Insider trading: Misappropriation theory vs. tipper tippee?

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thexfactor
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Insider trading: Misappropriation theory vs. tipper tippee?

Postby thexfactor » Mon Nov 14, 2011 8:12 pm

Hey guys I am a little confused about the two different theories. Can someone explain the difference between the misappropriation theory vs. the classical tipper tippee theory?

Tipper's fiduciary duty may be transferred to the tippee correct?

Under misappropriation theory it seems like the same thing. The person trading with the information received a fiduciary duty? Furthermore under O'hagan isnt a lawyer already a temporary insider and therefore is a classical theory of insider trading.

Thanks

random5483
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Re: Insider trading: Misappropriation theory vs. tipper tippee?

Postby random5483 » Mon Nov 14, 2011 8:58 pm

Traditional / Classical Theory/Tipper-Tippee: Rule 10(b) and 10b-5 are violated when a corporate insider trades in securities of his corporation on the basis of material non-public information.

Misappropriation Theory: A person commits fraud in connection with a securities transaction, and thereby violates section 10(b) and 10b-5 when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information.


Not taken Sec Reg, so might not be detailed enough for that class. This was from a more light weight non-law undergraduate class.

GHH923
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Re: Insider trading: Misappropriation theory vs. tipper tippee?

Postby GHH923 » Sat Apr 21, 2012 6:31 pm

Studying for my secreg final now, and I have the same question.

Here is how I've constructed my hypo:

A is an officer of company X
B is a broker for company X
C is a purchaser of securities of company X

Facts:

A tells B "I shouldn't be telling you this, but we've cooked our books and have therefore underreported our profitability. Our stock price next quarter should skyrocket. And when it does, I'm entitled to a 50% pay increase and a bonus." Edit: B then sells to C, who knows nothing of A and B's conversation.

Classical Theory via tipper/tippee:

Both A and B violate 10b-5 when B trades on the basis of material, nonpublic information with C and A breaches his fiduciary duty owed to shareholders by disclosing the info to B and B knows or should know there has been a breach of that duty. Dirks. How do we know whether A has breached his fiduciary duty? If A will personally benefit, directly or indirectly, from his disclosure. Cady, Roberts. Assuming all of the foregoing is established, then A and B are subject to liability.

Misappropriation:

Here is where it gets fuzzy. Under the same hypo, I think the party bringing the action may be able to establish liability, because liability is predicated on B breaching some fiduciary duty owed to A, and brokers owe duties to corporations not to do the sorts of things done in the hypo. With tipper/tippee, although both A and B owe duties to shareholders, the analysis regarding breach of that duty centers on A and his personal benefit.

Say we change the facts to say that B, still a broker, is merely a friend of A, and does not work for his company. I don't think liability based on misappropriation is proper under these circumstances, because an element of the theory is missing: the fiduciary relationship between A and B.

However, and as you point out, this sounds a lot like a temporary insider situation. I'm going to go enjoy my Saturday now.

GHH923
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Re: Insider trading: Misappropriation theory vs. tipper tippee?

Postby GHH923 » Sat Apr 21, 2012 6:53 pm

I think the difference between temporary insiders and the misappropriation theory is that under the latter the person with information owes a duty to the source of the information. The duty seems more broad under the former.

The example - see here page 4: --LinkRemoved--

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Big Shrimpin
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Re: Insider trading: Misappropriation theory vs. tipper tippee?

Postby Big Shrimpin » Sun Apr 22, 2012 10:19 am

thexfactor wrote:Hey guys I am a little confused about the two different theories. Can someone explain the difference between the misappropriation theory vs. the classical tipper tippee theory?

Tipper's fiduciary duty may be transferred to the tippee correct?

Under misappropriation theory it seems like the same thing. The person trading with the information received a fiduciary duty? Furthermore under O'hagan isnt a lawyer already a temporary insider and therefore is a classical theory of insider trading.

Thanks


Okay, I took corps 2L fall, and I'm taking M&A right now, but I don't know if this is 100% correct. If not, plz halp thx....

So, this is what I remember:

I think you're right about the tippers FD transferring to the tippee. In a scenario where A, either an insider in company C or owing some FD to C, give B material/nonpublic information, B must know/should have known A was breaching an FD and also trade on that information. Moreover, since courts pretty much construe anything as a "benefit" resultant from the tip, A will be on the hook as well.

The traditional theory is where A, who works for C (so he's an insider), trades directly on some material/nonpublic information. It's pretty plain vanilla.

Misappropriation sort of deals with a zone of FD and gets a little trickier. FDs extend to the guys at companies A and B (for this example, let's assume they're in merger talks or something), both to their own companies and to each others' companies. Moreover, FDs extend to the ibanks brokering the deal, the law firms doing diligence, etc. If Larry at lawfirm Z (who's not working on the deal but his partner Billy is), learns about the A/B merger and trades on that information, he's in violation of 10b-5 via misappropriation because he owes an FD to the firm's client, just as Billy does. Moreover, IIRC, depending upon the facts, I think you could make arguments that "other" employees, like secretaries, janitors, etc., where the FDs are more attenuated, might potentially be in violation under misappropriation if they come across something on Billy's desk and use that to trade upon.

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Indifferent
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Re: Insider trading: Misappropriation theory vs. tipper tippee?

Postby Indifferent » Sun Apr 22, 2012 11:17 am

Why are people who haven't taken sec reg answering this question. Ugh.

Misappropriation

This is a theory based on breach of a duty owed to the corporation. There is no private cause of action, the cause of action inures in the corporation itself and I believe the only entity that brings this action is the SEC - that's what my notes say. You misappropriate information when you gain that information from forming a confidential relationship or duty of trust to the corporation.

Under 10b5-2 a confidential relationship or duty of trust is deemed to exist when:
a) Person agrees to maintain info in confidence;
b) Where there is a history/practice of sharing confidences between person communicating and receiving info such that recipient knows or reasonably should know there is an expectation of confidentiality; or
c) When person receives material nonpub info from spouse, parent, child, or sibling, provided that the person can demonstrate lack of a duty

Tipper/Tippee Liability

A tipper is liable when he passes on material nonpublic information to the tippee. This is selective disclosure and the tipper is liable for the profits made by the tippee if he satisfies the requirements of 10b-5 (probably most importantly scienter) and is also criminally liable if he does it willfully.

However, a tipper is not liable for every disclosure of material nonpublic information. Disclosures to consultants, family members, and some isolated incidences are okay. The tipper will only be liable if he is attempting to benefit personally, either directly or indirectly, from the disclosure. Note that the benefit does not have to be pecuniary.

A tippee is liable for trading on the material, nonpublic information received in breach of a fiduciary duty. He is assuming a derivative fiduciary duty. To be liable, there must be a tipper who has breached his fiduciary duty (by attempting to benefit) AND the tippee must know or should have known there was a breach.

Note that a key difference between this and misappropriation is that someone with a nonconfidential relationship with the corporation, for example, a securities analyst, who receives information from a corporate insider would be liable here, where as under misappropriation theory he would not be liable because he owed no duty to the corporation itself.

GHH923
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Re: Insider trading: Misappropriation theory vs. tipper tippee?

Postby GHH923 » Sun Apr 22, 2012 1:47 pm

ID, sounds like we are on the same page re: distinctions between classical and misappropriation. And, for the record, I've taken all of a secreg course, save for the exam (on which I hopefully won't be learning anything new).

This led to questioning about the difference between liability for temporary insiders (considered to fall under the classical umbrella) and liability for those misappropriating information. I looked at O'Hagan again, and it makes things clear: under the classical theory, an insider violates the law when he "trades in the securities of his corporation."

But what if, in an imminent merger of corps A and B, a lawyer for A purchases securities in B on the basis of material nonpublic info? Classical theory doesn't appear to reach him here, but misappropriation does as a result of the Court saying, look, under 10b-5, one in a position of trust and confidence (subpoints A-C in your post, Indiff) cannot breach a duty owed to a corporation, specifically here a duty not to take advantage of information concerning the imminent merger in order to profit. Factually this mirrors O'Hagan.

Edit: the only thing I'm not sure about in your post Indiff is this part:

You misappropriate information when you gain that information from forming a confidential relationship or duty of trust to the corporation.


O'Hagan says the fraud is consummated not when the info is gained but when it is used to purchase or sell securities.

So:

Classical: trading in material nonpublic info in securities of your corporation for personal benefit

Classical/tipper-tippee: Both have duties to the corp; tippee assumes duty to shareholders not to trade on material nonpublic info only when insider breaches their fiduciary duty to shareholders (duty to SH's breached when insider would personally benefit) (this introduces an extra individual into the equation)

Misappropriation: reaches individuals misappropriating confidential information for trading purposes in breach of duty owed to the source of the information; is not limited to securities in ones own company.
Last edited by GHH923 on Sun Apr 22, 2012 1:51 pm, edited 1 time in total.

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Indifferent
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Re: Insider trading: Misappropriation theory vs. tipper tippee?

Postby Indifferent » Sun Apr 22, 2012 1:50 pm

GHH923 wrote:ID, sounds like we are on the same page re: distinctions between classical and misappropriation. And, for the record, I've taken all of a secreg course, save for the exam (on which I hopefully won't be learning anything new).

This led to questioning about the difference between liability for temporary insiders (considered to fall under the classical umbrella) and liability for those misappropriating information. I looked at O'Hagan again, and it makes things clear: under the classical theory, an insider violates the law when he "trades in the securities of his corporation."

But what if, in an imminent merger of corps A and B, a lawyer for A purchases securities in B on the basis of material nonpublic info? Classical theory doesn't appear to reach him here, but misappropriation does as a result of the Court saying, look, under 10b-5, one in a position of trust and confidence (subpoints A-C in your post, Indiff) cannot breach a duty owed to a corporation, specifically here a duty not to take advantage of information concerning the imminent merger in order to profit. Factually this mirrors O'Hagan.

So:

Classical: trading in material nonpublic info in securities of your corporation for personal benefit

Classical/tipper-tippee: Both have duties to the corp; tippee assumes duty to shareholders not to trade on material nonpublic info only when insider breaches their fiduciary duty to shareholders (duty to SH's breached when insider would personally benefit) (this introduces an extra individual into the equation)

Misappropriation: reaches individuals misappropriating confidential information for trading purposes in breach of duty owed to the source of the information; is not limited to securities in ones own company.

That is a solid clarification. I didn't include classical because I assumed it was overridden by 10b-5(2).

GHH923
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Re: Insider trading: Misappropriation theory vs. tipper tippee?

Postby GHH923 » Sun Apr 22, 2012 1:52 pm

Indiff - and for your part I appreciate the comment regarding whether under misappropriation an action may be brought by a private party. I can see many a law prof throwing in a fact like that to trip up an essay answer.




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