Indiana Law Review


Indiana Lair Reviei^
Volume 21 1988 Number 3

An Essay: Six Competing Currents of Rule lOb-5
Jurisprudence

David M. Phillips*

Carpenter v. United States,^ the recent decision in which the Supreme

Court failed to accept or reject the application of the '^misappropriation

theory"^ in rule lOb-5^ cases, reportedly surprised many observers. "*

Winans, a reporter for the Wall Street Journal and one of the authors

of its "Heard on the Street" column, tipped several confidants, including

two Kidder Peabody brokers, as to the contents of future columns.

Winans, Carpenter (Winans' lover), the brokers and a customer of the

brokers were able to earn short-swing profits from the movement of

*Professor, Northeastern University School of Law. This article is based on a paper

delivered at the Seventh National Conference on Business Ethics, conducted at Bentley College

on October 15-16, 1987. I would especially like to thank Virginia L. Symmes, class of 1988

at Northeastern University School of Law, for her research assistance and Barbara Aldave,

Tamar Frankel, John Leubsdorf, and Roberta Romano for helpful comments on an earlier
draft of the paper, «

408 S. Ct. 316 (1987).

^See generally Aldave, Misappropriation: A General Theory of Liability for Trading
on Non-Public Information, 13 Hofstra L. Rev. 101 (1984).

^Rule lOb-5, 17 C.F.R. § 240.10b-5 (1987), was promulgated by the Securities and

Exchange Commission (the "SEC") under § l(Xb) of the Securities Exchange Act of 1934,
15 U.S.C. § 78j(b) (1982). The rule states:

It shall be unlawful for any person, directly or indirectly, by the use of any means

or instrumentality of interstate commerce, or of the mails, or of any facility of

any national securities exchange,

(a) to employ any device, scheme, or artifice to defraud,

(b) to make any untrue statement of a material fact or to omit to state a
material fact necessary in order to make the statements made, in the light of the

circumstances under which they were made, not misleading, or

(c) to engage in any act, practice, or course of business which operates or

would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

'See, e.g., N.Y. Times, Nov. 17, 1987, at DIO, col. 1; Wall St. J., Nov. 17, 1987,

at 1, col. 6.

625



626 INDIANA LAW REVIEW [Vol. 21:625

securities' prices following the appearance of the columns. The govern-

ment brought a criminal action against Winans and several of these

tippees, alleging both mail and telephone fraud and rule lOb-5 violations.

Supreme Court decisions applying rule lOb-5 to insider trading re-

quire, as necessary conditions for both civil and criminal liability, not

only the purchase or sale of securities on the basis of information

unknown to the marketplace, but the violation of a duty in so trading.^
In the case of the traditional insider—the corporate officer, director or
controlling party—the duty breached is to the corporation or its share-
holders whose stock the insider has bought or sold. While the nexus

between the duty breached and the securities traded is problematic even

in the case of the traditional insider—does, for example, the corporate
insider who sells stock on the basis of inside information owe a duty
before or at the time of the purchase to the purchaser (who, prior to

the sale, was not a stockholder)?—at least the alleged breach of duty
directly relates to the securities sold and the identity of the party on

the other side of the transaction. But Winans, as an employee of the

Wall Street Journal, was not an insider of the corporations whose stock

was traded. The government, therefore, based its prosecution on the

theory that Winans had violated a duty he owed to his employer not

to disclose the contents of future columns (a term of employment of

which Winans was found to have been aware). Breach of duty and the

purchase or sale of a security, the conditions precedent to a possible

rule lOb-5 violation, became analytically distinct; the duty breached was

to one party (the employer), but the purchase was by an entirely different

party (the corporation's security holder).

The Supreme Court affirmed the convictions on the communications

violations, but spht 4-4 on whether Winans' violation of his obligation

to his newspaper employer could constitute the basis for a rule lOb-5

violation. Because the court unanimously upheld the convictions on the

communications grounds. Justice White's opinion for the Court did not

indicate which justices would have upheld the convictions on rule

lOb-5 grounds as well, and which justices would have reversed on the

same grounds. Nor, quite obviously, did the opinion indicate the content

and range of views of the justices on the rule lOb-5 issue. Although

the split left standing a Second Circuit decision that upheld the convictions

on rule lOb-5 grounds as well,^ the split seemed to guarantee that the

Court would face the issue again in future cases.

The surprise engendered by Carpenter was not unique. For example,

one would have thought that on the basis of past precedent, the Supreme

^See infra text accompanying notes 111-21.

^United States v. Carpenter, 791 F.2d 1024 (2d Cir. 1986).



1988] lOb-5 JURISPRUDENCE 627

Court would have decided differently in Landreth Timber Co, v. Landreth^

and Bateman Eichler, Hill Richards, Inc. v. Berner,^ two rule lOb-5

cases that came before the Supreme Court in 1985.^

Prediction has been difficult, in large part, because various strands

of thought about rule lOb-5 recur and compete for dominance in Supreme

Court opinions. The aim of this essay is to identify and untangle these
*

'competing currents." They are: ''idealism," "traditionalism," "eco-

nomic behaviorism," "paradigm case analysis," "literalism" and "textual

structuralism." The first three currents might properly be viewed as

substantive positions: idealism favors the expansion of rule lOb-5 Uability;

traditionalism has as its goal to contain rule lOb-5 liabiHty; and economic

behaviorism, while inherently not in favor of or against rule lOb-5

liability, would determine the issue of lOb-5 liability according to the

economic incentive effects of that liability on the actors concerned.

Paradigm case analysis, literalism and textual structurahsm are more in

the nature of interpretive strategies. Paradigm case analysis calls for the

issue of liability to depend upon the similarity of the facts of a given
case with certain paradigm fact situations. Literalism favors the language

of a statute or regulation in the interpretive process above, and sometimes

instead of, all other considerations. Textual structuralism is an interpretive

strategy that emphasizes harmony among various parts of a regulatory
scheme when interpreting any particular part of that scheme. While
certain justices have shown an affinity to both traditionalism and lit-

eralism, and other have favored both idealism and textual structuralism,

these correlations—particularly that between traditionalism and literal-
ism—have also proved to be quite weak at times.

Recognition of the competing currents can present a richer, more
realistic disclosure of Supreme Court jurisprudence with respect to rule

lOb-5, especially in its application to insider trading, than is possible

with attempted doctrinal statements of the law.'^ In particular, such

'411 U.S. 681 (1985). See infra text accompanying notes 141-48 & 159.
H12 U.S. 299 (1985). See infra text accompanying notes 39-54.

The dominant current in Supreme Court decisions from 1975 tlirough the early 1980's,
"traditionalism," had as one of its aims the discouragement of the initiation of causes of

action on the basis of rule lOb-5. See infra text accompanying notes 66-121. Yet, both

Landreth and Bateman Eichler would seem to encourage the initiation of such actions.

'"Doctrinal statements—for example, the common aphorism that insiders "must either
disclose . . . [inside information] to the investing public, or, . . . abstain from trading" (SEC

V. Texas Gulf Sulphur, 401 F.2d 833, 849 (2d Cir. 1%8), cert, denied, 394 U.S. 976 (1969))—

frequently fail to depict accurately the degree to which the law restrains the purchase or sale

of securities by those with informational advantages. Such statements both understate the

degree of legal proscription, which applies to more than traditional insiders, and overstate

the legal restraint because, in some sense, substantially all purchases by corporate insiders

are made with an informational advantage not shared by outside investors.



628 INDIANA LAW REVIEW [Vol. 21:625

recognition can facilitate our ability to predict future outcomes. ^^ In

light of the competing currents in rule lOb-5 jurisprudence, the Carpenter

decision, while not necessarily expected in its exact form as a tie-vote,

should hardly have come as a surprise.

I. The Competing Currents: The Past and Present

All justices seek to buttress their conclusions by references to textual

language, legislative history,*^ behavioral considerations and other policy

concerns. But identification of the competing currents demonstrates sub-

stantial differences in nuance and emphasis among the justices. And,
as we shall see, how faithfully a justice is prepared to follow the textual
language or what policy or incentive effect a justice chooses to emphasize,

materially affects the outcome of rule lOb-5 cases. '^

Various justices subscribe to one or several of the competing currents.

Some justices vacillate among them. Sometimes a particular current
dominates an opinion to which a majority of the Supreme Court nom-
inally subscribes. Which current dominates may depend on such factors
as the time period in which the case comes before the Supreme Court

{i.e., a pre- or post-1975 judicial decision) and the justice who is assigned
to write the majority opinion {i.e., to which competing current does

that justice usually subscribe). True, if another justice feels strongly

enough that the reasoning of the majority opinion writer does not comport

with his own, he will write a concurrence or,vif he disagrees with the

result, a dissent, ^"^ but often the feehngs are not so strong as to provoke

a separate opinion. At other times, no particular current dominates, but

the decision results from an uneasy alliance of several currents pointing

in favor of, or against rule lOb-5 liability in the particular case. A third

''See infra note 198.

'^Legislative history, in particular, has been used to support every conceivable position.

Section 10(b) of the Securities Exchange Act is quite broadly worded, and thus fails to give

specific guidance as to the contours of securities regulation to be promulgated under it. Rule

lOb-5 is itself the product of the SEC. Finally, private implied causes of action on the basis

of rule lOb-5 were judicially created. See Kardon v. National Gypsum Co., 69 F. Supp. 512

(E.D. Pa. 1946). To divine legislative intent as to the elements of that cause of action when
the cause of action, itself, is at most legislatively inspired, rather than specified, often seems

farfetched.

'The literalist, for example, is far more concerned with text than are traditionalists or

idealists. See infra text accompanying notes 153-69. hi contrast, idealists and traditionalists

often seem more imbued with their normative visions of federal securities laws than with

analyses which derive easily from legislative history. See infra text accompanying notes 15-

65 and 66-121.

'""Public choice" literature indicates that we should expect multiple opinions to be the

norm rather than the exception. See Easterbrook, Ways of Criticizing the Court, 95 Harv.

L. Rev. 802 (1982).



1988] lOb-5 JURISPRUDENCE 629

result is also possible: the competing currents cancel each other out,

and the Court is unable to reach a decision. This occurred in Carpenter.

What are the distinguishing characteristics of the various competing
currents and with which justices of the Supreme Court can we associate

them? Is it possible to speculate on how the justices who subscribe to
one of these currents would have voted in Carpenterl It is to these

questions that we now turn.

A. Idealism

We begin with idealism for two reasons. First, historically its heyday
occurred before competing currents of thought were recognizable. But

more importantly and for reasons I advance later, its influence still

affects the thinking of those justices of the Supreme Court who openly
espouse other currents. Hence, while idealism may not command the
same support it once did on the Supreme Court, fears about its demise

that have long been voiced by scholars and others have not been reahzed.^^

What are the distinguishing characteristics of idealism? Idealism is
characterized by three elements: first, a striving toward the ideal of

equal information among all participants in a securities transaction (or,
at least, equal access to information);'^ second, the unabashed espousal

of ethics as a source of law; and third, an emphasis upon the need to

protect the investing public, and hence, the deterrent function of suits

brought on the basis of rule lOb-5, including suits initiated by private

parties for damages.'^ This third characteristic implies that the defendant

and his conduct rather than the plaintiff and her conduct are the primary

factual foci of the justice.

The ideal of equal access to information by all investors appeared

in many of the early, landmark rule lOb-5 cases such as SEC v. Texas
Gulf Sulphur Co.,*^ a 1968 decision. Although Texas Gulf Sulphur was

^^See, e.g., Kaplan, Fiduciary Responsibility in the Management of the Corporation, 31

Bus. Law. 883, 897 (1976).

^^See generally Seligman, The Reformulation of Federal Securities Law Concerning
Nonpublic Information, 73 Geo. L.J. 1083 (1985). For an earlier academic expression of

idealism, although somewhat more limited than that expressed by Professor Seligman, see

Brudney, Insiders, Outsiders, and Informational Advantages under the Federal Securities Laws,

93 Harv. L. Rev. 322 (1979) (rule lOb-5 should be interpreted to bar the exploitation of

"unerodable advantages that one trader has over another").

'Tor an insightful critique of this emphasis upon deterrence, at least in the context of

private party suits on the basis of rule lOb-5 or other implied causes of action under the

securities acts, see Frankel, Implied Rights of Action, 67 Va. L. Rev. 553 (1981). In contrast

to the "idealist" emphasis upon deterrence, "traditionedist" decisions have emphasized the

plaintiff's position and, in particular, the question whether the plaintiffs deserve to be

compensated for their alleged loss. See infra text accompanying notes 76-80, 101-09.

'»401 F.2d 833 (2d Cir. 1968), cert, denied, 394 U.S. 976 (1969).



630 INDIANA LAW REVIEW [Vol. 21:625

itself the decision of the Second Circuit Court of Appeals, the Supreme

Court seemed to be moving towards the same parity of information

stance. In Affiliated Ute Citizens v. United States,^^ for example, the

disparity of information about the presence of another and higher market

for the shares of stock sold by the seller Indians to the buyers, employees

of the First Security Bank of Utah who also made a market in such
stock, was an important contributor to the Court's holding that the

plaintiff sellers need not allege and prove any reliance upon the buyers'

omissions.^^

The goal of deterrence in order to protect the investing public was

also highlighted in the early lOb-5 cases. The attention of the Court

seemed to focus primarily upon the conduct of the defendants and the

need to deter them and similarly situated parties from either misleading

investors or trading on the basis of information from which others were

excluded. Other than requiring that the plaintiffs, themselves, must have

bought or sold securities (a requirement seen as hmiting the class of

plaintiffs to those who had been injured), ^^ the Court devoted little
attention to the actual plaintiffs and their equities (as contrasted with

those of the investing public generally). This tendency is most apparent

in /./. Case Co. v. Borak^^ and Mills v. Electric Auto-Lite Co.,^^ two

Supreme Court opinions that dealt with impHed causes of action under

rule 14a-92^ (the anti-fraud provision of the proxy regulations), but

nonetheless had much to say about all implied causes of action brought
on the basis of misleading disclosures or omissions, ^^ especially those

'^406 U.S. 128 (1972).

^his is not to say, however, that the Court fully adopted a parity of information

stance. The Court emphasized that a duty of disclosure arose because the defendants had

been active in making a market for Ute Development Corporation stock. Id.

2'Even this requirement was the product of a Second Circuit decision, Bimbaum v.
Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert, denied, 343 U.S. 956 (1952). In 1975,

the Supreme Court explicitly adopted the Bimbaum doctrine. See Blue Chip Stamps v. Manor
Drug Stores, 421 U.S. 723 (1975).

^377 U.S. 426 (1964).

^^3% U.S. 375 (1970).

^Rule 14a-9, 17 C.F.R. § 240 (1987), states:

No solicitation subject to this regulation shall be made by means of any proxy
statement, form of proxy, notice of meeting or other communication, written or

oral, containing any statement which, at the time and in the light of the circumstances

under which it is made, is false or misleading with respect to any material fact,

or which omits to state any material fact necessary in order to make the statements

therein not false or misleading or necessary to correct any statement in any earlier

communication with respect to the solicitation of a proxy for the same meeting

or subject matter which has become false or misleading.

Its language, then, closely parallels that of Rule 10b-5(2). See supra note 3.

''See Borak, 311 U.S. at 433-35; Mills, 396 U.S. at 381-85.



1988] lOb-5 JURISPRUDENCE 631

based upon rule lOb-5.^^ The Supreme Court showed scant interest in

such questions as whether the actual litigating shareholders knew the

omitted facts or had actually been injured, both factors in determining

what the ultimate remedy would be.^^

The heyday of idealism occurred prior to 1975, after which tradi-

tionalism gained the upper hand.^^ Yet, while idealism, evidenced by the

espousal of the ideal of equal access and the need to protect the public

by deterring similarly situated insiders, went into a tailspin, it has

remained the dominant current of thought among Justices Blackmun,
Marshall and, for the most part, Brennan, although each of these Justices

has, at times, adopted other modes of reasoning as well.^^ Their idealism

has been evidenced by their dissents in Aaron v. SEO^ and Dirks v.
SEC,^^ and by the dissents of Justices Blackmun and Marshall in Chiarella

V. United States. ^^ In these dissents, the ethical underpinnings of idealism

became much more patent than in earlier idealist opinions.
The Dirks case, decided in 1983, involved Equity Funding Corpo-

ration, which wrote and then sold insurance policies to reinsurers. Secrist,

a former officer of Equity Funding, tipped Dirks, an insurance stock

analyst and broker for an investment banking firm, that many of the
insurance pohcies written by Equity Funding were fictitious." Dirks then

set out to investigate the allegation. In the course of his investigation.

Dirks apparently made some effort to encourage a reporter for the Wall
Street Journal to write an expose about the matter and to prompt the

SEC to initiate an investigation on its own, although the extent of Dirk's
efforts with respect to the Journal and the SEC was a point of some
dispute. In any event. Dirks also communicated with some of his in-

stitutional clients about Secrist' s allegations and the extent of his own

"^See, e.g.. Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-54 (1972) (the

Mills materiality standards, see infra text accompanying note 107, used to support the conclusion

that "positive proof of reliance is not a prerequisite to recovery"); Superintendent of Ins.

V. Bankers Life & Casualty Co., 404 U.S. 6, 13 n.9 (1971) {Borak cited to support the
statement, "[i]t is now established that a private right of action is implied under § 10(b)").

^Ultimately, in Mills, after many years of litigation, the plaintiffs were denied a monetary

remedy because the terms of the transaction involving a merger between Mergenthaler Linotype

Company and Electric Auto-Lite Company, were deemed favorable to the suing shareholders.
Mills V. Electric Auto-Lite Co., 552 F.2d 1239 (7th Or. 1977).

^See infra text accompanying notes 66-121

^'For example. Justice Marshall was quite traditionalist in his opinion in TSC Industries,
Inc. V. Northway, Inc., 426 U.S. 438 (1976) {see infra text accompanying notes 103-08), and

Justice Blackmun has been the most forceful voice for the current of "textual structuralism,"

See infra text accompanying notes 170-83.

^446 U.S. 680, 704 (1980).

^•463 U.S. 646, 667 (1983).

^^445 U.S. 222, 245 (1980).

^^Dirks, 463 U.S. at 649.



632 INDIANA LAW REVIEW [Vol. 21:625

investigation to confirm such allegations. The institutional clients were

generally able to sell their stock in Equity Funding at a price substantially

higher than the market price of the stock after the news of the fraud

became public. The SEC censured Dirks for violating rule lOb-S.^"*
Although a Supreme Court majority exonerated Dirks,^^ Justice

Blackmun dissented in an opinion joined by Justices Marshall and Bren-

nan. Justice Blackmun's dissent illustrates the idealist stance. To Justice
Blackmun, the fact that Dirks' investigation helped to expose the fraud

hardly justified his conduct: *'Even assuming that Dirks played a sub-

stantial role in exposing the fraud, he and his clients should not profit

from the information they obtained from Secrist."^^ Most indicative of

the tenor of the idealist position was Blackmun's open espousal of ethics

as a source of law: *'As a citizen, Dirks had at least an ethical obligation

to report the information to the proper authorities."^^

Having kept idealism alive in dissents such as that in Dirks, Justices

Blackmun, Marshall and Brennan were able to collect a majority for

its expression in both Herman & MacLean v. Huddleston^^ and Bateman
Eichler, Hill Richards» Inc. v. Berner.^^ The former of these cases,
decided in 1983, is of primary interest as a portent of things to come.

The Supreme Court, per Justice Marshall, held that the purchaser of

securities who asserts that a prospectus contained misrepresentations has
a lOb-5 claim, despite the presence of an express remedy in the Securities

Act of 1933 dealing with that context."^ The Court further held that

the allegedly defrauded purchaser need only prove his case by a pre-

ponderance of the evidence."^^ Herman & MacLean, with its encourage-
ment of rule lOb-5 litigation, its rejection of a state standard of proof

in such litigation, and its reference to the "broad remedial purposes"

of the Securities Acts,"^^ evinced that, although other currents may have
ecHpsed idealism for a five to seven year period, ideahsm as a significant

^Id. at 651-52.

^^See infra text accompanying notes 120-21.

^463 U.S. at 677.

"•'Id.

M59 U.S. 375 (1983).
'M72 U.S. 299 (1985).

'^Herman & MacLean, 459 U.S. at 387.
nd. at 390. The Court of Appeals for the Fifth Circuit had ruled that the plaintiff

must prove his case by "clear and convincing" evidence, a much harder standard to satisfy.
Huddleston v. Herman & MacLean, 640 F.2d 534, 545-46 (5th Qr. 1981). The "clear and
convincing" evidence standard comes from the common law of fraud. Thus, the Supreme
Court's decision in Herman & MacLean was a departure from the Court's pattern of referring
to state law to determine the elements of a rule lOb-5 suit. See infra text accompanying

notes 66-121.

"^59 U.S. at 386.



1988] lOb-5 JURISPRUDENCE 633

current had staged a substantial comeback. For present purposes, however,

Bateman Eichler, decided in 1985, is the more interesting case.

In that case, tippees, who had received confidential information from
a broker dealer regarding a gold discovery by a corporation whose stock

was traded over the counter, sued the broker who touted the stock to
them."*^ They also sued the principal of the corporation, who had advised
the tippees that the broker was a

*

'trustworthy and . . . good man."
Although the stock initially skyrocketed in value, the inside information

ultimately proved to be false, and the value of the stock plummeted.

The tippees sued on the basis of rule lOb-5. The defendants sought to

dismiss the suit on in pari delicto grounds: namely, that the plaintiffs,

who were also guilty of violating the law, should be precluded from
suing the defendant tipper."^

If Herman & MacLean was an aberration confined to the question
of remedy, one would have expected the defendants to prevail on their

motion to dismiss. "^^ Anyone but a formalist legal scholar would ac-
knowledge the tremendous influence of facts on a case, not simply in

the sense of determining whether a given legal principle is to be applied,

but also in the sense of affecting the court's interpretation of the elements

of that legal principle. If the plaintiffs in Bateman Eichler had knowingly

used inside information to purchase their stock, they had been hoisted

by their own petards and surely no one, including a court, should rescue
them! Moreover, liberal application of such common law defenses as
the in pari delicto defense would have much the same effect as application
of such common law elements of the fraud cause of action as scienter
or violation of a duty. It would serve to restrict the number of such

rule lOb-5 cases that could be successful and, therefore, ex ante discourage

their initiation. However, in an opinion by Justice Brennan, the Supreme

Court held that the case should not have been dismissed.''^

Although Justice Brennan did not completely rule out the possibility

of an in pari delicto defense"*"^ in private suits based upon alleged violations

''Bateman Eichler, 412 U.S. at 301.

^M at 305.
"^Indeed, the District Court for the Northern District of California had dismissed the

suit on in pari delicto grounds, cilthough the Court of Appeals for the Ninth Circuit had

reversed. See Berner v. Lazzaro, 730 F.2d 1319 (9th Cir. 1984).

^M at 310-11.
"•^Justice Brennan, speaking for the Court, stated:

[A] private action for damages in these circumstances may be barred on the grounds
of the plaintiff's own culpability only where (1) as a direct result of his own actions,
the plaintiff bears at least substantially equal responsibility for the violations he

seeks to redress, and (2) preclusion of suit would not significantly interfere with

the effective enforcement of the securities laws and protection of the investing

public.



634 INDIANA LAW REVIEW [Vol. 21:625

of rule lOb-5, he quite explicitly disagreed with the notion **that an

investor who engages in such [insider] trading is necessarily as blame-
worthy as a corporate insider or broker-dealer who discloses the infor-
mation for personal gain.""^ In Justice Brennan's words, "we do not
believe that the tippee properly can be characterized as being of sub-

stantially equal culpability as his tippers.
""^^

More important than the actual holding of Bateman Eichler were
the idealist themes that Justice Brennan openly espoused. Quite explicitly,

Justice Brennan laced his opinion with the need to protect the '* public"

and the deterrent nature of the rule lOb-5 suit, even when initiated by
private parties. For example, citing /./. Case Co. v. Borak,^^ Justice

Brennan noted that *'we [the Supreme Court] repeatedly have emphasized

that implied private actions provide 'a most effective weapon in the

enforcement' of the securities laws and are 'a necessary supplement to

Commission action.' "^^ In other words, the culpability of the defendants'

conduct and the conduct of those similarly situated was the focus of

Brennan's opinion, rather than the plaintiffs' conduct, and the implied

right of action was viewed in a very positive light, rather than the

negative light in which it had been viewed in traditionalist opinions that

preceded Bateman Eichler. To Brennan, ''deterrence of insider trading
most frequently will be maximized by bringing enforcement pressures to

bear on the sources of such information—corporate insiders and broker-
dealers.

"^^

Like Justice Blackmun in his dissent in Dirks, Justice Brennan did

not shy away from highlighting the ethical dimension that supports the
idealist view. To some, the impossibility of ever achieving complete parity
of information between transacting parties conduced toward a view that

insider trading should be tolerated, indeed perhaps encouraged, as the

key to other benefits. ^^ But to Brennan, speaking for the Court, the

ideal remains:

Id.

In Pinter v. Dahl, 108 S. Ct. 2063 (1988), the Supreme Court extended the

in pari delicto defense to actions brought under § 12(1) of the Securities Act of

1933. In so doing, it reaffirmed this test for the application of the defense which

it had enunciated in Bateman Eichler.

"^Bateman Eichler, 472 U.S. at 312.

''Id. at 314.

^377 U.S. 426 (1964).

''Bateman Eichler, Hill Richards, Inc. v. Berner, All U.S. 299, 310 (1985).

'^Id. at 316 (emphasis added).

"See, e.g., Dooley, Enforcement of Insider Trading Restrictions, 66 Va. L. Rev. 1

(1980); Scott, Insider Trading: Rule lOb-5, Disclosure and Corporate Privacy, 9 J. Legal

Studies 801 (1980).



1988] lOb-5 JURISPRUDENCE 635

We also believe that denying the in pari delicto defense in such
circumstances will best promote the primary objective of the

federal securities laws—protection of the investing public and
the national economy through the promotion of "a high standard
of business ethics ... in every facet of the securities industry. "^"^

Perhaps most interesting about Bateman Eichler is the fact that there
were no dissents to the decision. All Justices but two joined in Justice

Brennan's "ideaUst" expression of the law. The two were Justice Mar-
shall, whom we know from other opinions generally shares that "idealist"
view, and Chief Justice Burger, who simply concurred in the judgment
without writing a separate opinion.

At times, then, idealism has been a strong current, indeed a wave

in the pre- 1975 period; at other times, it has been a weaker current,

but one still present in the dissents of some of the Court's members.

More recently, a near unanimous majority of the Court has been willing
to follow its course in selected cases. What accounts for the endurance
of idealism, despite the vicissitudes in its popularity?^^ Can we speculate
as to how avowed idealists voted in Carpenterl

The recurrence of idealism in majority opinions strongly suggests
the existence of a widely-held intuition that affirmative misrepresentations

and, under certain circumstances, insider trading are
*

'wrongs. "^^ Con-

sensus may be lacking as to what those "circumstances" are, but no
sitting Supreme Court Justice is prepared to defend insider trading on

moral grounds. Thus, a growing body of literature that, on economic

grounds, either justifies insider trading or denigrates the ability of rule

lOb-5 practicably to unify ethical and legal norms^^ has had only moderate

impact on the Court. One should not expect greater impact from such
analysis if it is idealism's patent appeal to ethics as a source of law,

rather than, for example, economic arguments that can also be advanced

in its favor, 5^ that explains its strength.

^472 U.S. at 315.

"For some factors that bear on the vicissitudes themselves, see infra text accompanying

notes 96-102 (suggesting why traditionalism overtook idealism as a dominant force during the
latter 1970's) and text accompanying notes 190-98 (suggesting that personnel on the Court

and popular sentiment might be moving in opposite directions).

'*As Donald Langevoort has expressed, the acceptance of rule lOb-5 liability by the

courts and the SEC "seems to rest ... on the strongly held intuition that insider trading is
unfair." Langevoort, Insider Trading and the Fiduciary Principle: A Post-Chiarella Restatement,
70 Calif. L. Rev. 1, 2 (1982).

"5ee, e.g., Carlton & Fischel, The Regulation of Insider Trading, 35 Stan. L. Rev.
857 (1983); Cox, Insider Trading Regulation and the Production of Information: Theory and

Evidence, 64 Wash. U.L.Q. 475 (1986); Dooley, supra note 53; Haddock & Macey, A Coasian
Model of Insider Trading, 80 Nw. U.L. Rev. 1449 (1986); H. Manne, Insider Trading
AND THE Stock Market (1966); Scott, supra note 53.

^^These arguments are summarized in R. Clark, Corporate Law 273-77 (1986).



636 INDIANA LAW REVIEW [Vol. 21:625

In turn, this intuition seems rooted in a "truth norm" that pervades
much of our legal culture, even if the law does not fully implement it.
State fraud actions, consumer warranty law, creditor remedies against

debtors^^ and other provisions too numerous to mention have their

justification in an obligation to be truthful in one's dealings with others.

The same truth norm seems impHcated in the situations covered by rule
lOb-5 as well. Rule lOb-5's misrepresentation cases patently involve

conduct that directly violates an obligation to be truthful. But one can

also argue that insider trading is untruthful as well.

Silence, like declaring something to be a fact when it is not so, can

be a lie under circumstances where the other transacting party reasonably

expects to be informed if the actual facts differ from his understanding

of them.^^ Such expectations exist where one party is in a relationship

of dependence upon another, such as a trust or certain contractual

relationships. But, arguably, such expectations are also reasonably held

where only one of two parties to a trade has lawful access to material

information affecting the value of the security traded.^^ The insider

would want to be told the same information if the insider were standing

in the other party's shoes; that is to say, the insider is both aware of

and shares the reasonable expectations of the other party. Various ethical

sources teach the imperative that one should treat others as one wishes

others to treat him.^^ Thus, at least some acts of insider trading can

properly be depicted as attempts to avoid this ethical imperative of

reciprocal treatment. As such, these acts are disrespectful of others; the
insiders would deny to others the treatment that they would reasonably

'^See R. Clark, supra note 58, at 42-45.

^See S. BoK, Lying: Moral Choice in Public Life (1978).
*'5ee Bnidney, supra note 16. At least three situations require differentiation. First, if

the party with the inside information has unlawfully gained access to that information, the

other investor's expectations have been violated because he simply would not expect the other

p£Uty's access or use of the information. Second, the party trading on the basis of inside

information may have had lawful access to it, but for purposes other than gain in the trading
of securities. For example, the corporate officer or director might have such information as

a part of his corporate duties, or the newspaper columnist might have access to such information

for purposes of writing his column. Third, the party having the inside information might

have acquired it lawfully for the very purpose of capitalizing on the information acquired.

The argument that one's expectations have been violated seems strongest in the first two

situations, and weakest in the third. In the third situation, the second investor would probably

also want and think that, if he developed information for the express purpose of investment

gains, he could lawfully profit from such information. In other words, while there may be
some who would claim to hold expectations of sharing even in the third situation, their

expectations (if expressed) would seem to be feigned, or, at least, unreasonable.

^^See, e.g., I. Kant, Groundw^ork of the Metaphysics of Morals 88 (H. Paton trans.

1964) (first formulation of the categorical imperative). See also Phillips, The Commercial

Culpability Scale, 92 Yale L.J. 228, 252-53 (1982).



1988] lOb-5 JURISPRUDENCE 637

expect for themselves. The relationship between certain instances of

insider trading, the truth norm, and a general ethical imperative that

calls for mutually respectful conduct among people^^ probably explains
best the fact that idealism, despite some setbacks, has endured in Supreme

Court opinions.^

Finally, how did such idealists as Justices Blackmun, Marshall and
Brennan approach the Carpenter case? There is little doubt that they

voted to affirm the convictions of Winans and his tippees on rule 10b-

5 grounds. Carpenter implicated all three prongs of the idealist stance:

disparity of information; unethical behavior; and the need to deter

similarly situated actors. The transactions that formed the basis of the

suit were characterized by an informational disparity between the traders.

The idealists would especially be concerned with the lack of ethics on

the part of Winans and those he directly or indirectly tipped. And
because the informational disparity resulted from a misuse of information

by Winans, the idealists would stress the need to deter similarly situated

parties from behaving in a like manner.^^

B. Traditionalism

The distinguishing characteristics of the traditionalist current include:

first, a reluctance on the part of the Supreme Court to have federal

courts intrude excessively into areas traditionally reserved to state law;

second, even when rule lOb-5 is held to apply to a transaction, explicit

or implicit reference to state law, particularly the state law of fraud

and fiduciary duties, in order to derive rule lOb-5's substantive content;

and third, a tendency to view those plaintiffs who would sue on the
basis of rule lOb-5 in a more negative light than the defendants whose

alleged conduct necessitated initiation of the litigation. Traditionalism

gained the upper hand in rule lOb-5 jurisprudence in 1975 and dominated

the Supreme Court's holdings with respect to rule lOb-5 liability at least

through 1980. Because it succeeded idealism as the dominant theory

espoused by a majority of the Supreme Court, traditionalism is best

understood as a reaction to idealism. And because traditionalism looked

""See C. Fried, Right and Wrong 67 (1978).
^See Levmore, Securities and Secrets: Insider Trading and the Law of Contracts, 68

Va. L. Rev. 117, 122-23 (1982).

^'Significantly, Justices Blackmun and Marshall would have sustained Chiarella's con-

viction in Chiarella v. United States, 445 U.S. 222, 245 (1980). Although Justice Brennan

concurred, voting to overturn Chiarella's conviction, he did so because breach of a duty had

not been presented to the jury. Justice Brennan nonetheless stated that "a person violates §

10(b) whenever he improperly obtains or converts to his own benefit nonpublic information
which he then uses in connection with the purchase or sale of securities." Id. at 239. For

a discussion of Chiarella, see infra text accompanying notes 111-19.



638 INDIANA LAW REVIEW [Vol. 21:625

to State common law, especially the state law of fraud, to define rule
lOb-5 liability and because that body of law was restrictive in a number

of respects,^^ traditionalism can properly be viewed as restrictive; it tended

to restrict rather than expand the development of rule lOb-5. Although

traditionalism in its reactive and restrictive guise does not now enjoy
the same level of support it did some eight years ago, its basic tenet

that courts are to refer to state law—such as fraud doctrine, fiduciary
duties and property rights—to determine whether rule lOb-5 has been
violated still represents a frequently reiterated current in Supreme Court

opinions.

The Supreme Court's 1975 decision in Cort v. Ash,^^ a case that

itself had nothing directly to do with rule lOb-5, signaled a change in

the Court's attitude toward privately-initiated suits based upon implied

causes of action under federal law.^^ In Cort v. Ash, which dealt with

the attempt by shareholders to bring suit against the directors of Beth-

lehem Steel Corporation for violating a federal criminal statute that

prohibited corporations from making contributions or expenditures in

connection with presidential campaigns,^^ Justice Brennan, speaking for

the Court, specified four factors that were relevant to the decision whether

to imply a private cause of action under a federal statute. "^^ The restrictive

nature of the Cort v. Ash test is illustrated by one of these factors:
"Is there any indication of legislative intent, explicit or implicit, either

*^The state common law of deceit has remained quite restrictive. The elements of a tort
action for deceit are: a false representation, knowledge or belief that the representation is

false, intent to induce the plaintiff to act or refrain from acting in reliance on the misrep-

resentation, justifiable reliance by the plaintiff, and damage to the plaintiff as a result of

the reliance. W.P. Keeton, Prosser and Keeton on Torts 725-28 (5th ed. 1984). See also
Keeton, Fraud-Concealment and Non-Disclosure, 15 Tex. L. Rev. 1 (1936).

^'422 U.S. 66 (1975).

^See Frankel, supra note 17.

^he statute under which an implied cause of action was sought was 18 U.S.C. § 610
(repealed, 1976) which prohibited corporations "from making 'a contribution or expenditure

in connection with any election at which Presidential and Vice Presidential electors ... are

to be voted for.' " 422 U.S. at 68 (footnote omitted).

^Justice Brennan wrote:

In determining whether a private remedy is implicit in a statute not expressly

providing one, several factors are relevant. First, is the plaintiff "one of the class

for whose especial benefit the statute was enacted," —that is, does the statute
create a federal right in favor of the plaintiff? Second, is there any indication of

legislative intent, explicit or impUcit, either to create such a remedy or to deny

one? Third, is it consistent with the underlying purposes of the legislative scheme

to imply such a remedy for the plaintiff? And finally, is the cause of action one
traditionally relegated to state law, in an area basically the concern of the States,

so that it would be inappropriate to infer a cause of action based solely on federal

law?

422 U.S. at 78 (citations omitted).



1988] lOb-5 JURISPRUDENCE 639

to create such a remedy or to deny one?""^^ If Congress had intended

to grant a cause of action, it would be quite Ukely that an expHcit cause

of action would exist in the statute. In other words, the most probable

context to confront an attempt to imply a cause of action is in that

very context where evidence of such intent is lacking. Therefore, to

suggest that implied causes of action should be confined to those statutory

contexts where evidence of legislative intent to grant such causes of

action exists biases the issue against such actions."^^ The application of

the four factors, as well as their articulation, left no doubt that the

Court had as its primary agenda the restriction, rather than the further

expansion, of such implied causes of action.^^

While Cort v. Ash dealt with a statute outside the securities law
context, its restrictive tenor was soon reflected in securities law cases, ^"^

including a variety of rule lOb-5 cases. Having already sustained an

implied cause of action under rule lOb-5,^^ the Supreme Court would

be unhkely to deny that one existed. But it could, and did, seek to

deter the initiation of lOb-5 lawsuits.

Blue Chip Stamps v. Manor Drug Stores,'^^ a 1975 case, illustrates
the tendency of traditionalism to focus upon the litigating plaintiffs
rather than the defendants whose conduct gave rise to the suit. In Blue

Chip Stamps, the Supreme Court strictly interpreted a long standing

Court of Appeals requirement that the plaintiff in a rule lOb-5 case

must have been a purchaser or seller of securities. ^"^ In his opinion for

the majority. Justice Rehnquist spoke of the
*

'danger of vexatiousness

[in rule lOb-5 Htigation] different in degree and in kind from that which

accompanies litigation in general. '*^^ Ernst & Ernst v. Hochfelder.'''^ which

''Id.

^^As Professor Frankel pointed out, following Cort v. Ash, the Supreme Court soon

"moved toward a more restrictive test whereby legislative intent came to subsume the other

Cort factors." Frankel, supra note 17, at 560.

^Tor example, another test was whether the plaintiff was among the class sought to

be benefitted by the statute. There was evidence that one of the purposes underlying the

criminal statute was to protect stockholders since it was their money that was being spent.

But the Court did not give this factor much weight on the ground that "the protection of
ordinary stockholders was at best a secondary concern." Cort v. Ash, 422 U.S. 66, 81 (1975).

''See, e.g.. Piper v. Chris-Craft Industries, Inc., 430 U.S. 1 (1977) (the Court held that

the tender offeror has no implied cause of action for damages under § 14(e) of the Securities

Exchange Act of 1934).

'^See Affiliated Ute Citizens v. United States, 406 U.S. 128 (1972); Superintendent of

Insurance of the State of New York v. Bankers Life & Casualty Co., 404 U.S. 6 (1971).
M21 U.S. 723 (1975).
''Id. at 754-55. See Bimbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert,

denied, 343 U.S. 956 (1952).

'Hl\ U.S. at 739.

^'425 U.S. 185 (1976).



640 INDIANA LAW REVIEW [Vol. 21:625

illustrates the tendency of the Supreme Court to define the elements of

a rule lOb-5 claim in terms of the state law of fraud, followed in 1976.

The Supreme Court held, in that case, that the plaintiff must prove

that the defendant acted with scienter with respect to the words or

conduct that gave rise to the action.^ Justice Powell, speaking for the

Court, was hardly crystal clear in defining scienter.^' But, he did rule

out the possibility that scienter was satisfied by a mere allegation of

negligence. Although Justice Powell carefully stressed the language of

Section 10(b) of the Securities Exchange Act of 1934, pursuant to which

the SEC promulgated rule lOb-5, and the structure of remedies in the
Act, he nonetheless implicitly drew the parallel to the state law of deceit,

with respect to which the defendant must have intended to defraud the

plaintiff in order for the plaintiff purchaser to have established his case.^^

In 1977, Justice White wrote the opinion of the Court in Sante Fe
Industries, Inc. v. Green.^^ This decision evinced the reluctance of a

Supreme Court majority to continue to expand rule lOb-5 to areas that

traditionally had been the province of state fiduciary law. Prior to this

decision, some federal courts had broadly interpreted the kind of conduct
that would give rise to a rule lOb-5 suit. 'Traud" was said to include
not only fraudulent words or omissions, but also conduct that in everyday

parlance one would think of as fraudulent.^'* Even the Supreme Court,
in Superintendent of Insurance v. Bankers Life and Casualty Co.,^^
appHed rule lOb-5 to a fraudulent series of transactions that lacked any

""Id. at 193.

^'EHd it require intentional, knowing or only reckless conduct on the part of the defendant?

See 425 U.S. at 193-94 n.l2.

*^In note 33 of the opinion, Powell quoted with approval Justice Rehnquist's words in

Blue Chip Stamps that " '[w]hile much of the development of the law of deceit has been
the elimination of artificial barriers to recovery on just claims, we are not the first court to
express concern that the inexorable broadening of the class of plaintiffs who may sue in this
area of the law will ultimately result in more harm than good.' " 425 U.S. at 214 n.33,
(quoting Blue Chip Stamps, 421 U.S. at 747-48).

"430 U.S. 462 (1977).

^Id. at 479. See, e.g., Walling v. Beverly Enterprises, 476 F.2d 393 (9th Cir. 1973)

(entering into reorgeinization agreement without intention to perform held actionable under

rule lOb-5); Shell v. Hensley, 430 F.2d 819, 826 (5th Cir. 1970) (rule lOb-5 cause of action

stated where "[f]airly read, the complaint alleges that defendants, directly or indirectly, caused

at least a majority of the Alabama National board" to engage in a securities transaction
between two commonly controlled corporations); Bryan v. Brock & Blevins Co., 343 F. Supp.
1062 (N.D. Ga. 1972) (proposed merger to ensure that only "active employees" as shareholders

can be challenged on the basis of rule lOb-5), aff'd on other grounds, 490 F.2d 563, 570

(5th Cir.), cert, denied, 419 U.S. 844 (1974). But see Schoenbaum v. Firstbrook, 405 F.2d

200, 210-14 (2nd Cir. 1968), cert, denied sub nom. Manley v. Schoenbaum, 395 U.S. 906

(1969) (there can be no rule lOb-5 cause of action where no one is deceived).
«^404 U.S. 6 (1971).



1988] lOb-5 JURISPRUDENCE 641

misrepresentations or omissions of material facts directly relating to the

Treasury securities being sold.^^ Sante Fe Industries dealt with a "going

private" or "freezeout" transaction.^^ The plaintiffs claimed that they

were forced to surrender their investment in Kirby Lumber Corporation,

which Sante Fe Industries controlled, at only a fraction of the per share

value of its net assets. Justice White held, however, that the thrust of

rule lOb-5 was the accuracy of disclosure rather than unfairness. If the

price, no matter how unfair it was, had been disclosed, then rule 10b-
5 did not offer relief. For that, the plaintiffs had to seek relief pursuant

to state law.^^

Three years later the same restrictive trend seemed soundly in place.

In 1980, the Supreme Court decided two major cases interpreting rule

lOb-5.*^ One of these was Aaron v. SEC.^ One question that had been
left open by the Supreme Court's 1976 opinion in Ernst & Ernst v.
Hochfelder^^ was whether the requirement of scienter applied not only

to private causes of action founded upon rule lOb-5, but also to injunctive

proceedings initiated by the SEC. The issue generated a plethora of law

review commentary,^^ and the circuit courts of appeals had split on the

^*In a complicated multi-step transaction, one Begole managed to acquire all the stock

of Manhattan Casualty Co. ("Manhattan") from Bankers Life & Casualty Co. ("Bankers
Life") for $5,000,000 that was essentially paid out of the sale of nearly $5,000,000 of Treasury

bonds owned by Manhattan. Since the action was brought by the Superintendent of Insurance

of New York on behalf of Manhattan's creditors, rule lOb-5 was implicated only because
the Treasury securities were sold by Manhattan (Bankers Life was not complaining about its

sale of Manhattan stock to Begole). As Justice Douglas admitted in his opinion for the Court,

"To be sure, the full market price was paid for those bonds . ..." M at 9.
*^Although such transactions can be divided into various categories, such transactions

include the element that, following the transaction, the corporation is private rather than

public. The public shareholders have been "frozen out," sometimes willingly by selling their

shares or concurring to a merger, but often unwillingly. See Brudney & Chirelstein, A
Restatement of Corporate Freezeouts, 87 Yale L.J. 1354 (1978).

^Technically, this approach involved focusing upon subsection (b) rather than subsection

(a) or (c) of rule lOb-5. See supra note 3. To the Court, rule lOb-5 concerned misrepresentation,

not merely an act or practice which might, in the vernacular sense, defraud an investor.

More recently, the Supreme Court, in an opinion by Chief Justice Burger, held that mis-

representation or nondisclosure is also a necessary element of a cause of action based upon

§ 14(e) of the Securities Exchange Act. See Schreiber v. Burlington Northern, Inc., 472 U.S.

1 (1985).

^'Besides Aaron v. SEC, 446 U.S. 680 (1980), the Supreme Court decided Chiarella v.

United States, 445 U.S. 222 (1980). See infra text accompanying notes 111-19.

'«446 U.S. 680 (1980).

M25 U.S. 185 (1976).
^^See Berner and Franklin, Scienter and Securities and Exchange Commission Rule

lOb-5 Injunctive Actions: A Reappraisal in Light of Hochfelder, 51 N.Y.U.L. Rev. 769
(1976); Lowenfels, Scienter or Negligence Required for SEC Injunctions Under Section
10(b) and Rule lOb-5: A Fascinating Paradox, 33 Bus. Law. 789 (1978); Note, The Scienter
Requirement in SEC Injunctive Enforcement of Section 10(b) After Ernst & Ernst v.
Hochfelder, 77 Colum. L. Rev. 419 (1977).



642 INDIANA LAW REVIEW [Vol. 21:625

issue. ^3 Justice Stewart wrote the majority opinion for the Court in

Aaron. The Court held that the same requirement of scienter appUed

against the SEC even when it brought a suit for an injunction. And
given the facts of the case, Justice Stewart's opinion can also fairly be

read as saying something quite significant about the definition of scienter

itself.^^

Aaron stood at the zenith of the Supreme Court's apparent lack of
concern with deterrence of misleading statements or conduct. Even the

agency charged with enforcing the 1934 Act could not seek to stop

continuing securities acts violations under rule lOb-5 without alleging

and proving the state law-derived element of scienter. ^^ This attitude

stood in sharp contrast with that which had characterized the Supreme

Court's opinions of less than a decade earlier. Why had the Supreme
Court turned so restrictive?

Various reasons could be, and were advanced for the trend reversal

that had occurred in 1975 and still seemed in place in 1980.^^ The Sante

Fe case suggested that the Court was concerned with federalism, and

specifically, with the prospect of an open-ended doctrine such as rule

lOb-5 usurping all state law respecting the governance of corporations.

^'Compare SEC v. Cowen, 581 F,2d 1020 (2d Cir. 1978) (scienter not required) with
Steadman v. SEC, 603 F.2d 1126 (5th Cir. 1979) (scienter required).

*'With respect to a definition of scienter, the narrow holding of the Supreme Court's

opinion in Ernst & Ernst v. Hochfelder was negative, scienter did not include negligence.
Whether scienter could be satisfied not only by intentional conduct to deceive, but also by

knowing or reckless conduct, was still unsettled. Aaron, himself, was the branch manager of

a brokerage concern who was aware—i.e., knew—that salespersons in his office were promoting
the sale of a security with false claims. He did little to insure that the salespersons ceased
the practice. In addition to the explicit holdings, then, that the Ernst & Ernst requirement
of scienter applied to the SEC as well as private parties, and that it applied in a suit for
injunctive relief, the Supreme Court's opinion might be interpreted as implying that mere

knowledge did not suffice to constitute scienter. If knowledge did not suffice, nor could mere

recklessness.

^'If one takes seriously the need to protect the public, then requiring something more

than negligent conduct, particularly in the circumstances present in the Aaron case, would

seem to be counterproductive. First, the higher the state of scienter required, the more difficult

the burden of proof the plaintiff must meet. Even if the defendants intentionally sought to

mislead the plaintiffs, proof of intention, whether in civil or criminal law, has historically

posed great obstacles. Some truly guilty parties will win simply because of the difficulty of
proof. Second, either where misleading statements have been made or material facts omitted,
the investing public has been injured whether the party who produced the facts or omitted
them acted intentionally, recklessly, or negligently. If one concentrates upon the need to deter

conduct that can harm the investing public, then, it is not clear that one would make the
distinction. This is especially the case if one speaks about an action by the SEC for an
injunction.

"^See Conard, Securities Regulation in the Burger Court, 56 U. Colo. L. Rev. 193

(1985); Frankel, supra note 17.



1988] lOb-5 JURISPRUDENCE 643

Moreover, equal access to information, at least in the sense of information

that is immediately usable in the investment decision, is an ideal that

can hardly be realized. Consequently, one is inevitably expanding the

law trying, but never being able, to achieve the goal. Similarly, unless

one speaks in cost-benefit terms (a frame of analysis almost wholly

lacking among those adopting the idealist stance), deterrence is a "good'*
of which one cannot get enough. More litigation, in other words, is
axiomatically better. There is always some insider trading or unequal

access to information that must be discouraged. At some point, "over-

enforcement" results; some socially useful conduct is restricted, and, in

any event, the costs (including the litigation costs) of deterrence exceed

its benefits at the margin.^''

The general tightening of requirements for such actions, including

the reaffirmation of the standing requirement in Blue Chip Stamps,

enunciation and elaboration of the scienter requirement in the Ernst &
Ernst and Aaron cases, and the tightening of the materiality standard

in TSC Industries v. Northway, Inc.,^^ all indicated that the Supreme
Court was interested not in encouraging more litigation, but in reducing

the volume of suits brought on the basis of rule lOb-5.^^ To accompHsh
this required a philosophy other than ideaUsm. This desire to reduce

the volume of litigation, if true, would correspond to a general desire,

stated repeatedly by Chief Justice Burger during those same years, to

reduce the workload of the federal judiciary.**^ Limiting the opportunity

to bring suit on the basis of rule lOb-5, then, can be seen as an integral

aspect of a broader strategy implementing such a reduction.

There also seemed to be a feeling that rule lOb-5 had been misused,

at least when private parties brought suit. Private suits had at first

seemed quite equitable on the theory that private parties had in fact

been deceived, and an implied cause of action on the basis of rule

lOb-5 was the equivalent of giving that deserving private party the federal

analogue of a fraud cause of action. If the plaintiffs were deserving,

and if the dominant focus was on the need to protect the investing

pubhc from conduct such as that engaged in by the defendants, why
not construe the elements of this new cause of action quite liberally so

as to attain the maximum deterrence? However, an increasing number

^See Frankel, supra note 17, at 572-78.

M26 U.S. 438 (1976).
^See Conard, supra note 96, at 216-17.

^^See, e.g.. Chief Justice Burger's 1977 Report to the American Bar Association, 63

ABA Journal 504 (1977) (expressing support for the elimination of diversity jurisdiction
because the federal courts were overburdened); Chief Justice's Yearend Report, 1977, 64 ABA
Journal 211 (1978) (supporting elimination of the mandatory appeal jurisdiction of the

Supreme Court).



644 INDIANA LAW REVIEW [Vol. 21:625

of cases seemed to involve not private parties who in fact had been
deceived, but sophisticated investors who had not necessarily relied on
the alleged omission or false statement. '°' These investors were using

imphed causes of action, such as that based upon rule lOb-5, as a

strategic tool in the context of larger corporate battles. ^^^

TSC Industries v. Northway, Inc.^^^ illustrates this phenomenon.
Although this was not brought as a rule lOb-5 case—the allegation by
the plaintiffs in TSC Industries concerned alleged omissions in the proxy
statement of a corporation, and suit was brought on the basis of rule

14a-9—the standard of materiality articulated by the Supreme Court case
was interpreted to apply to rule lOb-5 cases as well.^^ On the basis of
Mills V. Electric Auto-Lite Co.,^^^ one would have thought that a mis-

statement or omission was material if "it might have been considered

important by a reasonable shareholder who was in the process of deciding
how to vote."^^ But the Supreme Court, in an opinion written by Justice
Marshall, interpreted Mills to have held only that materiality substituted

for proof of reliance in a rule 14a-9 case rather than to have defined

materiality. Justice Marshall, who was the author of the Court's opinion
in TSC Industries, then carefully laid out a definition of materiality
that subtly, but substantially, differed from the apparent definition found

in Mills: **An omitted fact is material if there is a substantial likelihood

that a reasonable shareholder would consider it important in deciding

how to vote."i«^ The '*might" of Mills became the "would" of TSC
Industries. Although the verbal change seemed slight, the consequences

•o'For example, the plaintiffs suing on the basis of rule lOb-5 have included business

enterprises, professional investors and insiders under circumstances patently illustrating that

the plaintiffs had not been deceived by the alleged misrepresentations or omissions. See, e.g.,

Wilson V. Comtech Telecommunications Corp., 648 F.2d 88 (2d Cir. 1981) (a professional

investor's suit on the basis of rule lOb-5 dismissed where the corporate statements alleged to

have been misleading were not determinative factors in his decision to purchase the stock);

Allen V. H.K. Porter Co., 452 F.2d 675, 679 (10th Cir. 1971) ("knowledgeable" plaintiffs,

who were a security brokerage firm and its clients, brought suit when "there was 'no semblance
whatever of a lawsuit' "); Harnett v. Ryan Homes, Inc., 360 F. Supp. 878 (W.D. Pa. 1973)

(former vice-president of a corporation unsuccessfully sought to sue the corporation on the

basis of rule lOb-5).

'°^See, e.g.. Electronic Specialty Co. v. International Controls Corp., 409 F.2d 937 (2d

Cir. 1969).

'°H26 U.S. 438 (1976).

'°*See, e.g., Starkman v. Marathon Oil Co., 772 F.2d 231, 238 (6th Cir. 1985); Basic

Inc. V. Levinson, 108 S. Ct. 978, 983 (1988).

'°^396 U.S. 375 (1970). Significantly, Justice Harlan's opinion in Mills fits the idealist

mode. It is laced with references to the need to protect the public, for deterrence, and, unlike

traditionalist views, dismissive of state law elements as restrictive of a federal cause of action.

^'^Id. at 384 (emphasis added).

'°'426 U.S. at 449 (emphasis added).



1988] lOb-5 JURISPRUDENCE 645

were not. To plaintiffs, the change in wording made the difference
between being able to secure a judgment as a matter of law on the

pleadings and having to spend resources at trial to prove materiality.'^^

For our purposes the key to Justice Marshall's opinion hes in the

identity of the plaintiff. The initiator of the suit was Northway, Inc.,

which held 2,000 shares of TSC stock. Although all the omissions from
the proxy statement about which Northway complained seemed to be

material even by the more restrictive definition laid down by Justice
Marshall, substantially all the omitted facts must have been known to
a corporate investor like Northway, presumably the recipient of so-

phisticated investment advice. For example, one omission was that Na-

tional Industries, which was on one side of the transaction to be voted

on, controlled TSC Industries, which was the other party to the trans-
action, and whose shareholders were asked to vote. Thus Northway was

using an impHed cause of action based upon inadequate disclosure not

because it had been misled, but simply to buttress its case; use of the

materiality doctrine (although the elements of the doctrine may have
been satisfied) did not seem to square with the motivation for the suit.

Whatever the reasons and motivations for the Supreme Court's swing

from idealism to traditionahsm'^^—a swing so strong as to carry with
it Justice Brennan in Cort v. Ash and Justice Marshall in TSC Industries—
the key respect in which traditionahsm has specifically affected rule

lOb-5's application to insider trading is the necessity for finding that

the defendants have violated some duty owed under state law (e.g., the
fiduciary duty that officers and directors owe to the corporation and
its shareholders). ''° Violation of a duty under state law as a precondition

to liability under rule lOb-5 for insider trading is illustrated by Justice

Powell's opinions for the majority in two key cases: Chiarella v. United

States''' and Dirks v. SEC."^

'««For example, in TSC Industries, Inc. v. Northway, Inc., 512 F.2d 324 (7th Cir. 1974),
the district court denied Northway's motion for summary judgment on the issue of liability,

but the court of appeals reversed, holding the omissions material as a matter of law. The

actual decision of the Supreme Court was to reverse the court of appeals and hold that

Northway was not entitled to summary judgment on the issue of liability.

"®Another reason for containing rule lOb-5 litigation was that the problems of damages

in private suits proved to be quite formidable. For example, unlike the plaintiff, the defendant

in a rule lOb-5 suit need not have been a purchaser or seller. But even if he was, the

defendant may have only traded a small number of shares. The damages the plaintiff alleged
to have suffered might be disproportionate to the defendant's gain (if one existed). Were

damages in such suits to be limited to the defendant's gain, or was the plaintiff to be allowed

the full amount of his alleged loss?

"°For an excellent exploration of this aspect of traditionalism, see Langevoort, supra

note 56.

'"445 U.S. 222 (1980).

"^463 U.S. 646 (1983).



646 INDIANA LAW REVIEW [Vol. 21:625

Chiarella was an employee of Pandik Press, a financial printer that,

inter alia, printed tender offer statements. Although the names of the

tender offer targets were omitted from the various printer's proofs until

the very last printing, Chiarella was able to determine certain tender

offer targets on the basis of the information presented in the tender

offer statement. Chiarella then purchased the stock, or call options that

enabled him to purchase the stock at a set price, of the tender offer

targets at a price that did not yet reflect the high probability, or even

in some cases the certainty, of a tender offer being made for the shares
of stock. The United States successfully brought a criminal suit against

Chiarella on the basis of rule lOb-5,'^^ and his conviction was sustained

by the Second Circuit Court of Appeals. '^"^ But the Supreme Court, per

Justice Powell, reversed, holding that the mere trading on the basis of

information unknown to the marketplace could not constitute a violation
of rule lOb-5.'^^ Justice Powell specifically rejected the "ideaUst" current

that had dominated the Court of Appeals' opinion:

Its decision thus rested solely upon its belief that the federal

securities laws have "created a system providing equal access to

information necessary for reasoned and intelligent investment

decisions." The use by anyone of material information not

generally available is fraudulent, this theory suggests, because

such information gives certain buyers or sellers an unfair ad-

vantage over less informed buyers and sellers.'*^

Rather, what is required is "the element ... to make silence fraudulent

—

a duty to disclose . . . ."'•' And that duty must be found in law other
than rule lOb-5 itself. For example, to consider the paradigm case of

conduct that would violate rule lOb-5—the corporate officer or director
who profits by the use of information confidential to the corporation
and known to him because of his officership or directorship—there
would be a breach of his fiduciary duty as an officer or director to

use the corporate property (including any information) for the benefit

of the corporation and its shareholders rather than himself.''^ But Chi-

arella, of course, was not an insider, that is, an officer or director,

having fiduciary duties under state law. Nor did he, as in the case of
many tippees, get his information from such an insider, for even the

"H50 F. Supp. 95 (S.D.N.H. 1978).
"^588 F.2d 1358 (2d Cir. 1978).

"^445 U.S. 222 (1980).

''"Id. at 232.

"Vcf. (emphasis added).

"*See Phillips, Managerial Misuse of Property: The Synthesizing Thread in Corporate

Doctrine, 32 Rutgers L. Rev. 184 (1979).



1988] lOb-5 JURISPRUDENCE 641

tender offeror could not be considered an "insider." In Justice Powell's

opinion, the government failed to allege (and thus, a fortiori, to prove)

violation of any other duty.

Chiarella thus put to rest the most expansive reading of rule

lOb-5—much of it derived from the Second Circuit's landmark decision
in SEC V. Texas Gulf Sulphur^^^—that rule lOb-5 itself was the source
of a duty to abstain from trading or to disclose the information on

which one wanted to trade.

Dirks V. SEC,^^^ unlike Chiarella, did involve a corporate insider

having fiduciary duties under state law. However, the insider, Secrist,

was viewed as not having violated any duties because his own motivation
was to expose rather than to profit. In his opinion for the Court, Justice

Powell again articulated his '* duty"-dependent analysis, this time in

regard to the liability of a tippee.^^' There was no doubt that Dirks had

both used, and profited from, the use of inside information. However,

Powell held that use and profit from inside information, by themselves,

could not spell liability. Rather, the tippee's liability depended upon the
breach of fiduciary duty by the corporate insider and upon the tippee's

knowledge of that breach. In this particular case, according to Justice

Powell, Secrist had not breached his fiduciary duty because he had not

exposed the fraud for personal gain. Quite the contrary, one could argue

that Secrist had acted most properly in trying to expose the fraud.

Traditionalism, then, looks to state law. First and foremost it looks

to the state law of fraud as the central focus of rule lOb-5; hence the

very strong scienter requirement and the emphasis that the thrust of a

complaint must allege a disclosure problem, not other conduct that is

allegedly unfair or even fraudulent in a vernacular sense. But tradi-

tionalism also looks to other state law. Most importantly, with respect

to rule lOb-5 regulation of insider trading, it looks to the state law of

agency. In most cases, this will involve a reference to the state law of

fiduciary duties. The necessity for finding a violation of a duty on

grounds other than the use of information unknown to others in the
marketplace puts traditionalism at odds with, and explains the charac-

terization of it as a reaction against, idealism.

Nor is this emphasis upon violation of duties an abstract proposition.
The traditionalist judge would want to see a direct nexus between the

violation of the duty and the act that allows prosecution to be based,

or suit to be brought, pursuant to rule lOb-5, that is, the purchase or

"''401 F.2d 833 (2d Cir. 1968), cert, denied, 394 U.S. 976 (1969).
'^°463 U.S. 646 (1983). For a discussion of Dirks, see supra text accompanying notes

31-37.

'^'Note that Dirks can be considered both a tippee—from Secrist, the insider—and a
tipper—to his institutional clients who had profited by his research unknown to the marketplace.



648 INDIANA LAW REVIEW [Vol. 21:625

sale of securities. Given the reluctance of state law to grant relief even

in instances of insider trading where the party purchasing or selling

securities on the basis of inside information is a true insider, and given
the strong attraction of traditionalism for state law, it is quite incon-

ceivable that the traditionalist judge would apply rule lOb-5 to the non-

traditional context presented by Carpenter. To hold otherwise would
undermine the authority of the Sante Fe case, one of the icons of
traditionahst rule lOb-5 jurisprudence. Thus, we can safely speculate that
those justices on the Court who have actively promoted this current of
thought in their opinions, such as Chief Justice Rehnquist and Justice

White, voted not to sustain the convictions in Carpenter on rule 10b-

5 grounds.

C. Economic Behaviorism

Every current we have identified has a behavioral dimension. We
have seen that one of the primary functions of traditionalism, placed

in historical context, was to deter the initiation of litigation based on
implied causes of action such as rule lOb-5. This is not to say, of course,

that traditionalists have always been frank in espousing that goal. In

contrast, idealists quite openly aspire to modify the behavior of actors

outside the litigation context. Idealism seeks to promote the disclosure

of information or, lacking fulfillment of that objective, to deter trades

in which the participants lack parity of information. ^^^

Like ideahsm, another current
—*

'economic behaviorism"—is directed
to conduct outside litigation. UnUke idealism and traditionalism, however,
this current does not view insider trading, or litigation based upon its
occurrence, as necessarily positive or negative. Economic behaviorism
considers the law of insider trading as bearing on the production of
information. ^2^ The ability to trade on the basis of information unknown
to others in the marketplace may stimulate the production of information.
In that respect, insider trading should not necessarily be discouraged.

On the other hand, not all use of information is desirable. If one party
has property rights in certain information, its use in a trading or other

context by another will be a theft of that information. Unless deterred,

that trading lessens the value of the information to its owner and,

indirectly, discourages its original creation. The task of the law, then,
becomes drawing the Hne that differentiates the legal from the illegal
in such a way as to encourage the creation and use of information that
is socially productive. Unhke idealism and traditionalism, economic be-

^^See Seligman, supra note 16.

^^^See Easterbrook, Insider Trading, Secret Agents, Evidentiary Privileges, and the Pro-

duction of Information, 1981 Sup. Ct. Rev. 309 (1981).



1988] lOb-5 JURISPRUDENCE 649

haviorism is neither inherently expansionary nor restrictive. It may lead
to findings of liability in certain cases and conclusions that rule lOb-5

has not been violated in others.

To illustrate this economic behaviorist view and its differences from
both idealism and traditionalism, consider three examples: first, the

corporate insider who, knowing of a corporate development before the

disclosure of information to the marketplace, trades on that information;

second, the printing employee who determines from materials he is
printing that a tender offer is to be made for a particular target and
profits from that insight; and third, the security analyst who, on the

basis of his research and thought-processes, determines that a particular

security is overvalued and, for profit, conmiunicates that information

to his clients prior to disclosing his conclusions to the marketplace as

a whole.

A strict economic behaviorist, i.e., one who determines the legality
of insider trading on economic behavioral considerations alone, might

either condone or condemn the insider's trading in the first of these
three examples. Before arriving at the ultimate question of legality, the

behaviorist would want to know answers to certain questions. Is the
ability to trade on the basis of inside information an incentive for the

insider to have developed the information in the first place? Does the

corporation indirectly get the benefit through the ability to compensate

such an officer at a level lower than he would otherwise demand for
his services? '^"^ Is any reduction in pay at least equal to the value the

information would have to the corporation if the insider had not exploited

the information for trading purposes? Finally, does either a rule that

allows the insider to trade or one that forbids trading offer advantages

in reducing the cost of transacting between the corporation and the

insider? Although certain academics have advocated economic be-

haviorism even as applied to the insider in this example, ^^^ no present

justice of the Supreme Court has openly equated economic behaviorism

with the law that should be applied to such facts. Nonetheless, the

academic literature has influenced the court, and that influence has been

felt in judicial reactions to the other two examples posed.

The second example, the printer who profits on the basis of in-
formation about a tender offer target, resembles in rough outline the

facts of Chiarella v. United States. ^^^ I have already alluded to the ideaHst

dissents in Chiarella^^'^ and the traditionalism voiced by Justice Powell

^^See Cox, supra note 57, at 488-92; Haddock & Macey, supra note 57, at 1460-62.
'^^See, e.g., Carlton & Fischel, supra note 57, at 867-68.
'^445 U.S. 222 (1980).

'^M at 245-52. See also supra text accompanying notes 28-32.



650 INDIANA LAW REVIEW [Vol. 21:625

in his majority opinion. ^^^ Chief Justice Burger's dissent '^^ illustrates an

economic behaviorist position. Unlike the idealists, Burger would neither

try nor even want to rectify all informational inequalities between sellers

and buyers. On this score, he agreed with Justice Powell that, '*[a]s a
general rule, neither party to an arm's-length business transaction has

an obligation to disclose information to the other unless the parties

stand in some confidential or fiduciary relation. "*^° However, unHke the
traditionalist who would justify the necessity for finding a violation of
a duty primarily on the basis that state law incorporates such a re-
quirement. Burger justified such a limitation of hability in terms of its

incentive effects: "This rule permits a businessman to capitaHze on his
experience and skill in securing and evaluating relevant information; it

provides incentive for hard work, careful analysis, and astute fore-

casting. "^^^ Why, then, did Burger dissent? That is, why would he have
upheld Chiarella's conviction?

Chief Justice Burger's economic behaviorism led him to suggest one
version of the misappropriation theory. ^^^ If the basis for concluding

that there is no Uability generally is the desire to influence the behavior

of the transactor, then surely there are some situations where the securing
and evaluating of relevant information are not the product of superior

skill and experience and, indeed, should be discouraged:

[TJhe poHcies that underlie the rule also should Hmit its scope.

In particular, the rule [of no liability generally] should give way
when an informational advantage is obtained, not by superior
experience, foresight, or industry, but by some unlawful means.

[The conduct of] [a]n investor who purchases securities on
the basis of misappropriated nonpubHc information . . . quite
clearly serves no useful function except his own enrichment at
the expense of others.*"

Chief Justice Burger thus, "would read § 10(b) and Rule lOb-5 to en-
compass and build on this principle: to mean that a person who has
misappropriated nonpubHc information has an absolute duty to disclose
that information or to refrain from trading. "'^'^

^^See supra text accompanying notes 111-18.

'^445 U.S. at 239-44.

'^M at 239-40.
'''Id. at 240.

'^^See generally Aldave, supra note 2, at 101

'"445 U.S. at 240-41.

'^/c?. at 240.



1988] lOb-5 JURISPRUDENCE 651

Chiarella did misappropriate information from his employer. Fi-

nancial printers must observe the confidentiality of their clients. Without

that confidentiality, news would leak to the markets, often to the preju-

dice of the client. Hence, the financial printer with a reputation for

leaking information is hardly a printer with bright prospects. But Chief

Justice Burger* s articulation of the duty owed and therefore breached

—

particularly his use of the phrase, '*an absolute duty to disclose"-—

implied that the printing employee owed a duty that extended well beyond

the printer's employer or even the employer's client, the tender offeror.

Once having failed to refrain from trading, the printer offended a duty

of disclosure owed to the investing public, or at least a subset of that
investing public consisting of the target corporation's shareholders who
had sold their stock. ^^^

Consider now the third example, that of the investment analyst who
investigates and concludes on the basis of his investigation that a security

is either over- or undervalued by the marketplace and communicates

that judgment to his clients prior to disclosing it to the public at large.

While the security analyst may trade or advise others to trade on the
basis of inside information, one may argue that the production of
information leads to better investment decisions and promotes allocational

efficiency. Because the production of information is considered a positive

good, the judge approaching the question from the production of in-

formation perspective would tend to find that this use of inside infor-

mation is not illegal. Without the ability to use the information, there

simply would not be an incentive to produce the information.

The third example is based on the facts of Dirks v. SEC.^^^ I have

already referred to the idealist dissent in Dirks by Justices Blackmun,

Brennan and MarshalP^^ and to the traditionahst basis of Justice Powell's

majority opinion that exonerated Dirks, the investment analyst, from

liability.
'^^ Part of Powell's reasoning, however, seemed to have been

influenced by Chief Justice Burger's earlier expressed economic behav-

iorism:

Imposing a duty to disclose or abstain solely because a person

knowingly receives material nonpublic information from an in-

sider and trades on it could have an inhibiting influence on the

role of market analysts, which the SEC itself recognized is
necessary to the preservation of a healthy market. It is com-

'^^At least one prominent academic authority supports Burger's conception of the mis-

appropriation theory. See Langevoort, supra note 56.

'^463 U.S. 646 (1983).

^^^See supra text accompanying notes 31-37.

''^See supra text accompanying notes 120-21.



652 INDIANA LAW REVIEW [Vol. 21:625

monplace for analysts to "ferret out and analyze information,"

. . . and this often is done by meeting with and questioning

corporate officers and others who are insiders. And information
that the analysts obtain normally may be the basis for judgments
as to the market worth of a corporation's securities. The analysts'
judgment in this respect is made available in market letters or
otherwise to clients of the firm. It is the nature of this type of

information, and indeed of the markets themselves, that such

information cannot be made simultaneously available to all of
the corporation's stockholders or the public generally. '^^

Were Chief Justice Burger still on the Supreme Court, it seems clear
that he would have voted to sustain the conviction of Winans and the

tippees involved in the Carpenter case on rule lOb-5 grounds. In fact,

the government's theory in Carpenter, that Winans breached the duty

he owed to his employer, the Wall Street Journal, is less embracing
than Burger's conception that Chiarella owed both a duty of silence

towards his employer and, once having violated the duty of silence, a

duty of disclosure towards investors in the marketplace. The government's
theory could only be used to justify civil or criminal enforcement actions

brought by the government itself. In contrast. Burger's theory would

seem to allow private investors to initiate causes of action against the

misappropriator. It seems clear, however, that no one presently sitting

on the Court, with the possible exception of Justice Scalia,'"*^ whose

views on this subject are presently unknown, has adopted economic

behaviorism in the form espoused by Burger. Hence, despite economic

behaviorism's influence on decisions that are primarily grounded upon

other currents, particularly traditionalism, I cannot conclude that eco-

nomic behaviorism contributed a fourth vote in favor of the convictions

in Carpenter.

D. Paradigm Case Analysis

Three additional recognizable currents represent general approaches

to interpreting statutes or administrative regulations more than they reflect
any substantive positions about regulating insider trading by means of

rule lOb-5. In this regard, they differ from idealism and economic

behaviorism, and even traditionalism, when account is taken of the
latter' s bias against the expansion of federal law to matters traditionally

within state law. I term the first of these modes of statutory interpretation

"paradigm case analysis."

'^'463 U.S. at 658-59 (citations and footnotes omitted).

'"^See infra note 198.



1988] lOb-5 JURISPRUDENCE 653

To analyze on the basis of paradigm cases is a particular mode of
deriving the legislative or administrative intent behind a statutory pro-

vision or administrative rule. First, the approach involves conceptualizing

the dominant paradigm to which the provision was directed, i.e., what

factual situation did the legislators have in mind when they drafted the
particular provision? The second step is to adjudge how congruent with
that paradigm are the actual facts of a given case. The closer the

congruence, the more the adherent of paradigm case analysis is prepared

to say the provision covers the case; the greater the dissimilarity between

paradigm and facts, the more one following this interpretive approach
would tend to conclude that the statutory or administrative provision

does not cover the situation.

To illustrate paradigm case analysis, first consider this interpretive
methodology in the opinions of Justice Stephens in Landreth Timber

Co. V. Landreth^'*^ and Gould v. Ruefenacht,^'^^ two rule lOb-5 cases
that did not concern insider trading. Then I will speculate about the
position that Justice Stevens probably took in Carpenter. That speculation

is, to some degree, informed by his concurring opinion in Chiarella.^'^^

Landreth involved the purchase of a lumber business in the State

of Washington by a Massachusetts attorney and other parties. The owner-

seller was to remain as a consultant. The transaction was to be accom-

plished through a sale of 100 percent of the common stock of the
corporation. The facts of Gould differ somewhat, in that only 50 percent

of the corporate stock was to be sold, with the purchaser to take on

some of the chores of the business while retaining his old job. But the

similarities between the two cases seemingly dwarfed their differences.

Although both acquisitions formally involved the sale of shares of stock,

a more realistic depiction of each was that a business, or a large portion

of a business, had been purchased and that the stock transfer, probably

selected for tax or recording purposes, provided the means. In each

situation the purchaser contended that misrepresentations had been made
to him, and sued, inter alia, for damages pursuant to rule lOb-5.

The issue before the Court was whether these cases really involved

the sale of "securities," a misrepresentation as to which would give rise

to various remedies under the Securities Act of 1933 and the Securities

Exchange Act of 1934, including relief under rule lOb-5. Under circum-

stances similar to the facts of Landreth and Gould, several Courts of

Appeals had propounded a *'sale of business" doctrine which would

•'"471 U.S. 681, 697 (1985) (Stevens, J., dissenting).

''Hl\ U.S. 701, 706 (1985) (Stevens, J., dissenting).

•«Chiarella v. United States, 445 U.S. 222, 237 (1980).



654 INDIANA LAW REVIEW [Vol. 21:625

exclude the reach of the Securities Acts to this kind of transaction.*"*^

The theory underlying this doctrine is, quite simply, that what is really

being sold is a business, not securities. The transfer of securities is

simply the means by which title to the business is transferred. Indeed,

the Ninth Circuit denied relief to the purchasers in Landreth on this

basis. '^^

The majority of the Supreme Court rejected the *'sale of business"

doctrine, holding that the purchasers did indeed have remedies under

the federal Securities Acts. I will discuss shortly the current in which

the majority's reasoning fits. Justice Stevens was the lone dissenter. In

effect, he reasoned from two paradigms, two models of facts towards

which the Securities Acts' remedies were directed. The first of these

paradigms was "transactions in securities that are traded in a public

market. "'"^^ Such transactions were clearly covered by the reach of the

Acts. But even if they were not, a second paradigm consisted of a

transaction involving '*an investor who is not in a position to negotiate
appropriate contractual warranties and to insist on access to inside

information before consummating the transaction."'"*^ Although Justice

Stevens did not as clearly state that this paradigm was intended to be

covered by the Securities Acts' reach, '"*^ he did not have to confront

'^5ee King v. Winkler, 673 F.2d 342, 345 (11th Cir. 1982) ("[t]he 'economic realities'

of the transaction indicate not a security transaction, but rather the sale and purchase of a

business using stock merely as a method of vesting the . . . [purchaser] with total ownership");

Frederiksen v. Poloway, 637 F.2d 1147 (7th Cir.), cert, denied, 451 U.S. 1017 (1981) (sale

of 1(X)% of the stock, and assumption of control over marina); Chandler v. Kew, Inc., 691

F.2d 443 (10th Qr. 1977) (sale of liquor store by transfer of stock). But see Daily v. Morgan,

701 F.2d 496 (5th Cir. 1983) (purchase of all shares of stock and assumption of managerial

control of truck dealership held to be a securities transaction); Golden v. Garafalo, 678 F.2d

1139 (2nd Cir. 1982) (purchase of l(X)97o of outstanding stock of corporation engaged in

ticket brokerage business); Coffin v. Polishing Machines, Inc., 596 F,2d 1202 (4th Cir.), cert,

denied, 444 U.S. 868 (1979) (purchase of 50% of corporate stock and entry into corporation
as executive vice-president).

'^^Landreth Timber Co. v. Landreth, 731 F.2d 1348 (9th Cir. 1984).

'^Landreth Lumber Co. v. Landreth, 471 U.S. 681, 698 (1985) (Stevens, J., dissenting).

'''Id. at 699.

"^At one point in his dissent, Justice Stevens hints that only the first paradigm was

intended to be covered by Congress:

I am not persuaded, however, that Congress intended to cover negotiated transactions
involving the sale of control of a business whose securities have never been offered

or sold in any public market. In the latter cases, it is only a matter of interest

to the parties whether the transaction takes the form of a sale of stock or a sale

of assets, and the decision usually hinges on matters that are irrelevant to the

federal securities laws such as tax liabilities, the assignability of Government licenses

or other intangible assets, and the allocation of the accrued or unknown liabilities

of the going concern.

Id. This formulation would seem to include the first paradigm, but exclude the second. Yet,



1988] lOb-5 JURISPRUDENCE 655

the legitimacy of applying the Acts to the second paradigm because the

facts of Landreth and Gould differed substantially from both paradigms.
How might one who argues from paradigm cases confront the cutting

edge of insider trading cases, such as Carpenterl One would first, as
Justice Stevens did in the Landreth and Gould cases, construct a paradigm
or paradigms to which rule lOb-5 is directed, and, second, measure in

at least a rough way the degree of similarity between such paradigms
and the facts of the given case. What would such paradigms concerning
insider trading appear to be? The most clear-cut would consist of the

corporate insider—officer, director or other employee having a fiduciary
duty not to trade on the basis of inside information—who either purchases
or sells stock to the plaintiff in the case without disclosing the inside

information to the other party. Another paradigm, only one step removed

from the first, would consist of a tippee from an insider, knowing that

the insider was breaching his duty by disclosing such inside information

to him, trading with another on the basis of such information.'"*^

The facts of Carpenter, like those of Chiarella, fell within neither

paradigm. Winans, the Wall Street Journal reporter, was neither an

insider of the corporation whose stock was traded nor, presumably, a

tippee of such insiders. Carpenter, a co-defendant with Winans and his

lover, and Felis, another co-defendant, were tippees, but they were tippees

from Winans alone.

Significantly, Justice Stevens concurred in Chiarella. In his concur-

rence, Stevens displayed unease with the extent to which the facts of

Chiarella departed from traditional paradigms of liability. He explicitly
rejected Chief Justice Burger's analysis that when Chiarella "bought
securities in the open market, he violated ... a duty to disclose owed
to the sellers from whom he purchased target company stock. "'^<^ Yet,
Stevens did suggest, without himself adopting, a version of the mis-

appropriation theory that the government later used to prosecute Winans

and his tippees in Carpenter. He opined that "[t]he Court correctly [did]
not address . . . whether the petitioner's breach of his duty of silence

—

a duty he unquestionably owed to his employer and to his employer's

at another point, Justice Stevens stated:

In short, I would hold that the antifraud provisions of the federal securities laws

are inapplicable unless the transaction involves (i) the sale of a security that is

traded in a public market; or (ii) an investor who is not in a position to negotiate
appropriate contractual warranties and to insist on access to inside information

before consummating the transaction.

Id. This statement of the propriety of remedial relief under the Securities Acts would include

facts falling within both paradigms.

'^^See Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, 495 F.2d 228 (2nd Cir. 1974).
'^Chiarella v. United States, 445 U.S. 222, 237 (1980) (Stevens, J., concurring).



656 INDIANA LAW REVIEW [Vol. 21:625

customers—could give rise to criminal liability under Rule lOb-5."'^'
Stevens was not then prepared to adopt his own suggestion because,
'inasmuch as those companies [the tender offerors] would not be able

to recover damages from petitioner for violating Rule lOb-5 because

they were neither purchasers nor sellers of target company securities,
... it could also be argued that no actionable violation of Rule 10b-

5 had occurred.'' '"

It is unclear how Justice Stevens voted in Carpenter. If Stevens
would have reversed the convictions under rule lOb-5, the reason would

have been that the facts of Carpenter differed materially from those

paradigms to which rule lOb-5 is applied most comfortably. If, on the

other hand, Stevens did vote to uphold the convictions on rule lOb-5

grounds, that vote would mean that he managed to dispel the doubts
he had raised in Chiarella. He would, in effect, have constructed a third
paradigm of rule lOb-5 liability: the party who steals information from
one party and uses it to profit against another. Facts falling within this

third paradigm could give rise to criminal Hability, but not civil suits

on the part of the sellers or purchasers of the securities.

E. Literalism

Another current that represents a theory of statutory interpretation

is
*

'literalism." It has had a large impact on rule lOb-5 cases generally, '^^

although thus far its influence on that subset of rule lOb-5 cases dealing

with insider trading has been subtle. Among the justices whose opinions
have evinced literalism are Justices O'Connor, Powell and arguably

White.

For example. Justice Powell wrote the majority opinion in Landreth

to which Justice Stevens dissented. Having reviewed the facts and pro-

cedural history of the case, Powell initiated his legal discussion with the

axiom *'that '[t]he starting point in every case involving construction of

a statute is the language itself.' "'^'^ From axiomatic statement to holding

'^'/(C/. at 238. Despite Justice Stevens' reservations, at least one prominent scholar (see

Aldave, supra note 2) and the Second Circuit Court of Appeals {see, e.g.. Moss v. Morgan

Stanley, 719 F.2d 5 (2d Cir. 1983)) have advocated or adopted, as the case may be, Stevens'
suggested version of the misappropriation theory, vk^hich emphasizes a duty of silence owed

to one's employer rather than any purported duty of disclosure owed to others (such as had

been suggested by Chief Justice Burger).

^^^Id. One can sense Justice Stevens' struggle by his comment in a footnote at that

point: "the limitation on the right to recover pecuniary damages in a private action identified

in Blue Chip Stamp is not necessarily coextensive with the limits of the rule itself." Id.

'"5ee Conard, supra note 96, at 210-12.

'^Landreth Timber Co. v. Landreth, 471 U.S. 681, 685 (1984) (quoting Blue Chip Stamps

V. Manor Drug Stores, 421 U.S. 723, 756 (1975) (Powell, J., concurring)).



1988] lOb-5 JURISPRUDENCE 657

became a brief exercise: "the plain meaning of the statutory definition

mandates that the stock be treated as 'securities' subject to the coverage

of the Acts."^^^ While Powell gave some consideration to statutory

purpose, the reference to purpose seemed more in the nature of a rebuttal

of those arguments tendered in support of "the sale of business" doctrine.

Two of Justice O'Connor's recent opinions in rule lOb-5 cases reflect
the same paramountcy of language as an index of statutory intent. In

Randall v. Loftsgaarden,^^^ a 1986 case, the Supreme Court was con-

fronted with the issue of whether tax benefits received by investors

should be used to reduce their awards in actions to rescind the sale of

limited partnership interests. The plaintiffs based their claims both on

Section 12(2) of the Securities Act of 1933,'^^ which explicitly grants a

right of rescission for misleading statements or material omissions in a

prospectus, and on rule lOb-5. The allegation in the case was that

statements made in connection with the limited partnership interests were
false, '^^ and the project in which interests were sold in fact became

bankrupt. While Section 12(2)'s right of rescission allows for recovery

of "the consideration paid for such security with interest thereon," it

also provides that "the amount of any income received thereon" is to

be deducted from the recovery. The defendants argued that the plaintiffs

had invested primarily for tax considerations, so that their out-of-pocket

loss was but a miniscule percentage of the consideration they had tendered

for their interests. The first part of Justice O'Connor's opinion thus

concerned whether "any income received thereon" in section 12(2) should

be construed to include tax benefits gained from the investment. Justice

O'Connor answered this question in the negative, relying, as had Justice

Powell in the Landreth case, almost exclusively on the "plain meaning"

rule. 1^9

'''Landreth at 687.

'^406 S. Ct. 3143 (1986).

'^n5 U.S.C. § 771(2) (1982).

i^spor example, it was alleged that the availability of financing, the terms of the land

lease, and the manner and extent of the compensation for services rendered were mischar-

acterized. 106 S. Ct. at 3147.

'^^Justice O'Connor stated:

Here, as in other contexts, the starting point in construing a statute is the language

of the statute itself. . . . Moreover, "if the language of a provision of the securities

laws is sufficiently clear in its context and not at odds with the legislative history,

it is unnecessary 'to examine the additional considerations of "policy" . . . that

may have influenced the lawmakers in their formulation of the statute.' " Section

12(2), we think, speaks with the clarity necessary to invoke this "plain language"

canon .... [S]uch [tax] benefits cannot, under any reasonable definition, be termed

"income."

106 S. Q. at 3150 (citations omitted).



658 INDIANA LAW REVIEW [Vol. 21:625

The rule lOb-5 claim for rescission could not be settled so easily
by looking at the "plain meaning" of the language. Section 28(a) of

the Securities Exchange Act, in fact, limits damages for causes of action

brought under that Act to "actual damages, "'^^ a phrase which, when
taken in the vernacular, would seem to require that such matters as tax

benefits be considered in any award. But with respect to the 10(b) claim.

Justice O'Connor argued for the desirability of interpreting both section

12(2) and rule lOb-5 similarly with respect to rescissionary damages. '^^

Significantly, recognizing that her resolution of the two issues would

grant a windfall to the suing investors, Justice O'Connor laced both
her section 12(2) and section 10(b) discussions with the idealist element

of deterrence:

The effect of allowing a tax benefit offset . . . [and] resulting
diminution in the incentives for tax shelter promoters to comply

with the federal securities laws would seriously impair the de-

terrent value of private rights of action, which, we have em-
phasized, "provides 'a most effective weapon in the enforcement'
of the securities laws and are a 'necessary supplement to Com-
mission action.' "'^^

Literalism also colored Justice O'Connor's recent majority opinion

in Shearson/American Express, Inc. v. McMahon.^^^ The case presented
the issue of whether a provision in the agreement between a customer

and her brokerage firm that all disputes shall be submitted to arbitration

is binding even as to rule lOb-5 and RICO'^ claims. The customer's
argument depended, in part, on the combination of sections 29(a) and

27 of the Securities Exchange Act. The former section declares void
"[a]ny condition, stipulation, or provision binding any person to waive

compHance with any provision of [the Act],"*^^ while the latter section
provides that "[tjhe district courts of the United States . . . shall have

'«^15 U.S.C. § 78bb(a) (1982).

'^'This is a mode of statutory construction I term, "textual structuralism," See infra
text accompanying notes 170-83. Justice O'Connor stated:

When section 28(a) was enacted section 12(2) stood as a conspicuous example of
a rescissionary remedy, and we have found that Congress did not intend that a
recovery in rescission under section 12(2) be reduced by tax benefits received.

Accordingly, we think section 28(a) should not be read to compel a different result
where rescissionary damages are obtained under section 10(b).

106 S. a. at 3153.
•*^M at 3154 (quoting Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299

(1985), which in turn quoted J.I. Case Co. v. Borak, 377 U.S. 426 (1964)).
'"107 S. Ct. 2332 (1987).

•"18 U.S.C. § 1961 et seq. (1982).
'«15 U.S.C. § 78cc(a) (1982).



1988] lOb-5 JURISPRUDENCE 659

exclusive jurisdiction of violations of this chapter or the rules and

regulations thereunder, and of all suits in equity and actions at law

brought to enforce any liability or duty created by this chapter or the

rules and regulations thereunder. '*^^ The plaintiff argued that in light
of section 27, the agreement to arbitrate constituted a waiver in violation

of section 29(a). But, again, Justice O'Connor made reference to "the
statute's plain language," distinguishing a waiver of '^compliance" of

a substantive claim from a waiver of a right to a particular forum. *^^

The plaintiff-customer also relied upon the idealist consideration that
requiring submission of such disputes to arbitration would diminish the

deterrent effect of such causes of action. In Shearson/American Express,

unlike in Randall, however. Justice O'Connor seemed unmoved by this
consideration.'^^

As this brief review of the literalist mode of construing statutes
indicates, it is difficult to interpret literalism as a philosophy that nec-

essarily favors or disfavors rule lOb-5 claims. In this regard, it differs

sharply from the Court's idealism of the late sixties and early seventies

and the traditionalism evinced by decisions in the later seventies, although

Justice O'Connor, to support her opinion, does not aver to cite either

idealist or traditionalist opinions to buttress her literalist interpretation.

Nonetheless, despite this seeming "neutrality," it is more than Hkely

that those disposed towards literalist interpretations would not have

sustained the convictions in Carpenter on rule lOb-5 grounds. To an
avowed literaUst such as Justice O'Connor, the case against application

of rule lOb-5 in Carpenter is, quite simply, that it would be an extension

beyond existing Supreme Court jurisprudence not required by the stat-

utory language. In Justice White's case, literalism as a judicial philosophy

would have strengthened his traditionalist leanings and insured a decision

not to sustain the convictions on the rule lOb-5 grounds. Furthermore,

although Justice Powell no longer sits on the Court, the praise lavished

upon him upon his retirement suggests that literaHsm has attained a
legitimacy among many observers. '^^

'**/af. § 78aa.

^^^Shearson/American Express, 107 S. Ct. at 234?,

'^Justice O'Connor is not alone in depending upon a "literalist" interpretation. Justice

White, joined by Chief Justice Burger and then Justice Rehnquist showed sympathy for the

same mode of interpretation in another, recent securities law case that did not concern rule
lOb-5. See Lowe v. SEC, 472 U.S. 181, 211 (1985) (White, J., concurring).

'*^uch legitimacy is hardly justified. In many if not most cases the meaning of statutory

language is hardly "plain"; reasonable people can and do disagree as to that meaning. See

Murphy, Old Maxims Never Die: The "Plain-Meaning Rule" and Statutory Interpretation in

the "Modern" Federal Courts, 15 Colum. L. Rev. 1299 (1975). In addition the literalist

would seem to prefer to hide from the difficult policy judgments inherent in the cases coming

before the Court, rather than own up to the fact that, whether overtly or covertly, the Court
necessarily makes such judgments.



660 INDIANA LAW REVIEW [Vol. 21:625

F. Textual Structuralism

Textual structuralism is an interpretive strategy that emphasizes the

desirability of having different sections of the same statute, or related

statutes and other bodies of law, be interpreted as a whole. The objective

is that each provision, as interpreted, not only make sense in itself, but
also logically and purposefully relate to other provisions of the relevant

legal framework. As appUed to rule lOb-5, this interpretive strategy calls

for determining the rule's elements, contours and defenses in a way that
promotes harmony rather than dissonance with other remedial sections

of the Securities Act of 1933 and the Securities Exchange Act of 1934,

other administrative regulations under those statutes, and the body of

case law dealing with the fraudulent sale or purchase of securities.

We already have observed one example of the use of textual struc-
turalism. In Randall v. Loftsgaarden,^''^ Justice O'Connor argued, in

part, that the plaintiffs' claims under rule lOb-5 should not be reduced

by any tax benefits received because they were not to be so reduced

under section 12(2) of the Securities Act of 1933.

Of all sitting justices, Justice Blackmun has been the strongest
advocate for textual structuralism in rule lOb-5 cases. One of his most
forceful pleas for textual structuralism appears in his dissent in Aaron
V. SEC,^^^ in which the majority held that the SEC, when suing for an
injunction under rule lOb-5, is bound by the same scienter requirement

as are private parties in a damage suit.'^^ Blackmun '*believe[d] [the

majority's] most serious error may be a failure to appreciate the structural
interrelationship among equitable remedies in the 1933 and 1934 Acts,
and to accord that interrelationship proper weight in determining the

substantive reach of the Commission's enforcement powers under § 17(a)

and § 10(b). "^^3 More specifically, Blackmun noted that the SEC is able
to secure relief against the negligent representation of sellers under section

17(a) of the Securities Act of 1933, but, as a result of the majority's

holding, unable to secure the same reUef against negligent misrepresenting

buyers under rule lOb-5. In his words, **the two statutes should operate

in harmony."'^'*

Similarly, when dissenting in Shearson/American Express, Inc. v.
McMahon,^^^ Justice Blackmun used the existence of longstanding prec-
edent that claims under section 12(2) of the Securities Act of 1933 are

'™106 S. Ct. 3143 (1986). See supra notes 156-62 and accompanying text.
•^'446 U.S. 680, 713 (1980) (Blackmun, J., dissenting).

'^^/(G?. at 689-95. See also supra notes 90-95 and accompanying text.
•^^446 U.S. at 713.

'''Id. at 715.

'"107 S. Ct. 2332, 2346 (1987) (Blackmun, J., dissenting).



1988] lOb-5 JURISPRUDENCE 661

not arbitrable as strong support that rule lOb-5 claims should not be

either J^^ In both of these cases, Blackmun, whose opinions were joined

by Justices Marshall and Brennan, also used idealist arguments such as

the need to protect the investing public. In Aaron, the idealist arguments

seemed to support textual structuralism; in Shearson/American Express,

textual structuralism supported a strongly argued idealist position.

Justice Blackmun's preference for structuralism as an interpretive

strategy surely would have reinforced his preference for idealism as a

substantive norm in Carpenter as well. To support this theory, I need
only refer to his dissenting opinion in Chiarella}'^^ Recall that the ma-

jority, per Justice Powell, reversed Chiarella's conviction because the

government had not pleaded and proved a violation by Chiarella of any

affirmative duty of disclosure owed to the sellers of the securities,'^*

but that Chief Justice Burger, in dissent, would have upheld Chiarella's

conviction based, in part, on Chiarella's misappropriation of information

from his employer, the printing company, and his employer's customers. '^^

Justice Blackmun, in contrast, dissented from the whole traditionalist

notion that one need allege and prove violation of a duty. To Blackmun,
even if Chiarella's employer had given him permission to trade on the

basis of the information about tender offers he had received by virtue

of his position as a printer, Chiarella still would have violated rule

lOb-5.

Justice Blackmun's analysis focused on the position of the federal

securities laws in the total structure of law relating to insider trading,

and the specific position of section 10(b) in the structure of the federal

securities laws. If, as did the majority, one imports into section 10(b)

and rule lOb-5 a state-law derived fiduciary duty requirement, one "places

the federal securities laws in the rearguard of . . . [a] movement"'*^ that

would allow for a greater number of instances in which investors at an

informational disadvantage could recover. Instead, the purpose of the

federal securities law is to be in the foreground, that is, "to ensure the

^''^Id. See also Wilko v. Swan, 346 U.S. 427 (1953). Speaking for the majority, Justice

O'Connor placed Wilko's continuing validity in substantial doubt but did not explicitly overrule

the case.

'^^ChiareUa v. United States, 445 U.S. 222, 245 (1980) (Blackmun, J., dissenting).

*^^See supra text accompanying notes 111-19.

'^'Once having violated the duty of silence owed to his employer, Burger also intimated

that Chiarella owed a duty of disclosure towards investors in the marketplace. See supra text

accompanying notes 129-35. Other separate opinions included those of Justice Stevens (discussed

supra notes 150-52 and accompanying text) and Justice Brennan, who agreed with Chief
Justice Burger's theory that violation of a duty to Chiarella's employer would suffice but

concurred with the majority because Burger's theory was not the one presented to the jury.

445 U.S. at 239 (Brennan, J., concurring).

'®°/(C/. at 248 (Blackmun, J., dissenting).



662 INDIANA LAW REVIEW [Vol. 21:625

fair and honest functioning of impersonal national securities markets

where common-law protections have proved inadequate. "'^^ Within the

structure of the federal securities laws, section 10(b) was designed to be

'*an intentionally elastic 'catchall' provision. "'^^ Imposition of a fiduciary

duty requirement undermines the ability of the section to fulfill that

role within the structure of the securities laws. Hence, Justice Blackmun,

dispensing with breach of a fiduciary duty as a precondition to rule

lOb-5 liability, would have held "that persons having access to confi-

dential material information that is not legally available to others generally

are prohibited by Rule lOb-5 from engaging in schemes to exploit their

structural informational advantage through trading in affected se-

curities. "^^^ Winans and his co-defendants engaged in a scheme to exploit

the informational advantage Winans enjoyed as an author of the "Heard

on the Street" column in the Wall Street Journal. The fact that Winans

was not a traditional insider would hardly have mattered to Justice

Blackmun. After all, rule lOb-5 as a "catch-all" provision within the

remedial or enforcement structure of the securities acts may play its
most important role precisely when the facts do not fit more traditional

paradigms.

II. The Competing Currents: The Future

Certain metaphors, the linear and the cyclical, that are commonly
used to describe events^^^ do not aptly convey the use and force of the

strands of thought that characterize the Supreme Court's rule lOb-5

jurisprudence. For example, the case law clearly does not evince a linear

movement from point X to point Y. Even during the latter 1970's when
traditionahsm was strongest, some justices expressed an attachment to
idealism. In the mid- 1 980' s, ideahsm, traditionalism and literalism have

all recurred in majority opinions. Nor should a cyclical metaphor be
adopted, for we have not come full circle. Expressions of idealism in
the latter 1980's do not go unchallenged as frequently as they did in

the early 1970's. Idealism has recurred in majority opinions, but it has

no monopoly on them.
Rather, a wave-Uke metaphor seems most appropriate—hence, the

term, "competing currents." The currents come, recede and come again,
not alone, but in competition with other currents. Sometimes, like ide-

'»Vrf. at 246.

'*^M at 251. It is interesting to note that Blackmun is as disturbed by "structural"

anomalies on a substantive level as with respect to statutory text. In both contexts, Blackmun

seems to be asking the question, does the particular make sense in terms of the whole?
'^See, e.g., S. Gould, Time's Arrow, Time's Cycle (1987).



1988] lOb-5 JURISPRUDENCE 663

alism in the early seventies, traditionalism in the latter seventies and

arguably literalism in today's opinions, they dominate or tend to dominate

but do not exclude the appearance of other currents. At times a particular

current first appears in a minority opinion—for example, economic
behaviorism in Chief Justice Burger's dissenting opinion in Chiarella—
only to resurface in the majority's opinion several years later. As I
noted, at least some of Justice Powell's discussion in Dirks can be traced

to Burger's discussion in Chiarella}^^

Two of the factors that correlate positively with the appearance or
even dominance of a current in the Court's opinions are the identity

of that opinion's author and the time frame in which the case comes

before the Court. True, the importance of these factors can be inflated.

Justice Brennan, for example, most often appropriately characterized as

an ideaUst,'^^ has not been averse to espousing traditionalist views. ^^^

Justice O'Connor, a literaHst, has buttressed her opinions with both

idealism'*^ and textual structuraUsm.'^^ With the caveat, then, that the

correlation between these factors and the strength of competing currents

is frequently a weak one, what if anything can be said about the future
course of the Supreme Court's jurisprudence in this area?

A number of personnel changes have occurred recently: Chief Justice
Burger and Justice Powell have retired; Justice Rehnquist has been

elevated to Chief Justice; and Justices Antonin Scalia and Anthony

Kennedy have replaced Rehnquist and Powell as Associate Justices. In
truth, very little is known about either Scalia' s or Kennedy's views with
respect to rule lOb-5 and insider trading. ^^^ Nonetheless, we can speculate
that, collectively, these changes and others that may soon come will
strengthen traditionalism and literalism and weaken idealism and textual

structuralism. Chief Justice Rehnquist is one of the foremost tradition-

alists on the Court. His ability to lead the Court by, among other
things, assigning cases to particular justices could influence case law

development over time. Scalia' s writings show a closer affinity to tra-
ditionaUsm or economic behaviorism than to any form of ideahsm.'^'

'**See supra text accompanying note 139.

'*^For example, if Justice Brennan is assigned to write the Court's opinion, as he

was in Bateman Eichler, Hill Richards, Inc. v. Berner, 472 U.S. 299 (1985), we are likely
to see an idealist expression of rule lOb-5, even if most justices join in that opinion.

'^Cort V. Ash, 422 U.S. 66 (1975). See supra text accompanying notes 67-73.

'^Randall v. Loftsgaarden, 478 U.S. 647 (1986). See supra notes 156-62 and accompanying

text.

^^See supra notes 163-68 and accompanying text.

'^'Kennedy has shown some sympathy towards implied causes of action. See, e.g., Texas

Partners v. Conrock Co., 685 F.2d 1116 (9th Cir. 1982) (reversing the district court's grant

of summary judgment for defendants in an alleged proxy violation case).

^^^See Scalia, Morality, Pragmatism and the Legal Order, 9 Harv. J.L. & Pub. Pol'y



664 INDIANA LAW REVIEW [Vol. 21:625

All three of the idealist Justices—Blackmun, Brennan and Marshall

—

reportedly have suffered physical setbacks in recent years that may induce
the retirement of one or all of them. If Blackmun retires, textual
structuralism will also lose its foremost enunciator. In contrast, at least

one outspoken literaHsts, Justice O'Connor, seems likely to remain on

the Court for some time.

At the same time, it is at least conceivable that current trends outside

the Court will induce some movement in the direction of ideaUsm,
somewhat neutralizing the personnel changes. Justices are politicians of

a kind, even though they are not elected. The Court's legitimacy ultimately
depends upon the acceptance of its opinions not only as legal documents,

but also as symbols of what is correct and incorrect. It may be that
the traditionalism of the Court in the latter 1970's presaged the political

conservatism that was demonstrated at the polls only several years later.

But, in contrast to the latter seventies, political opinion today seems

different.

Reports of certain recent insider trading cases reached a wide au-

dience, and prosecution of such trading seems very popular. ^^^ Certain

program trading activities, such as index arbitrage and portfolio insur-

ance, practiced by a relatively small number of sophisticated institutional
traders, generally are considered to have accelerated the decline in the

stock market that resulted in its collapse in October, 1987.^^^ The strong
trend towards the passage of state anti-takeover legislation*^^ is consistent

with a popular discontent with financial manipulations that seem to

make money for a few at the expense of others, *^^ regardless of the
vaHdity of that popular perception when appHed to corporate takeovers
and restructurings. Significantly, the Supreme Court encouraged the trend

by sustaining the present generation of such legislation,*^^ in contrast to

123 (1986). Scalia, without referring to rule lOb-5, seems to reject the necessary fusion of

law and morality which underlies at least some of the idealist expressions.

"^See, e.g.. Wall St. J., Feb. 13, 1987, at 1, col. 6 (details of arrests of Richard Wigton

of Kidder Peabody and Robert Freeman of Goldman Sachs for swapping information about

impending takeovers).

'^See, e.g., N.Y. Times, Feb. 3, 1988, at D4, col. 1 (excerpts from S.E.C. Report on

Factors in October Stock Market Plunge); N.Y. Times, Jan. 11, 1988, at D8, col. 1 (analysis

of Brady Commission report on stock market plunge).

"^The latest evidence of the trend is the enactment by Delaware of HB 396. See 20
Sec. Reg. & L. Rep. (BNA), 209 (Feb. 5, 1988). Delaware had previously resisted the trend.

"'This is not to say that such anti-takeover legislation results from such popular discontent.

Rather, evidence suggests that lawmakers are reacting to demands from particular constituents

such as corporations incorporated and/or operating within the borders of their states. See

Romano, The Political Economy of Takeover Statutes, 73 Va. L. Rev. Ill, 135-36 (1987).
But the popular perception might indicate why there is little if any opposition to such legislation
on the part of others.

'^See CTS Corp. v. Dynamics Corp. of America, 107 S. Ct. 1637 (1987).



1988] lOb-5 JURISPRUDENCE 665

its earlier decision about state legislation that also sought to limit take-

overs.'^ With respect to rule lOb-5 jurisprudence, therefore, we can
suspect that the Court will not totally shun idealism, with its nexus

between law and ethics, until and unless the public mood again shifts.
With personnel moving in one direction and the popular mood in

another, the currents we have identified will continue to compete against
each other. For the foreseeable future, none is likely to dominate the

Supreme Court's rule lOb-5 jurisprudence, although the majority opinion

in any particular case will reflect the predilection of the opinion's author

for one of the currents. In light of the eight member Court sitting at
the time of the decision, the four-four spHt in Carpenter was not a

surprise. Nor will be the split decisions, whether five to four or six to
three, '^^ that are Ukely to follow.

'""See Edgar v. MITE Corp., 457 U.S. 624 (1982).
"*For example, the Supreme Court recently split 4-2 in Basic Inc. v. Levinson, 108 S.

Ct. 978 (1988), in which it faced, inter alia, the issue of whether to accept the "fraud on

the market" theory in rule lOb-5 cases. That theory would allow plaintiffs who are sellers
or buyers of stock traded in market transactions to recover regardless of whether they can

prove their own particular reliance on a misleading statement or omission. The presumption
(which, depending upon one's version of the theory, might be rebuttable) is that the misleading

statement has affected the market as a whole, and hence the plaintiffs can be presumed to

have relied whether or not they actually read or heard of the statement or omission. In Basic

Inc., the corporation issued three press releases over a fourteen month period denying any

merger negotiations at a time when such negotiations were proceeding, although no deal had

then been struck. The plaintiff brought a class action against the corporation and its directors.

The class was defined as those who had sold the corporation's securities during the fourteen
month period. Justice Blackmun wrote the opinion for the majority, in which Justices Brennan,

Marshall and Stevens joined. Justice White wrote an opinion, concurring in part and dissenting

in part, joined by Justice O'Connor. White dissented from the majority's acceptance of the

fraud on the market theory. Chief Justice Rehnquist and Justices Scalia and Kennedy took

no part in the consideration of the case.

The split in Basic Inc. v. Levinson was quite predictable, although the absence of three

justices might have skewed the vote somewhat. Justices Blackmun, Brennan and Marshall

were pursuing their idealist goal, and Justice Stevens joined because the facts of Basic Inc.

fell within his dominant paradigm for the application of rule lOb-5. Justice White dissented

on traditionalist grounds, and the literalism of Justice O'Connor, a current that Justice White

also shares, dictated an alliance with traditionalism rather than idealism in the circumstances

of the case.

To Justice Blackmun, one if not the main reason for adopting the fraud on the market
theory was that "[r]equiring proof of individualized reliance from each member of the proposed
plaintiff class effectively would have prevented respondents from proceeding with a class

action, since individual issues then would have overwhelmed the common ones." Id at 989.
That resolution would discourage the initiation of such rule lOb-5 litigation. Instead, Justice

Blackmun was quite open in the fact that his goal was to "facilitat[e] . . . Rule lOb-5

litigation," Id. at 990. As an idealist. Justice Blackmun was undaunted by the fact that the

state law of fraud or deceit included a reliance element: "Actions under Rule lOb-5 are

distinct from common-law deceit and misrepresentations claims, . . . and are in part designed



666 INDIANA LAW REVIEW [Vol. 21:625

to add to the protection provided investors by the common law, ..." Id. at 990 n,22.
Significantly, Justice Blackmun laced his opinion with references to such idealist icons as

Affiliated Ute Citizens v. United States and Mills v. Electric Auto-Lite Co. See, e.g., id. at

989-90.

Justice Blackmun also added language to his opinion that would appeal to Justice Stevens'

emphasis upon paradigm cases. Recall that Justice Stevens dissented in Landreth Timber Co.

V. Landreth and Gould v. Ruefenacht primarily on the ground that the facts of those cases

differed too substantially from the prime paradigm case to which the Securities Acts were

directed: the trading of securities in market transactions. For the benefit of Justice Stevens

(and obviously because it also fit with Justice Blackmun's idealist agenda), Justice Blackmun

made reference to Justice Stevens' paradigm: 'The modem securities markets, literally involving
millions of shares changing hands daily, differ from the face-to-face transactions contemplated

by early fraud cases, and our understanding of Rule lOb-5's reliance requirement must

encompass these differences." Id.

Justice Blackmun also supported his decision by reference to economic theory supporting

the "premise that the market price of shares traded on well-developed markets reflects all

publicly available information, and, hence, any material misrepresentations." Id. at 991. Justice

Blackmun's use of economic theory demonstrates that while economic behaviorism does not

dominate the thinking of any present sitting justice, with the possible exception of Scalia,

this current has had some influence on other justices. See supra text accompanying notes

122-40.

To a traditionalist like Justice White, at least two aspects of Justice Blackmun's opinion
were quite objectionable. First and most importantly, it was anathema to White to develop

rule lOb-5 along lines that departed substantially from state law elements of fraud. In Justice

White's own words, "In general, the case law developed in this Court with respect to §
10(b) and Rule lOb-5 has been based on doctrines with which we, as judges, are familiar:

common-law doctrines of fraud and deceit." 108 S. Q. at 994. In addition. Justice White,
unlike Justice Blackmun, voiced the concern of traditionalists with the equities, or more

accurately, the lack thereof, of the suing plaintiffs: "I suspect that all too often the majority's

rule will 'lead to large judgments, payable in the last analysis by innocent investors, for the

benefit of speculators and their lawyers.' . . . This Court and others have previously recognized

that 'inexorably broadening ... the class of plaintiff[s] who may sue in this area of the law
will ultimately result in more harm than good.' " Id. Justice White cited his own traditionalist
opinion in Sante Fe Industries, Inc. v. Green for the development of rule lOb-5 along the

lines of the state law of fraud, id., and such other traditionalist touchstones as Blue Chip

Stamps V. Manor Drug Stores and Ernst & Ernst v. Hochfelder to support his suggestion
that too much litigation would be produced by the majority's decision. Id. at 999.

Justice O'Connor's attachment to literalism led her to support Justice White's tradi-

tionalism. Nothing in the statutory language supported the majority's adoption of the fraud

on the market theory.

The absence of Chief Justice Rehnquist and Justices Scalia and Kennedy obviously

changed the numbers in the majority and the dissent, but probably did not change the result.

Justice Rehnquist would probably have dissented on traditionalist grounds, and it is unknown

whether Justice Kennedy would have sided with idealism or traditionalism on the issue raised.

But Justice Scalia would have added a fifth vote for the majority's decision, not because of

any agreement with Justice Blackmun's idealism, but because of the majority's adoption of

a theory grounded in economic behaviorism. In at least one prpminent case outside the

securities law context. Justice Scalia has exphcitly pledged his allegience to economic theory

as the determinant of rights under federal law. See Boyle v. United Technologies Corp., 108



1988] lOb-5 JURISPRUDENCE 667

S. Ct. 2510 (1988) (manufacturer of helicopter that crashed held not susceptible to suit by

father of deceased Marine pilot because, inter alia, "[t]he imposition of liability on Government

contractors will directly affect the terms of the Government contracts: either the contractor

will decline to manufacture the design specified by the Government, or it will raise its price").

Id. at 2515. The only question about whether Justice Scalia would have concurred with the

idealist majority in Basics Inc. v. Levinson is whether his espousal of economic behaviorism

will carry over to contexts where the plaintiff rather than the defendant is aided by the

application of economic theory.