supp. 341 (E.D.Pa. 1996)(fiduciary relationship between husband and wife) with United States v. Chestman, 947 F.2d at 566 (no fiduciary relationship between husband and wife).

222. Indeed, it is even unclear whether O'Hagan breached his fiduciary duty, at least to his client, Grand Met. O'Hagan's professional obligation is only to keep confidential information secret, not to refrain from using it, particularly when there is no damage to the client. See Model Rules of Professional Conduct Rules 1.6 and 1.9 (1983). Of course as an agent, O'Hagan's profits belong to his principal. Restatement (Second) of Agency § 388 (1958). But, that obligation certainly doesn't make it fraudulent to earn such profits. See also Stephen M. Bainbridge, Insider Trading Under the Restatement of the Law Governing Lawyers, 14 J. of Corp. L. 1, 35 (1993) (stating that it is arguable that lawyer may trade on client information).

223. Although no appellate court has yet ruled that the misappropriation theory is void for vagueness, or fails to give fair notice of its prohibitions, many judges (even Justices) have grappled with its indeterminancy. See O'Hagan, 117 S. Ct. at 2220 (Scalia, J., dissenting)(arguing that "principle of lenity" requires fraud upon sellers or purchasers of securities); O'Hagan, 117 S. Ct. at 2221 (Thomas, J., dissenting)(arguing misappropriation theory is incoherent and inconsistent). See also supra, notes 189 and 218.

224. Musick, Peeler, & Garrett v. Employers Insurers of Wausau, 508 U.S. 286, 293 (1993)("We are not alone in recognizing a judicial authority to shape, within limits, the 10b-5 cause of action."). See also Kevin R. Johnson, Bridging the Gap: Some Thoughts About Interstitial Lawmaking and the Federal Securities Laws, 48 Wash. & Lee L. Rev. 879 (1991)(overview of the federal common law of securities).

225. In addition to criminal liability, those who violate insider trading laws may be subject to SEC civil enforcement actions, (15 U.S.C. § 78u(d)(1994)), as well as private civil actions. 15 U.S.C. § 78e-1 (1994). This article focuses primarily upon criminal liability because many insider trading cases are brought as criminal actions, and this fact must, as a matter of due process, to some extent, define the elements of the violation. 15 U.S.C. § 78ff (1994). Except for issues of intent and burden of proof criminal and civil liability under the securities laws are co-extensive. United States v. Chiarella, 588 F.2d 1358, 1368 n. 16 (2d Cir. 1978) rev'd on other grounds 445 U.S. 222 (1980).

226. See United States v. Bass, 404 U.S. 336, 347-50 (1971)(explaining why "legislatures and not courts define criminal activity," why ambiguity in criminal statutes should be resolved in favor of lenity, and why, absent clear Congressional intent the Court will not venture into areas traditionally governed by state law).

227. Erie R.R. Co. v. Tompkins, 304 U.S. 64 (1938)("There is no general federal common law."). In response to federalism concerns, the Court has also recognized that even in areas where federal common law is applicable, state law should be applied as a matter of "judicial policy." United States v. Kimball Foods, Inc., 440 U.S. 715, 728 (1974). This is certainly an area where such a judicial policy makes sense.

228. Atherton, 117 S. Ct. at 669.

229. The fundamental debate regarding Rule 10b-5 has been for decades whether it merely federalizes preexisting common law fraud or creates a new set of prohibitions and remedies as a matter of federal law, and if so how should such prohibitions and remedies be defined. In the insider trading context, the courts have allowed Rule 10b-5 to operate to expand the prohibitions of the common law. See SEC v. Texas Gulf Sulphur, 401 F.2d 833, 848 (2d Cir. 1968)(stating, at the high tide of 10b-5's reach, that the Rule should be read to assure that "all investors should have equal access" to material information). Indeed in transactions on impersonal stock exchanges the common law imposed virtually no insider trading prohibition. Strong v. Repide, 213 U.S. 419 (1909)(recognizing exceptions for "special circumstances"); Goodwin v. Agassiz, 186 N.E. 659 (Mass. 1933)(holding that directors owe no fiduciary duty, and thus no duty to disclose to shareholders); Robert Charles Clark, Corporate Law 311-12 (1986)(the common law duty to disclose to investors was quite limited). The SEC early on expanded the insider trading prohibitions applicable under federal law pursuant to Rule 10b-5. In re Cady Roberts & Co., 40 S.E.C. 907 911-912 (1961)(imposing an affirmative duty to disclose on corporate insiders). Th