Misunderstanding the Role of a Relationship of Trust and Confidence in O'Hagan

The recent action brought by the SEC against Mark Cuban for allegedly violating SEC Rule 10b-5 by selling stock in Mamma.com on the basis of information he allegedly expressly promised to keep confidential has drawn an amicus brief from five distinguished securities law professors urging dismissal of the complaint. The professors argue that the misappropriation theory of liability for insider trading (approved by the Supreme Court in the O'Hagan case) requires that a relationship of trust and confidence exist between the individual trading the securities and the source of the information in order for that theory to apply. They also argue that to the extent SEC Rule 10b5-2 allows for liability based on a mere promise to the source, which is not made in the context of a relationship of trust and confidence, Rule 10b5-2 exceeds the scope of the SEC's authority to make rules under Section 10(b) of the Securities Exchange Act of 1934. With all due respect to the distinguished professors, their argument ignores the actual context in which the O'Hagan case uses the term “relationship of trust and confidence.”

O'Hagan was a partner at a Minneapolis law firm. His firm was representing a firm which was about to make a tender offer for the stock of a publicly traded company. Through his firm's representation of the acquirer he learned of the pending offer for the target firm, and in advance of the public announcement of the tender offer, purchased stock in the target company. The Supreme Court overturned the Eight Circuit's reversal of O'Hagan's conviction for a criminal violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

The opinion of the Court, written by Justice Ginsburg, does, as suggested by the amicus brief, heavily emphasize that a relationship of both trust and confidence existed between O'Hagan and his sources of information, his law firm and its client, the acquiring firm. However, the reason that Justice Ginsburg heavily emphasized the relationships of trust and confidence that O'Hagan had with the sources of his information was that, in the actual case, the relationship was necessary to establish that O'Hagan's conduct “satisfie[d] Section 10(b)'s requirement that chargeable conduct involve a 'deceptive device or contrivance'.” O'Hagan could not be found to have engaged in deception against the sellers of the target company's stock since he, like the defendant in Chiarella, did not have any duty to disclose the information because he had no fiduciary type of relationship with those sellers. O'Hagan did not deceive his law firm or its client in the sense that he expressly lied to them about what he was going to do with the information. At least as reflected in the Supreme Court's opinion, O'Hagan never expressly promised or assured either his firm or its client that he would keep the information confidential. However, his status as a fiduciary of those two entities created an implied promise that he would use information he obtained from them only for the purposes for which they supplied it. By “feigning fidelity” and not telling the sources that he intended to trade upon the information, O'Hagan broke that implied promise, and “deceived” the sources of his information, thereby satisfying Section 10(b)'s deception requirement.

When a person breaks an express promise to keep information confidential, as alleged in the Cuban case, or as contemplated by Rule 10b5-2, one deceives the source of the information just as much as if the person broke an implied promise to keep the information confidential. It is true that at the time the promissor makes the promise of confidentiality he or she may have no intention of breaking that promise. That, however, should make no more difference to a finding of deception than if the maker of the implied promise intended to keep his or her implied promise at the time he or she entered into the fiduciary relationship, or received the confidential information.

The bottom line is that a relationship of trust and confidence plays a very different role in a misappropriation insider trading case than in a case brought under :”the classical theory” of insider trading. In the latter, some form of relationship of trust and confidence is necessary to show that an insider deceived persons on the other side of securities transactions by withholding material information from them, i.e., that a pure omission was the equivalent of an affirmative misrepresentation. In the former theory, the relationship of trust and confidence is sometimes needed to show that the defendant somehow deceived the source of his or her information. When the defendant breaks an express promise to keep the information confidential, a relationship of trust and confidence is no longer needed to show deception. A breach of the express promise will show deception at least as well as a breach of the implied promise. The argument that O'Hagan precludes a finding on insider trading based upon a mere breach of an express promise of confidentiality ignores the different roles that fiduciary relationships play in the two theories, as well as the specific legal issues Justice Ginsburg was addressing in O'Hagan.