Introduction: Mapping the Future of Insider Trading Law: Of Boundaries, Gaps, and Strategies


INTRODUCTION: MAPPING THE FUTURE
OF INSIDER TRADING LAW: OF

BOUNDARIES, GAPS, AND STRATEGIES

John C. Coffee, Jr.*

The current law on insider trading is remarkably
unrationalized because it contains gaps and loopholes the size
of the Washington Square Arch. For example, if a thief
breaks into your office, opens your files, learns material
nonpublic information, and trades on that information, he
has not breached a fiduciary duty and is presumably exempt
from insider trading liability. But drawing a line that can
convict only the fiduciary and not the thief seems morally
incoherent. Nor is it doctrinally necessary.

The basic methodology handed down by the Supreme
Court in SEC v. Dirks and United States v. O'Hagan dictates
(i) that a violation of the insider trading prohibition requires
conduct that is "deceptive" (the term used in Section 10(b) of
the Securities Exchange Act of 1934), and (ii) that trading
that amounts to an undisclosed breach of a fiduciary duty is
"deceptive." This formula illustrates, but does not exhaust,
the types of duties whose undisclosed breach might also be
deemed deceptive and in violation of Rule 10b-5. Many forms
of theft or misappropriation of confidential business
information could easily be deemed sufficiently deceptive to
violate Rule 10b-5. More generally (and more
controversially), the common law on finders of lost property
(which generally treats a finder as a bailee for the true owner)
might be used to justify a duty barring recipients from
trading on information that has been inadvertently released
or released to them without lawful authorization.
Nonetheless, current law has stopped short of generally

* Adolf A. Berle Professor of Law and Director, Center on Corporate
Governance, Columbia Law School. The author wishes to acknowledge the
helpful assistance of his colleagues Henry Monaghan and Jason Parsont,
but alone is responsible for any mistakes.



COLUMBIA BUSINESS LAW REVIEW

prohibiting the computer hacker and other misappropriators
who make no false representation and do not compensate the
tipper.

This article surveys possible means by which to fashion a
more coherent and consistent prohibition on insider trading.
It assumes that legislation is unlikely (and might even
aggravate the problem), but that the SEC has broad
discretion to adopt rules (just as it did in 2000 in adopting
Rule 10b5-1 and 10b5-2). Specific rules are proposed.

At the same time, this article acknowledges that the goal of
reform should not be to achieve parity of information, and
that there are potentially high costs in attempting to extend
the boundaries of insider trading to reach all instances of
inadvertent release. Deception, it argues, should be the key,
both for doctrinal and policy reasons.

I. Introduction ............................. 282
II. Gaps in the Law .................... ...... 289

A. Careless Tipper/Corrupt Tippee ...... ....... 291
B. Non-Deceptive "Theft" of Business Information 294
C. "Warehousing" and Selective Disclosure..........:. 295

III. Potential Theories .................... ..... 296
A. Fraud on the Market ............... ..... 297
B. The Duty to Hold Lost or Stolen Information in

Confidence ..................... ...... 299
C. Codifying Dorozhko............... ...... 306
D. The Restatement of Agency ............... 309
E. Willful Violations of Regulation FD.................... 310

IV. An Evaluation...................... ...... 311
A. Overcriminalization................ ..... 311
B. The Impact on Market Efficiency ..... ...... 312
C. Federalism .................. ......... 314

V. Conclusion .............................. 316

I. INTRODUCTION

Inherently, the common law is path dependent. As a
result, as the twig is bent, so grows the tree. Once a legal
doctrine has developed beyond its infancy, its future

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trajectory is largely confined within boundaries established
by the limited plasticity of common law concepts. Gaps may
be filled in, some critical terms may be marginally
reinterpreted; but radical change is unlikely. In this light,
both because the law of insider trading is largely judge
made,' and because it is well past its early formative period, 2

it seems particularly subject to these constraints.3

That said, common law concepts are nonetheless
malleable and have the potential for expansion. In the case
of insider trading law, duties can be derived from the
common law that would trigger an obligation to disclose or

1 See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 737
(1975) (aptly describing Rule 10b-5 as "a judicial oak which has grown
from little more than a legislative acorn"). However, Rule lob-5 has also
grown through administrative rulemaking as well, and this Article will
suggest that the most sensible way to fill in gaps in the law is through
SEC rulemaking. Rules 10b5-1 and 10b5-2 are the leading examples of
such administrative gap filling, and they define important fact patterns
that today fall within Rule 10b-5 (but did not always). See 17 C.F.R. §§
240.10b5-1,-2 (2013). Both rules were clearly intended to reverse judicial
decisions that had construed Rule 10b-5 narrowly. Compare United States
v. Chestman, 947 F.2d 551, 568 (2d Cir. 1991) (en banc) (deeming
relationship of husband and wife not to be a fiduciary relationship), with
Rule 10b5-2(b)(3), 17 C.F.R. § 240.10b5-2(b)(3) (2013) (declaring spouses to
owe a "duty of trust or confidence" to each other the breach of which can
violate Rule 10b-5).

2 More than fifty years have passed since the SEC's decision in Cady,
Roberts & Co., Exchange Act Release No. 6668, 40 S.E.C. 907 (Nov. 8,
1961), in which then-chairman William Cary first provided a substantive
definition of the insider trading prohibition, formulating the "disclose or
abstain" standard for insiders.

3 In both Stoneridge Investment Partners, LLC v. Scientific-Atlanta,
Inc., 552 U.S. 148, 165 (2008) and Janus Capital Group, Inc. v. First
Derivative Traders, 131 S. Ct. 2296, 2302 (2011), the Court emphasized in
decisions construing Rule 10b-5 (which is the source of authority for the
insider trading prohibition) that "[cloncerns with the judicial creation of a
private cause of action caution against its expansion." In short, judge
made law must be construed to give it "narrow dimensions." Stoneridge,
552 U.S. at 167. Still, if the Court's concern is with the problems it
perceives with private causes of action, expanding the insider trading
prohibition itself should not heighten this concern, because insider trading
is seldom enforced through private litigation, but instead through criminal
and SEC enforcement.

No. 2:281]) 283



abstain from trading, but no article has yet seriously
explored these possibilities. This Article will survey some of
these possibilities, but its goal is not to urge the maximum
expansion of the insider trading prohibition. Rather, it seeks
to evaluate the tools at hand.

At the outset, it must also be recognized that the scope of
the insider trading prohibition has recently expanded, as the
result of decisions that appear to relax older doctrinal
constraints. In net effect, these liberalizing decisions have
shifted the balance of advantage in securities enforcement
litigation in favor of the government. This expansion in the
law has largely occurred along two distinct axes: (1)
additional duties have been recognized whose breach violates
Rule 10b-5;4 and (2) deception not involving a breach of duty
has also been found to violate Rule 10b-5.6

4 A leading example is SEC v. Cuban, which accepted in principle that
a legal duty can arise by contract, whose breach would violate Rule 10b-5.
SEC v. Cuban, 634 F. Supp. 2d 713 (N.D. Tex. 2009). The defendant had
claimed that only fiduciary breaches recognized under state law could
support a violation of Rule 10b-5. Id. at 726. Conservative law professors
have long argued the thesis that only such a state law grounded violation
could support a Rule 10b-5 violation. See Stephen A. Bainbridge,
Incorporating State Law Fiduciary Duties into the Federal Insider Trading
Prohibition, 52 WASH. & LEE L. REV. 1189, 1267 n.320 (1995). But Rule
10b5-2 today recognizes that a "duty of trust or confidence" can be
grounded on a contract or an agreement "to maintain information in
confidence." See Rule 10b5-2(b)(1), 17 C.F.R. § 240.10b5-2(b)(1) (2013).
Decisions to date have largely upheld the rule. See SEC v. Yun, 327 F.3d
1263, 1273 (11th Cir. 2003) (recognizing that "a breach of an agreement to
maintain business confidences would also suffice" to support insider
trading liability); SEC v. Lyon, 529 F. Supp. 2d 444, 452-53 (S.D.N.Y.
2008). However, in SEC v. Cuban, the court drew a tortured distinction
between agreeing to maintain confidentiality and agreeing not to trade.
Cuban, 634 F. Supp. 2d at 729-31. In its view, Rule 10b5-2(b)(1)
improperly "attempts to predicate misappropriation theory on a mere
confidentiality agreement lacking a non-use component." Id. at 730-31.
This distinction between agreeing to maintain confidentiality and agreeing
not to trade was, however, viewed skeptically by the Fifth Circuit, which
vacated and remanded. See SEC v. Cuban, 620 F.3d 551 (5th Cir. 2010).
In United States v. Whitman, the district court went well beyond Cuban
and held that Rule 10b-5 is not grounded on state law theories of fiduciary
duty, but rather on federal common law. United States v. Whitman, No.

COL UMBIA B USINESS LA W RE VIE W [Vol. 2013284



The specifics of these decisions are carefully analyzed by
Professor Donald Langevoort, Stephen Crimmins, and
Edward Greene and Olivia Schmid in their excellent
contributions to this Symposium, but this Article will use
this recent expansion as a jumping-off point to ask: How
much more doctrinal evolution is possible, without
legislation, in the foreseeable future? More specifically, how
could the law evolve over the next decade? Is it possible that
the law could expand to the point that anyone who acquires
and trades on material nonpublic information would violate
Rule 10b-5?

This Article has both descriptive and normative
intentions. Initially, it will first map the gaps in existing
insider trading law; then, it will consider how far the law
could be expanded, without legislation, through
administrative rulemaking. Its model for reform is the
SEC's successful effort in 2000 to extend the boundaries of
Rule 10b-5 through the promulgation of Rules 10b5-1 and
10b5-2. 6 Motivating this inquiry is a premise that needs to
be explicitly stated at the outset: the current reach of the
insider trading prohibition is both arbitrary and incomplete.
Egregious cases of informational misuse are not covered,
while less culpable instances of abuse are criminalized. For
the long term, the scope of the insider trading prohibition
needs to be better rationalized.

To understand this contention, it is useful to begin our
mapping of the current outer boundaries of insider trading
law with three recent decisions. First, in SEC v. Dorozhko,7

12 Cr. 125 (JSR), 2012 U.S. Dist. LEXIS 163138, at *14-16 (S.D.N.Y. Nov.
14, 2012). To the extent that federal law controls, SEC rules could do
much more to generalize or expand the scope of the insider trading
prohibition.

5 See SEC v. Dorozhko, 574 F.3d 42 (2d Cir. 2009) (discussed infra
notes 7, 28, 54-62 and accompanying text).

6 These rules were adopted in 2000 along with Regulation FD, which
selectively bars selective disclosure. See Selective Disclosure and Insider
Trading, Exchange Act Release No. 7881, 73 SEC Docket 3 (Aug. 15,
2000).

7 Dorozhko, 574 F.3d at 51. In Dorozhko, the defendant appeared to
have hacked into a secure server at Thomson Financial Inc. to gain access

No. 2:281]1 THE FUTURE OF INSIDER TRADINVG I.AW 285



the Second Circuit opened the door to the prosecution of
persons who trade on material nonpublic information, even
when they do not breach a fiduciary (or similar confidential)
relationship, at least so long as they obtain the material
nonpublic information through "deception." Immediately,
questions arise as to how far this minimal requirement of
deception can be stretched. Could even overhearing an
extended conversation (say, in an elevator ride or in a bar) be
deemed deceptive if the others have incorrectly assumed that
the defendant is part of their group and the defendant omits
to disclose the truth?

Second, in SEC v. Obus,8 the Second Circuit appears to
have relaxed the former requirement that tipper and tippee
must be part of a de facto conspiracy in which the tipper was
deliberately providing the material information to benefit
the tippee (either (1) in return for an economic benefit
conferred by the tippee on the tipper; or (2) as a gift by the
tipper to the tippee).Y Today, under Obus, it may be possible
for the tippee to "recklessly" violate Rule 10b-5, even without

to the soon-to-be released, but still confidential, third quarter earnings of
IMS Health, Inc. (which had hired Thomson Financial "to provide investor
relations and web-hosting services" for it). Id. at 44. Learning that the
third quarter results were highly unfavorable for IMS, the defendant then
purchased "put" options on IMS that would very shortly expire, thus
implying that the options would soon be worthless if IMS's stock price did
not fall quickly. Id. On these facts, the defendant had no connection to
IMS or Thomson Financial and clearly owed no fiduciary duty to either.
Id. Nonetheless, the Second Circuit panel found that to the extent the
defendant had "deceptively" gained access to material nonpublic
information, he had violated Rule 10b-5. Id. at 51. It remanded to the
district court to determine whether the computer hacking on its actual
facts had "involved a fraudulent misrepresentation that was 'deceptive'
within the ordinary meaning of Section 10(b)." Id.

8 SEC v. Obus, 693 F.3d 276 (2d Cir. 2012).
9 These are the standards specified in Dirks v. SEC, which said that

"the test is whether the insider personally will benefit, directly or
indirectly, from his disclosure. Absent some personal gain, there has been
no breach of duty to stockholders." Dirks v. SEC, 463 U.S. 646, 662 (1983).
The Court further recognized that a fiduciary breach occurred "when an
insider makes a gift of confidential information to a trading relative or
friend." Id. at 664.

COL UMBIA B USINESS LA W RE VIE W [Vol. 2013286



paying any benefit to the tipper, at least if the tippee has
''reason to know" that the tipper breached its duty in
communicating the information.o Again, countless
variations on this fact pattern can be proposed: for example,
suppose that one member of a live-in couple tells the other
what he or she is working on around the clock at the office
and thereby divulges material nonpublic information,
because he or she is under stress and wants sympathy. At
the bottom of this slippery slope lies the simply negligent
leakage of information: i.e., the loose-lipped law firm
associate in the crowded elevator who carelessly divulges the
name of the target company. The concept of deception
cannot be reasonably stretched to reach all these possible
cases of unintentional tipping, but prosecutors and
regulators are motivated to strain to find deception because,
under existing law, the liability of the tippee is derivative of
the liability of the tipper. Under Dirks, unless the tipper has
breached some duty, the tippee who profits cannot be held to
account. "

10 In Obus, the Second Circuit summarized the law on tippee liability
under Rule 10b-5, as follows:

Tippee liability requires that (1) the tipper breached a duty
by tipping confidential information; (2) the tippee knew or
had reason to know that the tipper improperly obtained the
information (i.e., that the information was obtained
through the tipper's breach); and (3) the tippee, while in
knowing possession of the material non-public information,
used the information by trading or by tipping for his own
benefit.

Obus, 693 F.3d at 289.
Nothing is said in this passage that requires that the tippee pay a

benefit to the tipper, even though the court in the same paragraph
required that such a benefit be paid to the tipper to establish tipper
liability. Seemingly, a distinction has been drawn here between tipper
and tippee liability. There may well be policy justifications for such a
distinction, but the decision is silent on this point and does not express
them.

11 See Dirks, 463 U.S. at 659 ("Thus, the tippee's duty to disclose or
abstain is derivative from that of the insider's duty.").

287No. 2:281] THE FUTURE OF INSIDER TRADING LA W



Finally, several decisions have recognized that state law
definitions of fiduciary duty do not control or exhaust the
field. Most notably, in SEC v. Cuban," the court recognized
that a duty to keep information confidential can arise either
by contract or based on other relationships that do not give
rise to traditional fiduciary duties. In its view, a breach of a
contractual duty provides an even "stronger footing for
imposing liability for deceptive conduct than does the
existence, without more, of a fiduciary or similar relationship
of trust and confidence.""

Once we move beyond state law defined fiduciary duties
as the exclusive source of duties that can trigger a Rule 10b-
5 violation, then the next question becomes: How many other
duties can similarly be postulated whose breach should
violate Rule 10b-5? This Article will survey several potential
such duties, in part because their discovery could simplify
insider trading enforcement, and in part because their
recognition would make the insider trading prohibition more
consistent and equitable. But the recognition of these
additional duties also exposes those who have legitimately
gained informational advantages to potential prosecution
and may create a trap for the unwary with very uncertain
boundaries. Balancing the costs and benefits of any
extension is therefore essential. Accordingly, the aim of this
overview is more to map the possibilities than to argue for
any definitive position. Part II will begin by seeking to
identify where the major gaps exist in contemporary law.
Part III will then turn to conceivable doctrinal answers that

12 SEC v. Cuban, 634 F. Supp. 2d 713, 729-31 (N.D. Tex. 2009),
vacated and remanded, 620 F.3d 551 (5th Cir. 2010). Cuban was, of
course, analyzing SEC Rule 10b5-2, 17 C.F.R. § 240.10b5-2 (2013), which
defendant had challenged as beyond the scope of the SEC's authority. For
an equally important, if less noticed, decision, see United States v.
Whitman, No. 12 Cr. 125 (JSR), 2012 U.S. Dist. LEXIS 163138, at *14-16
(S.D.N.Y. Nov. 14, 2012) (finding federal law to control the issue of who
qualifies as a fiduciary for purposes of insider trading liability). See also
infra note 69.

13 Cuban, 634 F. Supp. 2d at 725 (explaining that a contract can
capture the defendant's "obligation with greater acuity than does a duty
that flows more generally from the nature of the parties' relationship").

288 COL UMBIA B USINESS LA WRE VIE W [Vol. 2013



could be used to plug these gaps, and will consider possible
SEC rules to implement such duties. Finally, Part IV will
conclude with an evaluation of these possibilities.

II. GAPS IN THE LAW

Thirty years ago, in Dirks v. SEC," the Supreme Court
grafted a "breach of duty" precondition onto insider trading
law. Essentially, the Court ruled that it was the breach of a
fiduciary or similar duty that made the use of an
informational advantage deceptive and thus within the scope
of Rule 10b-5's prohibition. Doctrinally, this step was
necessary because Rule 10b-5 necessarily rests on Section
10(b) of the Securities Exchange Act, which grants authority
to the SEC to adopt rules proscribing the use of "any
manipulative or deceptive device or contrivance."',
Deception thus becomes an indispensable element.16
Although Dirks clearly established that the failure to
disclose a breach of fiduciary duty before trading is
deceptive, it did not hold that this one example of deception
exhausts the field. Other forms of deception that do not
involve a fiduciary breach remain possible.

In all likelihood, Dirks was a product both of its time and
a post-Watergate zeitgeist. The defendant analyst (Ray
Dirks), who received material information from an insider at
Equity Funding, seemed more like a hero than a villain to
most observers, but not to the tone-deaf SEC (which may
have been embarrassed by the fact that Ray Dirks, and not
it, had uncovered the epic fraud at Equity Funding). The
Court in Dirks elaborately strove to find ways to protect the
securities analyst from potential prosecution any time it

14 Dirks, 463 U.S. at 647-48.
15 15 U.S.C. § 78j(b) (2011).
16 In principle, the government could alternatively seek to prove a

Rule 10b-5 violation by showing that conduct was "manipulative." But
"manipulation" and "manipulative" are terms of art that the Supreme
Court has long narrowly construed to exclusively cover practices "intended
to mislead investors by artificially affecting market activity." Santa Fe
Indus. v. Green, 430 U.S. 462, 476 (1977). Hence, neither "contrivance"
nor "manipulative" in Section 10(b) add much, if anything, to its coverage.

THE FUTURE OF INSIDER TRADING IA WNo. 2:2811 289



passed on information to institutional clients. Motivating
this desire was probably the sense that only with such
insulation could securities analysts uncover and expose
dangerous frauds, which seemed to elude bureaucratic,
slower-moving regulators. 17

The Dirks decision also resonated with the dominant
post-Watergate sensibility of its era. The defendant
securities analyst had played a socially desirable role that
was functionally equivalent to the role of the Washington
Post journalists (Woodward and Bernstein) who had
uncovered Watergate years earlier. Because the SEC's broad
theory of liability would have chilled analysts' incentive to
investigate, the Court seemed motivated to resist the SEC's
theory. Today, securities analysts less often resemble heroes
and often look more like highly conflicted gatekeepers,
particularly after the burst of the IPO bubble in 2000 and
the resulting global settlement in 2003. That settlement,
engineered by then New York Attorney General Eliot Spitzer
with the major investment banks, reflected a consensus that
securities analysts were involved in marketing activities for
their investment bank employers that left them highly
conflicted.'a If Dirks had instead been decided today,
analysts might have received considerably less deferential
treatment from the Court.

17 Dirks tends to glorify the role of the securities analyst, defining
that role as "to 'ferret out and analyze information,"' and describing such a
role as "necessary to the preservation of a healthy market." Dirks, 463
U.S. at 658.

18 For a brief description of this settlement, which also involved the
National Association of Securities Dealers ("NASD"), the New York Stock
Exchange ("NYSE") and most state securities commissioners, see JOHN C.
COFFEE, JR. & HILLARY A. SALE, SECURITIES REGULATION: CASES AND
MATERIALS (12th ed. 2012) at 111-12. Several Financial Industry
Regulatory Authority ("FINRA") rules were also adopted to curb analyst
conflicts by precluding analysts from participating in certain marketing
activities, but some of these rules have been subsequently preempted by
the JOBS Act. Id. at 112. See also Jumpstart Our Business Startups
("JOBS') Act §105, Pub. L. No. 112-106, 126 Stat. 306, 310-12 (2012) (to be
codified in scattered sections of 15 U.S.C.).

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THE FUTURE OF INSIDER TRADING LAW

Because law is path dependant, Dirks will continue to
shape the development of contemporary law. But, after
Dorozhko, alternative forms of deception may be accepted as
a substitute for the fiduciary breach that Dirks placed at
stage center. How far can these substitute theories be
stretched? To answer, it is useful to survey the most obvious
categories of misconduct that seem today to fall outside the
scope of the existing insider trading prohibition, as defined
by Dirks and O'Hagan.'" These include:

A. Careless Tipper/Corrupt Tippee

In SEC v. Yun,20 a senior corporate officer and his wife
were in the process of divorce. She called her divorce
attorney from her office at a real estate brokerage firm to
pass on facts that she had just learned from her husband,
indicating that stock and options he owned in his employer
were about to decline in value. The purpose of the call was
to adjust the valuation of his assets for the purpose of the
divorce settlement. The negative news that she disclosed
was overheard by another real estate broker in the office,
who quickly sold the company's stock short and profited.
The SEC sued the non-trading wife, as well as her coworker,
probably because it realized it needed to show a breach by
the tipper to hold the tippee liable. Thus, the SEC alleged
that the wife had "recklessly" tipped her coworker. In all
likelihood, the SEC believed that the wife had tipped her
colleague knowingly and deliberately as part of a
longstanding pattern of sharing real estate commissions, but
it was uncertain that it had sufficient evidence to prove this
contention. Although the district court accepted the SEC's
theory of "reckless" tipping, the Eleventh Circuit reversed,
finding that the "recklessness" charge unfairly prejudiced
the defendant and that such conduct by the tipper, when
unmotivated by any expected benefit from the tippee, was
beyond the scope of Rule 10b-5.

19 United States v. O'Hagan, 521 U.S. 642 (1997) (discussed infra
notes 29-30, 34, 37 and accompanying text).

20 SEC v. Yun, 327 F.3d 1263 (11th Cir. 2003).

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COLUMBIA BUSINESS LAW REVIEW

Although the SEC lost round one in Yun, it may have
scored a comeback victory more recently in Obus.2' There,
an employee of GE Capital, which was considering financing
an acquisition of a target company, called a college friend
who worked at a hedge fund that owned a large stake in that
target company. Apparently as the result of this
conversation, the hedge fund increased its stake in the
target. The defendant GE employee attempted to justify this
contact as a means of gaining information about the target
for his employer. No evidence suggested that the defendant
GE employee expected or received any personal benefit from
tipping his college friend (although it is arguable that their
college friendship might have inclined the GE employee to
make a gift to his friend).

Sidestepping these factual issues, the Second Circuit
found that the defendant GE employee could be liable as a
tipper if he acted "recklessly" in communicating the
information to his college friend in violation of GE's policies.
The Second Circuit panel gave a "hypothetical" example of a
person on a train who knowingly discusses material
nonpublic information in the presence of a friend who he
expects will trade on it.22 Although it seems doubtful that
the facts in Obus would suffice to show a "willful" violation
(as is required in the Second Circuit in the case of a criminal
prosecution),13 the bottom line seems to be that the SEC, at
least in the Second Circuit, can go forward by alleging that a
friend "recklessly" enabled another friend to trade. Although
the cases are thus divided, the "gift" or economic benefit
requirement in Dirks seems to have become attenuated.24

21 SEC v. Obus, 693 F.3d 276 (2d Cir. 2012).
22 Id. at 287.
23 Section 32(a) of the Securities Exchange Act criminalizes "willful"

violations of the rules or regulations adopted under that Act (including
Rule 10b-5). See 15 U.S.C.A. § 78ff(a) (West 2013). Courts in the Second
Circuit have interpreted this language to require "specific intent to
defraud." See United States v. Cassese, 428 F.3d 92, 98 (2d Cir. 2005);
United States v. Whitman, No. 12 Cr. 125 (JSR), 2012 U.S. Dist. LEXIS
163138, at *23-28 (S.D.N.Y. Nov. 14, 2012).

24 Most of us have college friends that we dearly like, but we would
not make multi-million dollar gifts to these persons when such a gift could

292 [Vol. 2013



THE FUTURE OF INSIDER TRADING LAW

At least for the present, Obus seems limited to the context
of communications among friends. It would seemingly not
apply to the garrulous associate who discusses material
nonpublic information in the elevator (unless possibly if the
elevator was filled with his friends). Closer cases can,
however, be imagined. For example, how should the law
treat the more opportunistic conduct of the bartender in a
Wall Street club who carefully listens to the conversation of
two increasingly tipsy investment bankers? No intention to
make a gift is apparent here, nor is there any clear breach of
fiduciary duty, as presumably the club lacks policies
regarding information that its employees learn from
customers. Finally, it is unlikely that the relationship
between the bartender and his customers would rise to the
level that it could be said that the parties had "a history,
pattern or practice of sharing confidences, such that the
recipient of the information knows or reasonably should
know that the person communicating the material nonpublic
information expects that the recipient will maintain its
confidentiality."2 5 If that were the case, then Rule 10b5-2
would prohibit trading on those facts,26 but most tips among
acquaintances will not involve facts satisfying this standard.
In short, the bartender today can listen carefully to his tipsy
customer and trade.

Consider next one last case where the relationship is even
more predatory: assume that a cab driver waits outside the
offices of a well known Manhattan law firm late at night,
hoping to pick up mergers and acquisitions "M&A" lawyers
who then discuss pending transactions on their cell phones
on the drive home. Assume further that the cab driver has
done this repeatedly and profited handsomely. Still, no
fiduciary or other confidential relationship is present here.
Nor, at least on these facts, is the cab driver breaching any

result in career-ending reputational damage to ourselves or (after Obus)
criminal liability. Nonetheless, any passage of such information to a
friend, after Obus, may be viewed by regulators as a "gift" that satisfies
the Dirks standard.

25 See Rule 10b5-2(b)(2), 17 C.F.R. § 240.10b5-2(b)(2) (2013).
26 Id.

No. 2:281 ] 293



instructions given, or expectations held, by his own
employer. At most, there is a weak agency relationship here
between the cab driver and his client that might come under
the outer wings of the Restatement of Agency.2

Comparatively, the behavior in both the foregoing
bartender and taxi-driver hypotheticals is more
opportunistic and predatory than the case of the loose-lipped
associate who is simply overheard in an elevator. Thus, it
may then seem arbitrary to draw a line that holds liable the
defendant in Obus, who arguably made a gift (but for no
personal benefit) but finds no liability in the cases of more
predatory defendants, who have stalked and stolen from
their "victims," as in the last two examples of the bartender
and taxi driver.

B. Non-Deceptive "Theft" of Business Information

Dorozhko extends the law of insider trading significantly,
but it recognizes that some element of deception must still be
present for a defendant to violate Rule 10b-5. Thus, it drew
a questionable line between a person who misappropriates
material information through an affirmative
misrepresentation and one who steals the same information
and trades without disclosure. Specifically, it found that a
computer hacker who misrepresents his identity to gain
access to the information does violate Rule 10b-5, but it also
suggested that a hacker who penetrates computer security
without a misrepresentation and then fails to disclose that
he is trading based on the "possession of nonpublic market
information" does not.2 8 Understandable as this distinction

27 See RESTATEMENT (SECOND) OF AGENCY § 388 cmt. c (1958)
(discussed infra notes 63-65 and accompanying text).

28 See SEC v. Dorozhko, 574 F.3d 42, 51 (2d Cir. 2009) ("It is unclear,
however, that exploiting a weakness in an electronic code to gain
unauthorized access is 'deceptive,' rather than being mere theft.
Accordingly, depending on how the hacker gained access, it seems to us
entirely possible that computer hacking could be, by definition, a
'deceptive device or contrivance' that is prohibited by Section 10(b) and
Rule 10b-5.") (emphasis added). The court then remanded for a
determination on this issue. Id. The above-quoted language suggests that

294 COLUMBIA BUSINESS LAW RE VIEW [Vol. 2013



may have been in light of the existing case law, it is neither
morally self-evident nor compelled by the language of Rule
10b-5, as will be later discussed. Sunday school instructors
will never teach their pupils that the former hacker has done
evil, but the latter hacker who steals without a
misrepresentation has not. Only doctrine-obsessed (but
morally myopic) lawyers can be satisfied with such a line.

To be sure, artful prosecutors can potentially describe
much behavior as deceptive. Defendants can be alleged to
have "stealthily snuck" into an investment banker's office
late at night to read his files, or they can "furtively glance"
over another's shoulder on a train to read a memorandum he
is studying. It may also be deceptive for a private party to
illegally wiretap another's phone or to focus powerful
microphones on such a person to overhear conversations.
But stealing someone's briefcase at gunpoint still seems like
robbery, and not fraud. In short, Dorozhko can be pushed,
but only so far.

C. "Warehousing" and Selective Disclosure

In United States v. O'Hagan,29 the majority of the
Supreme Court postponed for another day whether
"warehousing"-"the practice by which bidders leak advance
information of a tender offer to allies and encourage them to
purchase the target company's stock before the bid is
announced"" 0 -violated the federal securities laws. Today,
such behavior would clearly violate Rule 14e-3 if a takeover
bid is already being structured and is later announced,a" and
it could sometimes violate Regulation FD, which seeks to
restrict selective disclosure. 2  Still, Regulation FD has

a "mere theft" without an affirmative misrepresentation is not "deceptive"
and thus not within the scope of Section 10(b) or Rule 10b-5. This Article
suggests that this analysis is too glib, as much theft is deceptive.

29 United States v. O'Hagan, 521 U.S. 642 (1997).
30 Id. at 672 n.17.
31 See Rule 14e-3, 17 C.F.R. § 240.14e-3 (2013). Technically, the rule

is only applicable if a person has already taken "a substantial step or steps
to commence .. . a tender offer." See id. § 240.14e-3(a).

32 See Regulation FD, 17 C.F.R. §§ 243.100-103 (2013).

295No. 2:28 1] THE FUTURE OF1INSIDER TRADING LA W



numerous exceptions and applies only to reporting
companies. 33 Further, O'Hagan expressly states that one
may use material nonpublic information obtained as the
result of a breach of a fiduciary duty if one first discloses to
the source that one is about to breach one's fiduciary duty by
trading on that information. 34 The Court's rationale is that
an open and disclosed fiduciary breach is not deceptive.

To be sure, there is a distinct possibility in warehousing
cases that the corporate officer who deliberately tips
arbitrageurs is breaching his fiduciary duty to his acquiring
corporation. But this is hardly self-evident when the
intention behind his tipping is to increase the acquirer's
prospects of success. As in Obus, much may depend on
whether the acquiring corporation has policies that forbid
such disclosure, and these policies can be amended to create
exceptions when a bidder wishes to engage in such conduct
(and can avoid the reach of Rule 14e-3).

In summary, gaps and loopholes exist in current law that
permit the misuse of material nonpublic information and
have no strong efficiency justification. The aspirational
"abstain or disclose" rule of Cady, Roberts has not then been
fully implemented. To be sure, the overall significance of
these gaps can be debated (as, realistically, bartenders and
cab drivers do not trade with the same volume or frequency
as hedge funds). Nonetheless, given these gaps, the next
question becomes: Are there legal theories that could
preclude such conduct that are within the potential reach of
existing legal doctrine?

III. POTENTIAL THEORIES

Herein, we will examine potential theories that could
close the foregoing gaps without legislation, but this section

33 See Rule 101(b), 17 C.F.R. § 243.101(b) (2013) (defining "issuer" to
include only reporting companies).

34 O'Hagan, 521 U.S. at 655 ("[I]f the fiduciary discloses to the source
that he plans to trade on the nonpublic information, there is no 'deceptive
device' and thus no § 10(b) violation .... ).

296 COL UMBIA B USINESS LA W RE VIE W [Vol. 2013



does not consider the costs, wisdom, or practicality of such an
effort.

A. Fraud on the Market

One of the curious features of existing insider trading law
is that it has largely ignored the "fraud-on-the-market"
doctrine and the significance of market efficiency. Again,
this seems to be the product of path dependency. Dirks was
decided in 1983,35 five years before the Supreme Court in
1988 accepted the "fraud-on-the-market" doctrine in Basic
Inc. v. Levinson.16  In Dirks, the Court redefined insider
trading liability to rest it on a "property rights" foundation
under which the corporation became the victim, injured by
the insider leaking information belonging to it. Later, in
endorsing misappropriation theory in United States v.
O'Hagan,37 the Court simply extended this same theory to
the source of the material information, at least when the
tippee "feign[ed] fidelity" to that source." In all likelihood,
the Court was motivated to adopt this "property rights"
interpretation because the corporation seemed a clearer
victim than its investors. Particularly when the investors
are not already shareholders in the company at the time they
purchase, the doctrinal problems are substantial: How are
such persons legally injured in the absence of any
demonstrated detrimental reliance on their part or any
obvious duty owed to them, as non-shareholders? In
contrast, when confidential business information is released
without the corporation's authorization, the injury to the
corporation seems more obvious (and, early on, Texas Gulf
Sulphur gave a graphic illustration of this problem)."

35 Dirks v. SEC, 463 U.S. 646 (1983).
36 Basic Inc. v. Levinson, 485 U.S. 224 (1988).
37 O'Hagan, 521 U.S. 642.
38 Id. at 655.
39 See SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968).

Texas Gulf Sulphur ("TGS") discovered extraordinary mineral and
precious metal deposits in Timmins, Ontario. Id. at 843-44. TGS then
suspended drilling in part to buy the surrounding land. Id. But heavy
trading in its securities by its management drove up its stock price,

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COLUMBIA BUSINESS LAW REVIEW

Still, a few years after Dirks, in Basic, the Court did focus
on this issue of individual reliance and decided that there
was an injury to the individual investor when material
information is concealed or omitted.40 Misleading
statements or omissions do defraud investors, it concluded,
"even if the purchasers do not directly rely on the
misstatements,"41 because, in essence, the investor relies
instead on the integrity of the market price. 42 Logically, if
this theory works for purposes of a garden-variety securities
fraud action, then it should work as well in insider trading
cases, which equally rest on Rule 10b-5. Hence, Basic
provides a plausible basis for viewing the trading
counterparty as a victim of insider trading. In both contexts,
the investor who buys an overvalued stock is relying on the
accuracy of the market price. The defendant in both cases
knows the stock is mispriced.

Still, the problem with such a theory is that it may prove
too much. Conceivably, it might overbroadly require
corporations to inform the market on a daily, or even hourly,
basis of all material developments. As Basic itself
recognized, this would go too far. But Basic also solved this
problem by further holding that "[s]ilence, absent a duty to
disclose, is not misleading under Rule 10b-5."43 This rule
protects the corporation that remains silent, but not the
insider who wishes to trade. Once the issue is framed so
that there must be a requisite duty to disclose, the corporate
insider is caught because, as an insider, he or she has a
fiduciary duty to disclose before trading.

Still, the individuals in our foregoing hypotheticals-the
bartender, the cab driver, and the person who overhears

started rumors of a major discovery, and may have alerted the market to
the significance of TGS's ore strike. Id. at 851. If this trading made it
more costly for TGS to acquire the surrounding land, there is an obvious
corporate injury on these facts.

40 Basic, 485 U.S. 224.
41 Id. at 241-42.
42 Id. at 245 (courts may utilize a presumption that persons who trade

"had done so in reliance on the integrity of the price set by the market").
43 Id. at 239 n.17.

298 [Vol. 2013



THE FUTURE OF [NSIDER TRADING LAW

material information in the elevator-are not fiduciaries. To
find their conduct deceptive, some other undisclosed breach
of a duty must be postulated. That is, in the case of a tippee
who is not part of a conspiracy with the tipper in which some
benefit is exchanged, we must find some other duty that has
been breached in order to be able to characterize this tippee's
conduct as deceptive and therefore in violation of Rule 10b-5.
Some may broadly assert that all tippees have a duty to
disclose before trading, but the doctrinal foundation for such
a rule seems weak, because such a tippee and its
counterparty are legal strangers to each other who trade in
anonymous markets. For liability to be imposed on the non-
fiduciary, some duty must be postulated that obligates such
a tippee to disclose or abstain. But, as next discussed,
finding such a separate and distinct duty is not an
insurmountable obstacle.

B. The Duty to Hold Lost or Stolen Information in
Confidence

As just discussed, it can be argued that other
contemporaneous traders do rely on the accuracy of the
market price, and so those trading on the opposite side are
injured when defendants trade knowing that the price is
inaccurate. Indeed, Basic appears to say exactly this, but it
also recognizes that silence should not be actionable unless
some specific duty to disclose is triggered.4 In O'Hagan, the
tippee "feign [ed] fidelity" to his source to gain the
information, and that was held "deceptive."45

As a result, under the logic of these cases, if a tippee has
neither misappropriated the information from the source nor
provided some benefit to the tipper (or received a gift from
the tipper), then Rule 10b-5 seemingly permits the non-
fiduciary tippee to trade. After all, this was exactly the
status of Ray Dirks, who neither paid his tipper anything nor
"feigned fidelity" to the source of the information. Still, if the

44 See supra note 43 and accompanying text.
45 United States v. O'Hagan, 521 U.S. 642, 655 (1997).

No. 2:281] 299



tippee both trades and breaches some distinct duty in so
doing, nothing in Dirks insulates him from liability.

That brings us to the harder part: What is the duty that
the tippee might breach when the tippee is not a fiduciary (or
the tippee of a fiduciary) but has come into possession of
material nonpublic information? Here, the suggested answer
is best stated in two parts: First, when the information is
stolen (but taken without deception), the law could be viewed
as imposing a constructive trust on such stolen property that
holds the thief accountable for his ill-gotten profits.
Second, even when the information is leaked inadvertently
(as in the overheard conversation in the elevator), the law
could treat the recipient of the information as a "finder" who
has come into possession of lost property (and therefore has

46 As a technical matter, the appropriate remedy may be an equitable
accounting, rather than a constructive trust. See Newby v. Enron Corp.,
188 F. Supp. 2d 684, 706 (S.D. Tex. 2002) (distinguishing remedies); 1
GEORGE E. PALMER, THE LAW OF RESTITUTION § 2.11 (1978) (arguing that a
fiduciary is accountable for profits without regard to injury to principal);
RESTATEMENT (SECOND) OF AGENCY § 388 cmt. c (1958). Nonetheless, courts
often prefer to use the phrase "constructive trust." See, e.g., United States
v. Reed, 601 F. Supp. 685, 700 (S.D.N.Y.), rev'd on other grounds, 773 F.2d
477 (2d Cir. 1985); Diamond v. Oreamuno, 248 N.E.2d 910, 914 (N.Y.
1969).

Semantics aside, the law has long recognized that a thief or a knowing
receiver of stolen goods is subject to an equitable accounting or
constructive trust. See Lightfoot v. Davis, 91 N.E. 582 (N.Y. 1910); Fur &
Wool Trading Co. v. Fox, 156 N.E. 670 (N.Y. 1927); see also Comment, A
Thief as a Constructive Trustee, 37 YALE L.J. 654 (1928). Also, the
common law has traditionally favored the original owner of stolen property
even over a "good faith" purchaser from the thief. For a modern such case,
see O'Keeffe v. Snyder, 416 A.2d 862 (N.J. 1980). In this case, the artist
Georgia O'Keeffe was held entitled to recover, from a good faith purchaser
from the intermediate possessor, a painting by her that she either lost or
had stolen. Id. The court noted that if the painting had been stolen,
plaintiff O'Keeffe would have been entitled to recover if she sued within
the statute of limitations. Id. at 867. For an overview of these rules on
good faith purchasers of stolen property, see Saul Levmore, Variety and
Uniformity in the Treatment of the Good-Faith Purchaser, 16 J. LEGAL
STuD. 43 (1987). This Article, however, does not address the "good faith
purchaser" but only the tippee who is aware of an unauthorized release.

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THE FUTURE OF INSIDER TRADING LAW

an obligation to act as a bailee to protect this property by not
tipping or trading on it).4 7

This latter claim about lost property requires an
explanation of complex common law principles that have
frankly never been applied to the context of insider trading.
At common law (and by statute in many jurisdictions), one
who finds lost property (say, a diamond ring left by mistake
in a washroom) is typically under a duty to restore it to the
true owner.48 Although this body of law on "finders" and lost
property is hypertechnical," the finder is essentially in the

47 For recent summaries of the law applicable to finders, see 1 AM.
JUR. 2D, Abandoned, Lost, and Unclaimed Property § 27 (2013) ("The
finder of lost property holds it as a bailee for the true owner; as to all
others, the finder's rights are tantamount to ownership. . . ."). Cf. Hurley
v. City of Niagara Falls, 289 N.Y.S.2d 889 (App. Div. 1968), aff'd, 254
N.E.2d 917 (N.Y. 1969). Thus, the thrust of this analogy is to treat the
recipient of inadvertent releases of material nonpublic information as
bailee.

48 See, e.g., N.Y. PERs. PROP. LAW §§ 252-54 (McKinney 2013)
(requiring a finder to deliver any item of personal property with a value
over twenty dollars to the police within ten days, and awarding such
property to the finder after the expiration of a period ranging from three
months to three years, depending on its value).

49 The law on finders in the United States has been described as "a
state-by-state hodgepodge of common law, modern statutes, and
haphazard local regulations." See Mark D. West, Losers: Recovering Lost
Property in Japan and the United States, 37 LAW & Soc'Y REV. 369, 396-97
(2003). More than one-third of the states have enacted legislation
requiring a finder to deliver lost property to public authorities for a
prescribed period before the finder can claim ownership. Id. at 397.
However, these statutes have generally been narrowly construed. See,
e.g., Saritejdiam, Inc. v. Excess Ins. Co. Ltd., 971 F.2d 910 (2d Cir. 1992).

Little of this complexity and confusion in the law of lost property is
relevant to this Article. Typically, the litigated dispute is between the
owner of the location on which the lost property was found and the finder.
Their relative rights to the property may turn on whether the property
was "lost" or only "mislaid"-a distinction most commentators find
hopelessly indeterminate. See R.H. Helmholz, Equitable Division and the
Law of Finders, 52 FORDHAM L. REV. 313, 315, 317-21 (1983); Leanna
Izuel, Comment, Property Owners' Constructive Possession of Treasure
Trove: Rethinking the Finders Keepers Rule, 38 UCLA L. REV. 1659 (1991);
David Riesman, Jr., Possession and the Law of Finders, 52 HARV. L. REV.

No. 2:281]) 301



position of a bailee of the lost property, accountable to the
true owner.

The premise here is that a person who overhears material
nonpublic information (such as in a public elevator) is
functionally equivalent to a "finder" who discovers lost
property, at least when the informational recipient knows
that the release of the information has not been authorized.
Once that condition is satisfied, it follows that the
tippee/finder's duty is to hold the information as a bailee and
not profit from its conversion.

Viewed intuitively, this asserted duty is probably easiest
to accept when the information has been obtained
deliberately by someone who is "stalking" the source of the
information (as in our earlier cases involving the bartender
and the cab driver). Here, equitable considerations dictate
that the law should impose a constructive trust on the
"stolen" property to prevent these more predatory actors
from realizing an ill-gotten gain. In any event, the relevant
point here is that once a duty to hold lost property for the
true owner is recognized, then that duty would functionally
play the same role as a fiduciary duty in the Dirks case:
trading on this information in violation of this duty to return
or restore can be viewed as just as "deceptive" as trading in
violation of a fiduciary duty in Dirks.

To illustrate this, let us return to the case of the person
who escapes liability under Dorozhko because he is simply a
thief who has stolen property (for example, a briefcase
containing material nonpublic information). If this thief
were to sell this briefcase and its contents, the common law
would likely subject his ill-gotten gains to a constructive or

1105, 1121 (1939). None of this complexity need concern us over the range
of cases here considered.

50 The principle that the original owner has superior title to the finder
(who, in turn, has superior title to all others) dates back nearly three
hundred years to Armory v. Delamirie, (1722) 93 Eng. Rep. 664 (K.B.). In
that case, a chimney sweep found a jewel, amidst the ashes, while cleaning
a chimney. Id. The decision held that he was entitled to keep the jewel
against all others, except "the rightful owner." Id.

COL UMBIA B USINESS LA W RE VIE W302 [Vol. 2013



THE FUTURE OF INSIDER TRADING LAW

implied trust." Even the good faith purchaser of the
property would often have to restore it to the true owner. By
analogy, such a trust might also be imposed on the proceeds
from the misuse of stolen information.

To be sure, this analogy extends legal principles
applicable to tangible personal property to intellectual
property, and that is a doctrinal leap. Still, the Supreme
Court has not hesitated to say that a corporation is entitled
to "exclusive possession" of its confidential business
information." The net effect of this doctrinal extension is
that a tippee who has not participated in any breach of
fiduciary duty, but who has either "stolen" information or
simply knowingly received "lost" information, may not trade
on it (at least without disclosure to the source). Any
undisclosed breach would be deceptive and thus within the
scope of Rule 10b-5.

Concededly, few courts, if any, would be willing to go this
far on their own. But they might be induced to accept and
enforce SEC rules articulating such a duty. Such a rule
would specify the duty of a tippee who becomes aware of
material nonpublic information that such tippee knows was
not intended to be (and has not otherwise been) publicly
released. A line would necessarily need to be drawn in such
a rule between information that was truly "lost" and
information that was "abandoned" through reckless
mishandling. In my view, the earlier bartender and cab

51 The law of equity makes some technical distinction between the
"conscious wrongdoer" and the "innocent wrongdoer," and the person who
trades on information that was not stolen, but whose release was not
authorized, may fall into the latter category and be subject therefore to a
"resulting trust," not a "constructive trust." See Henry Monaghan,
Constructive Trust and Equitable Lien: Status of the Conscious and the
Innocent Wrongdoer in Equity, 38 U. DET. L.J. 10 (1960).

52 See Carpenter v. United States, 484 U.S. 19, 26 (1987) (quoting 3
WILLIAM MEADE FLETCHER ET AL., FLETCHER CYCLOPEDIA OF THE LAW OF
PRIVATE CORPORATIONS § 857.10 (rev. ed. 1986) ("Confidential information
acquired or compiled by a corporation in the course and conduct of its
business is a species of property to which the corporation has the exclusive
right and benefit, and which a court of equity will protect through the
injunctive process or other appropriate remedy").

No. 2:281]1 303



driver hypotheticals would fall on the unlawful side of this
line, and such recipients should be barred from trading on
such information.

More difficult, to be sure, is the case of merely "lost"
information, such as the information overheard in the
elevator where the recipient is not stalking the victim. But
at common law, even in this case, the superior property right
in "lost" property still remains with the owner (i.e., the
corporate issuer), unless it "abandoned" the property.

How could such a legal rule be feasibly implemented?
Imagine an SEC Rule (let us call it proposed Rule 10b5-3),
which might be captioned "Duty Not to Trade on Inadvertent
or Unauthorized Releases of Material Information." It might
read:

Proposed Rule 10b5-3
(a) Whenever a person receives or obtains material
nonpublic information from a source that owns or has
the right to control the release of such information
and such recipient either (i) knows that the release of
such information has not been lawfully authorized by
the party entitled to possession or control over such
information, or (ii) is aware of a reasonable
possibility that such release was not lawfully
authorized, such person may not (1) purchase or sell
any security, or any security-based swap agreement,
whose value is likely to be affected by such
information, or (2) communicate such information to
other persons under circumstances which make it
reasonably foreseeable that they will trade on such
information, until in each case such information has
been publicly released.
(b) As used in this rule, the phrase "lawfully
authorized," when used with respect to the release of
information, shall not include, without limitation,
information that is released (i) inadvertently or by
mistake; (ii) as the result of a trick, subterfuge, false
representation, or other misappropriation; (iii) as a
gift, favor or other benefit, either from or to the
information recipient; or (iv) for a specific, limited
purpose to a customer, supplier, lender, business

304 COL UMBIA B USINESS LA W RE VIE W [Vol. 2013



associate, or agent of any thereof, but was not
intended to be generally released.

The foregoing rule is drafted so that it would apply to
material information that has been released either as the
result of a misappropriation or a mistake; the information
could concern either the actual corporate issuer having
possession of the information, or a third party (such as the
target company that the corporate issuer intended to acquire
at a premium). The proposed rule would thus bar the
"finder" of such information from either trading or tipping
others, but only until the information was publicly released.
Still, the rule would not bar the recipient from
communicating the information to regulators or the press (as
in Dirks). Also, it would not apply to the person who
discovers information through his own research or efforts
(where there was neither a misappropriation nor a mistaken
release).53 Finally, the proposed rule should not apply to the
person who simply hears a rumor (because such person does
not "know," or have reason to believe, that the information's
release has not been "lawfully authorized"). Negligence is
insufficient for liability; rather, some awareness is required
to establish scienter.

The feasibility of this proposed rule must be considered in
light of recent technological innovations, most notably the
advent of social media. Would this rule mean that
information released in a "tweet" or on Facebook would bar
those receiving it from trading? The answer is no, because
the term "publicly released" would be broadly interpreted to
include the release of information on social media and widely
followed websites. Any contrary rule would sweep
overbroadly.

53 Hence, if I wish to observe the size of the crowds at various outlets
of a chain or department store to estimate its holiday sales, I may trade on
this information. The proposed rule would also not apply if the
information is not acquired from a source that has possession or control
rights over it. Thus, if I observe a major airline plane crash, even though
this information is both material and still nonpublic, I could trade on such
information, without violating this proposed rule.

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Would such a rule be upheld by the courts? Would it
sweep too broadly, creating undesirable uncertainty and
criminalizing mere negligence? Would its costs outweigh its
benefits? These questions will be deferred temporarily.

C. Codifying Dorozhko

Although the Second Circuit said in Dorozhko that
deception is sufficient without a breach of fiduciary duty, the
SEC has not yet spoken on this issue, and the Dorozhko
decision defined deception narrowly to require a false
representation.54 In principle, if the SEC were to endorse
Dorozhko, or some variant of it, the SEC's position should
merit Chevron deference.s5 Moreover, given its expertise, the
SEC would be the appropriate body to attempt to define
what "deception" might mean in this special context of
trading markets. Thus, consider the following proposed rule
that the SEC could adopt (let us call this proposed Rule
10b5-4):

Proposed Rule 10b5-4
For the purposes of Section 10(b) of the Securities
Exchange Act of 1934 Section 17(a) of the Securities
Act of 1933, and the antifraud rules thereunder, the
terms 'deceptive,' 'deceit,' and 'artifice to defraud'
shall be deemed, without limitation, to include the
following conduct when done in connection with the
purchase or sale of a security or a security-based
swap agreement:
(1) misrepresenting one's identity or purpose in
obtaining, or attempting to obtain, access to
information that the actor is aware is likely to be
material and nonpublic;
(2) taking, emailing, reproducing, photocopying, or
otherwise misappropriating business records or other

54 See SEC v. Dorozhko, 574 F.3d 42, 51 (2d Cir. 2009); supra note 28
and accompanying text.

55 See Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467
U.S. 837 (1984) (holding that an agency's interpretation of a statute it
administers is entitled to deference when not inconsistent with clear
congressional intent).

306 COL UMBIA B USINESS LA W RE VIE W [Vol. 2013



confidential information, or disseminating such
records or information to persons not authorized to
receive such information, through either an
affirmative misrepresentation or by means of a
covert act or subterfuge, when one knows, or is
recklessly indifferent to the prospect, that such
records or information are likely to contain material,
nonpublic information that the lawful owner of the
information has not authorized for contemporaneous
public release;
[(3) failing to disclose one's identity, employment,
status, conflict of interest, or other relevant
information when one knows that such disclosure
would likely cause another person not to reveal, or to
cease to reveal, information that is material and
nonpublic.]

This language deliberately expands Dorozhko to the
limits of its logic, but it does not reach simple negligence. It
would cover theft through deception (but not armed robbery),
to the extent that the actor knows (or is recklessly aware)
that he or she is likely misappropriating material nonpublic
information. In its view, the individual who opens another's
briefcase or desk drawer to discover confidential information
has engaged in a "covert act or subterfuge" that is sufficient
to satisfy Rule 10b-5's deception requirement. The third and
final bracketed clause reaches the furthest (and may be more
exposed) in requiring the disclosure of one's identity or
conflict when one is hearing an extended conversation, but it
would not cover overhearing the ten-second remark in an
elevator. It is included mainly for discussion purposes.

In all cases, this proposed rule would be violated only if
the defendant trades or causes others to do so on an
approximately contemporaneous basis;" no violation results
from simply misappropriating information unless there is a

56 The standards with respect to the "in connection with" requirement
are set forth in SEC v. Zandford, which held a broker to have violated
Rule 10b-5 when the broker stole funds from his client's discretionary
trading account. SEC v. Zandford, 535 U.S. 813, 820-21 (2002). Although
the issue in that case was the "in connection with" requirement, the Court
had no difficulty in finding theft to violate Rule 10b-5. Id. at 820.

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trade "in connection with such" misappropriation. In
overview, this route is probably the simplest, most direct
path to the end of reaching cases that do not involve a breach
of fiduciary duty, but it depends on Dorozhko remaining good
law.

In response to this proposal, some may question whether
the SEC can effectively rewrite Dorozhko and eliminate its
seeming requirement of a false representation. One answer,
of course, is that this is exactly what the SEC did in adopting
Rule 10b5-2, which overrode the Second Circuit's earlier en
banc holding in United States v. Chestman7 that husbands
and wives were not fiduciaries to each other. 8 Today, Rule
10b5-2 expressly provides that they owe each other a duty of
trust or confidence.59 Chevron deference enabled the SEC to
make new law in defining the scope of fiduciary
relationships, and it even more clearly entitles the SEC to
define the meaning of "deception" and "deceptive."60

Equally important, the Dorozhko court appears to
construe the term deception overly narrowly. Looking to the
definitions of "deception" and "deceive" in Webster's
International Dictionary's 1934 edition (the year of passage
for the Securities Exchange Act), the panel emphasized that
Webster's defined "deceive" to mean "to cause to believe the
false, or to disbelieve the true."61 But, as the panel noted but

57 United States v. Chestman, 947 F.2d 551 (2d Cir. 1991).
58 Id. at 568-71.
59 See Rule 10b5-2(b)(3), 17 C.F.R. § 240.10b5-2(b)(3) (2013).
60 Because "deceptive device" is expressly used in Section 10(b) of the

Securities Exchange Act, it seems even more within the logical scope of the
SEC's Chevron authority than does the issue of which relatives constitute
fiduciaries (the issue addressed by Rule 10b5-2). Nor does state law tend
to vary on this question of what is "deceptive." Finally, Dorozhko does not
expressly hold that conduct not involving a false representation is always
insufficient to satisfy the "deceptive device" standard, but only suggests
that such a line is likely on its facts. See SEC v. Dorozhko, 574 F.3d 42 (2d
Cir. 2009).

61 Dorozhko, 574 F.3d at 50 (quoting WEBSTER'S INTERNATIONAL
DIcTIoNARY 679 (2d ed. 1934)). The Supreme Court has also looked to the
1934 edition of Webster's to understand the meaning of words in the 1934
Act. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 199 n.20 (1976).

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did not discuss, this same edition of Webster's also defined
the term to mean "to impose upon; to deal treacherously
with; cheat."62 Reading another's mail, opening their desk
drawers, or hacking their computer (by any means) is
cheating and amounts to "treacherous" behavior. Or, at
least, the SEC could safely so rule.

D. The Restatement of Agency

Section 388 of the Restatement (Second) of Agency has
long stated a broad theory of an agent's duty to protect and
keep confidential information that it learns from its
principal. Specifically, comment c to that section states:

c. Use of confidential information. An agent who
acquires confidential information in the course of his
employment or in violation of his duties has a
duty ... to account for any profits made by the use of
such information, although this does not harm the
principal.6"

The commentary to this section specifically applies this rule
to the context of insider trading, and the New York Court of
Appeals relied on this language in Diamond v. Oreamuno
over forty years ago.64

62 Dorozhko, 574 F.3d at 50.
63 See RESTATEMENT (SECOND) OF AGENCY § 388 cmt. c (1958) (citation

omitted). Section 395 then forbids the agent to tip others. See id. § 395;
see also RESTATEMENT (THIRD) OF AGENCY § 8.05 cmt. c (2006) (using same
language).

64 Diamond v. Oreamuno, 248 N.E.2d 910 (N.Y. 1969). The Court
added that profits made by the agent in stock transactions based on such
inside information "are held in constructive trust for the principal." Id. at
914; see also United States v. Reed, 601 F. Supp. 685, 700 (S.D.N.Y.)
(imposing constructive trust on stock-trading profits based on inside
information), rev'd on other grounds, 773 F.2d 477 (2d Cir. 1985). Not all
courts have followed Diamond. See Freeman v. Decio, 584 F.2d 186, 192
(7th Cir. 1978). But those that have not have chiefly relied on the fact that
federal insider trading law already supplies an adequate remedy. That is
not an answer when federal law stops short. Finally, this Article does not
propose that state courts take any step, but only that, in determining the
scope of the federal remedy, courts should consider the classic law of
agency.

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COLUMBIA BUSINESS LAW REVIEW

Under Section 388, no fiduciary breach or act of deception
is necessary. It is sufficient that the agent acquire the
"confidential information in the course of his ... duties."65

Thus, in terms of our earlier hypotheticals, if a cab driver is
considered an agent to his passenger, then under Section
388, he may not profit, as agent, from confidential
information received from the passenger, as his principal.

Of course, in any realistic case, issues could arise both as
to whether the cab driver was an agent (as opposed to an
independent contractor)6 or whether he knew the
information was confidential. Still, Section 388 reaches well
beyond the narrower definition of fiduciary and covers all
agents. Thus, in cases involving "stalking" of the victim (as
in our earlier taxi driver hypothetical), prosecutors have at
their disposal both a potential "deception" theory under
Dorozhko and an agency theory under Section 388.

E. Willful Violations of Regulation FD

Regulation FD prohibits "reporting companies" from
making selective disclosures, subject to certain exceptions. 6 7

Thus, by itself, it would probably preclude the practice of
warehousing if the tipper was a senior executive of a
reporting company.

But the penalties for such a violation are likely to be far
more modest than those for insider trading, and Regulation
FD expressly provides that a failure to comply with it does

65 RESTATEMENT (SECOND) OF AGENCY § 388 cmt. c.

66 The definition of agent is set forth in Section 1 of the Restatement
(Second) of Agency, and covers any relationship that "results from the
manifestation of consent by one person to another that the other shall act
on his behalf and subject to his control, and consent by the other so to act."
This broad language might reach the cab driver, but probably not the
bartender in our earlier hypotheticals. To the extent that the passenger
can instruct the cab driver what route to take, the cab driver is arguably
"subject to his control" and thus resembles an agent. The bartender (like
the soda jerk) is simply selling a product (alcoholic beverages), although
when James Bond asks for his Beefeater martini to be shaken and not
stirred (and the bartender agrees), this may take the bartender a small
step closer to being an agent.

67 See Regulation FD, 17 C.F.R. §§ 243.100-.103 (2013).

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THE FUTURE OF INSIDER TRADING LAW

not violate Rule 10b-5." Still, one potential theory has not
yet been pursued: a "willful" violation of any SEC rule is a
criminal offense under both the Securities Act of 1933 and
the Securities Exchange Act of 1934.69 Thus, a corporate
officer of a reporting company who willfully tips arbitrageurs
about an impending transaction in violation of Regulation
FD is seemingly subject to criminal prosecution. Although
the JOBS Act exempts many issuers from becoming
reporting companies,7 0 this is a theory of liability that could
already apply to most listed companies, but it has not yet
been utilized by prosecutors.

IV. AN EVALUATION

To this point, it has been argued that some common law
doctrines have sufficient plasticity that they can be
manipulated to reach desired results: specifically, they could
enable the SEC to describe many forms of misbehavior as
"deceptive," even though they involve neither a false
representation nor a fiduciary breach. But, the issue
remains: How desirable is it to push the law to the outer
boundaries of "deception"? The following considerations bear
on this question:

A. Overcriminalization

Do we really want to reach the person who is provided a
valuable tip unintentionally? Opinions will vary. Some will
argue that the temptation to trade on such information will
often be irresistible and that the persons who violate the
proposed rule will not have knowledge of the applicable law,

68 See Rule 102, 17 C.F.R. § 243.102 (2013). This also likely means
that there is no private cause of action for a violation of Regulation FD.

69 See Securities Act of 1933 § 24, 15 U.S.C.A. § 77x (West 2013),
Securities Exchange Act of 1934 § 32, 15 U.S.C.A § 78ff (West 2013). For a
recent analysis of the requirement of "willfulness" under these provisions,
see United States v. Whitman, No. 12 Cr.125 (JSR), 2012 U.S. Dist. LEXIS
163138 (S.D.N.Y. Nov. 14, 2012).

70 Jumpstart Our Business Startups (JOBS) Act, Pub. L. No. 112-106,
126 Stat. 306 (2012) (to be codified in scattered provisions of 15 U.S.C.).

No. 2:28 1]1 311



thus trapping unwary (even if somewhat culpable) ordinary
laymen. But the primary rule here proposed (Rule 10b5-4)
does not make equivocal conduct actionable. Under it, the
tippee must stalk the victim, using either a covert means or
subterfuge to obtain the information or misrepresenting the
tippee's identity or purpose. This is not morally neutral
conduct, and those who engage in it are entitled to little
empathy.

In contrast, proposed Rule 10b5-3, which applies to those
who come into possession of "lost" information, does sweep
more broadly and can be asserted to potentially criminalize
fairly equivocal conduct. Even this rule, however, would be
limited by a broad interpretation of the concept of "public
release," so that information on social media or widely
followed websites would be considered to be in the public
domain and freely usable.

B. The Impact on Market Efficiency

Arguably, Dirks may be at least partially explained by the
Court's fear that the SEC's proposed theory of liability would
chill securities analysts and thereby prevent the detection of
some frauds. Certainly, it is implausible that Ray Dirks
would have traveled from the East Coast to Los Angeles to
investigate Equity Funding firsthand if he had not seen the
prospect of profit (for himself and his clients).

Indeed, the Dirks case dramatically underscores the
social value in the early detection of fraud. Not only was the
overvaluation in the market price of Equity Funding
corrected (which admittedly helps some investors (i.e.,
purchasers) and hurts other (i.e., sellers)), but non-
shareholders also benefitted: the prospective purchasers of
Equity Funding's insurance were protected from investing
their retirement savings in a worthless product. If analysts
are chilled, the social injury might be considerable and
extend beyond investors to a variety of third parties.

Thus, most securities law scholars and practitioners have
resisted a parity-of-information approach to defining the
scope of the insider trading prohibition because it would dull
market efficiency by chilling the incentive to search for new

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information.n Proposed Rule 10b5-3 does not go anywhere
near adopting a parity-of-information approach. Research
could still fuel trading, even when it developed material new
information. But the tippee who learns new material
nonpublic information that is owned or controlled by another
would no longer be protected, even though he owes no duty
to that source." Under proposed Rule 10b5-3, he would be

71 An exception to this generalization is Edward Greene's and Olivia
Schmid's provocative article in this Symposium. Edward Greene & Olivia
Schmid, Duty-Free Insider Trading?, 2013 COLuM. Bus. L. REv. 369 (2013).
Effectively, they would overrule Dirks by legislation, and they find my
rule-based approach insufficient. Yet, although they argue for parity of
information, they never address the impact that their approach would
have on the incentive to search for new information. Would Ray Dirks
have still boarded his plane, flown to Los Angeles, and uncovered the
Equity Funding fraud if he would have been barred from passing this
information to his clients? If he had not uncovered the fraud at Equity
Funding, how many more innocent victims would have invested their
retirement savings in worthless life insurance? Possibly, there are
answers to my claim that we need to be cautious about barring analysts
from searching for new information through broad prophylactic rules
(particularly those that carry potential criminal penalties), but they and
other proponents of parity of information need to face the ex ante impact
of their proposed legislation.

Several other questions surrounding their proposal also need to be
faced in more detail. Although Greene and Schmid believe their bright-
line standard would be clear cut and would allow analysts to discover
"publicly available" information (as British law now provides), the term
"publicly available" is not self-defining and in the U.S. context might prove
as prolific a source of litigation as the current breach of duty standard.
Next, they also should address the impact of Regulation FD, which bars
the issuer from tipping the analyst. In my view, Regulation FD is a
sensible example of the use of less drastic means in a sensitive area.

Finally, those endorsing the British approach must also recognize that
securities litigation is rare in the United Kingdom, but ubiquitous in the
United States. Thus, a rule mandating parity of information might
unleash a flood of class action litigation of dubious merit. Precisely for
this reason, I doubt that we will see legislation enacted in the United
States in the foreseeable future adopting the Greene and Schmid
approach.

72 SEC v. Obus, 693 F.3d 276, 289 (2d Cir. 2012), may have already
gone substantially this far by seemingly eliminating the need to show that
the tippee paid an economic benefit to the tipper, but it still remains

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made a "finder" who could not trade on such information. As
a result, proposed Rule 10b5-3 would largely swallow up
most of the terrain now covered by Regulation FD, but it
would extend even further. Some uncertainty would likely
surround the loose edges of this rule, including in cases
where analysts have arguably pieced together a "mosaic" of
information from multiple sources. To say the least, such a
rule would be resisted by analysts and others within the
financial services industry.

Still, these concerns about uncertainty and the soft edges
of the rule apply much more to proposed Rule 10b5-3 than to
proposed Rule 10b5-4. The latter rule requires some "covert
act" of deception or an affirmative misrepresentation. It
aims at prohibiting stealth, theft, and misappropriation, not
simply mistaken or unauthorized release. Valuable as
analysts may be, they are not entitled to steal information.
Dorozhko's unwillingness to cover "mere theft" of information
seems anomalous and unjustified (at least on public policy
grounds), and proposed Rule 10b5-4 responds to its shortfall.
But Rule 10b5-4 (unlike Rule 10b5-3) does not restrict the
analyst who simply stumbles across new information. Thus,
it leaves largely in place the protective shield that Dirks
erected around analysts. In contrast, Rule 10b5-3 would
largely remove that shield. Thus, the case for proposed Rule
10b5-4 is again much simpler than that for proposed Rule
10b5-3.

C. Federalism

Although several decisions have found that the duty to
disclose should be determined by federal (and not state) law,
federalizing a duty not to trade on 'lost" information pushes
the SEC's power to make new law to its limit. No term
actually in the 1934 Act would be construed by proposed
Rule 10b5-3, and thus the claim that the SEC is entitled to
Chevron deference is weakened. Moreover, the actual law on
"finders" and lost property varies widely among the states

unclear what the court actually meant in that case. See supra note 10 and
accompanying text.

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THE FUTURE OF INSIDER TRADING LAW

and was never truly applied to information (as opposed to
personal property). Finally, although the theory outlined in
proposed Rule 10b5-3 applies only when the person trading
on the lost information trades in an efficient market (and
thus deprives other investors of their right to rely on the
accuracy of the market price), it is far from clear that courts
would regard such behavior as adequately "deceptive" to fall
within Rule 10b-5's prohibition.

For all these reasons, the far simpler approach would be
for the SEC to define "deceptive" to include stealing
information or acquiring it by trick or ruse (as proposed Rule
10b5-4 would do). Such a rule has a better chance of
receiving Chevron deference, and its premise, that theft of
information is generally deceptive, eliminates the strange
distinction that Dorozhko has seemingly erected between
fraud and theft. Historically, the draftsmen of the Securities
Exchange Act of 1934 explained the intent of Section 10(b) to
Congress, saying that it was meant to be a "catch-all"
provision that essentially declared: "Thou shalt not devise
any other cunning devices." 73

More recently, the Court has said in a case also involving
simple theft that Section 10(b) "should be 'construed not
technically and restrictively, but flexibly to achieve its
remedial purposes."'74 Stealing information by any trick,
ruse, invasion of privacy, or simple theft-however novel the
means-is at bottom just another "cunning device," which
should be within the scope of Rule 10b-5, at least if the SEC
would so indicate.

73 This is the famous statement of Thomas G. Corcoran on behalf of
the draftsmen to the House Committee on Interstate and Foreign
Commerce. Mr. Corcoran (also known as "Tommy the Cork") was one of
the principal draftsmen of the Securities Exchange Act and a prot6g6 of
Justice Felix Frankfurter (who also influenced the legislation). See Stock
Exchange Regulation: Hearing on H.R. 7852 and H.R. 8720 Before the H.
Comm. on Interstate and Foreign Commerce, 73d Cong. 115 (1934).

74 SEC v. Zandford, 535 U.S. 813, 819 (2002). The Court also
emphasized that "any distinction between omissions and
misrepresentations is illusory in the context" of a theft by a broker owing a
fiduciary duty. Id. at 823. This rejection of technical distinction may
continue in other cases involving similarly egregious misbehavior.

No. 2:281]1 315



This suggested intermediate position would leave
unchanged the status of the tippee who simply overhears
information innocently,75 but that "gap" does not-today at
least-threaten the integrity of the market. This does not
mean that the SEC could not at some future point also seek
to restrict the use of lost information. But change best comes
incrementally. The first step should be to generalize the
outcome in Dorozhko, but without its strange requirement of
a false representation.

Is it realistic to think the SEC might take such a step?
That is harder to predict. The SEC is undoubtedly
overworked and underfunded, and has much on its plate.
Moreover, the agency appears anxious that rules proposed by
it might be rejected by the D.C. Circuit on cost/benefit or
related grounds." But rules relating to insider trading are
less likely to be challenged by industry groups, and the
Commission is in a safer position when it promulgates anti-
fraud rules against insider trading than when it seeks to
regulate corporate governance. Although the SEC moves
slowly, it should move ultimately in the general direction
here outlined.

V. CONCLUSION

Above all, this Article has argued that the process of
defining insider trading has not been completed. Gaps
remain, and new ones will likely arise again in the future.
The SEC can fill these gaps, and doctrinal means are

75 It can be argued that such tippees are already exposed to liability
under the Second Circuit's standard for tippee liability in SEC v. Obus,
693 F.3d at 298. See also supra notes 8-11 and accompanying text. To the
extent that Obus is read literally, a case may exist for a safe harbor rule
protecting analysts and others where no benefit or payment is exchanged
by them for information. In essence, this would only restore the Dirks
standard from erosion.

76 In Business Roundtable v. SEC, 647 F.3d 1144, 1156 (D.C. Cir.
2011), the D.C. Circuit Court of Appeals invalidated the SEC's newly
adopted Rule 14a-11 for failure to adequately consider the potential costs
and benefits of the rule.

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available by which the SEC could extend the reach of Rule
10b-5.

Closer questions surround the various tools that the SEC
could use. For the short run, the simplest course would be
for the SEC to define by rule that deception by trick, ruse, or
subterfuge violates Section 10(b) and Rule 10b-5, even if no
affirmative misrepresentation is made. This is justifiable
both in terms of Section 10(b)'s original purpose of serving as
the flexible catch-all remedy to bar all other "cunning
devices,"77 and Webster's 1934 definition of "deceive" to
include "cheating" and dealing "treacherously" with
another. 78 For the longer run, the ability of the non-
fiduciary to trade on material nonpublic information that has
been inadvertently released or selectively distributed raises
more difficult problems, but ones that also merit closer
scrutiny and constraint.

This process may never end. Predictably, new "cunning
devices" will surface from time to time, as fraud evolves and
mutates. Voluminous as the writing has been about insider
trading, this point has been largely missed: Rule 10b-5 was
intended to evolve to keep pace with the ingenuity of
fraudsters. It still can-if the SEC will only exercise its
authority.

77 See supra note 73 and accompanying text.
78 See supra notes 61-62 and accompanying text.

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