Facts of the Case

The Securities and Exchange Commission (SEC) found James O'Hagan, a partner at Dorsey and Whitney law firm (Dorsey), guilty of 57 counts of fraud for profiting from stock options in Pillsbury Company based on nonpublic information he misappropriated for his personal benefit. O'Hagan knew that Dorsey's client, Grand Metropolitan PLC, was considering placing a tender offer (a public offer to pay shareholders a premium for their stock at a specified time) to acquire a majority share in Pillsbury Company. O'Hagan bought a large number of stock options without telling his firm and later sold his options for a $4.3 million profit.

The U.S. Court of Appeals for the Eighth Circuit reversed O'Hagan's convictions under the Securities Exchange Act of 1934. The Eighth Circuit applied the Act only to security-traders who wrongfully use confidential information pertaining to their own companies. The Circuit Court ruled that the SEC had exceeded the rule-making authority granted to it by the Act by making it a fraudulent action to trade securities on exclusive non-public foreknowledge of a tender offer.

Question

1) Does a security-trader violate the Securities and Exchange Act of 1934 by trading securities on the basis of misappropriated information pertaining to a company other than his own?

2) Did the Security Exchange Commission have the authority to make Rule 14e-3(a), which forbids security trading on nonpublic foreknowledge of a tender offer?

Conclusion

Yes and Yes. Justice Ruth Bader Ginsburg authored the opinion in the Court's 6-3 decision. The Court ruled that a security-trader who fails to disclose personal profits gained from reliance on exclusive information is guilty of employing "a deceptive device...in connection with the purchase of a security." The security-trader knowingly abuses the duty owed toward the source of information, whether the source is the company he works for or not.

The Court also held that the SEC has authority to "define and prescribe means reasonably designed to prevent fraudulent...acts...in connection with any tender offer." Rule 14e-3(a) of the Exchange Act, adopted under this fraud-prevention authority, forbids security-traders from trading on the basis of information they know should be kept private unless they publicly disclose their trades.