Vanderbilt Law Review


Steve Thel

First Page



Insider trading has presented some of the most unsettled and contentious issues of corporate law. These issues have been particularly difficult because often it has not even been clear whether the law forbids those who possess material nonpublic information to trade securities. Even as commentators have debated whether insider trading ought to be forbidden, the courts have disagreed on the more basic question of when and whether such trading is, in fact, forbidden.

The law governing insider trading has been unclear because the scope of the SEC's authority to regulate insider trading has been unclear. For a while, courts uniformly held that section 10(b) of the Securities Exchange Act (the "Exchange Act") authorizes the SEC to forbid trading by those in possession of misappropriated material nonpublic information, and that section 14(e) of the Exchange Act authorizes the Commission to forbid trading on the basis of any material nonpublic information about tender offers. However, two circuit courts of appeal subsequently rejected this precedent and held that the Commission could not forbid trading on the basis of misappropriated information or prohibit informed trading in the context of tender offers. Earlier this year, in United States v. O'Hagan, the Supreme Court held that (1) a person who trades securities for personal profit using confidential information misappropriated in breach of a fiduciary duty to the source of the information violates section 10(b) and rule 10b-57 and (2) at least insofar as the question had been presented to the Court, the SEC did not exceed its rulemaking authority under section 14(e) when it adopted rule 14e-3,8 which establishes a sort of parity-of-information regime for trading in connection with tender offers.

Although the Court's opinion in O'Hagan strongly endorsed the SEC's regulation of insider trading, it left several important questions unanswered. For example, it is not entirely clear what sort of confidential relationship creates a duty of loyalty protected by section 10(b). Defendants presumably will argue that the breach of a noncommercial confidential relationship, such as that between a therapist and patient or between family members, does not suffice to establish securities fraud. In addition, the Court explicitly refrained from deciding whether rule 14e-3 is valid insofar as it prohibits trading in advance of a tender offer. A final question is whether the Court's holding was correct. Two courts of appeal had construed section 10(b) and rule 14e-3 much more narrowly, as had numerous academic commentators. Moreover, three justices dissented from parts of the majority's opinion in O'Hagan, and Justice Thomas, joined by the Chief Justice, strenuously argued that neither the misappropriation theory nor rule 14e-3 was consistent with the Exchange Act.

This Article is about a provision of the Insider Trading and Securities Fraud Enforcement Act of 1988 ("the 1988 Act") that directly addressed the validity of rule 14e-3 and the misappropriation doctrine, and the parameters of the latter. In the 1988 Act, Congress declared its finding that the "rules and regulations of the Securities and Exchange Commission under the Securities Exchange Act of 1934... governing trading while in possession of material, nonpublic information are, as required by such Act, necessary and appropriate in the public interest and for the protection of investors." The statute further provided that the SEC had "enforced such rules and regulations vigorously, effectively, and fairly.""

Inasmuch as the Exchange Act authorizes the SEC to promulgate necessary and appropriate rules and the 1988 Act says that the SEC's insider trading rules are necessary and appropriate, on first reading these findings seem to settle the matter and establish that the SEC's insider trading initiatives are within its statutory authority. Surprisingly, however, they have not figured at all in the debate over the validity of the SEC rules. Thus, one purpose of this Article is simply to highlight their existence.