SDNY Judge Finds Spousal Relationship is Predicate for Insider Trading Charges Based on Misappropriation Theory
Despite the Supreme Court’s view in United States v. O’Hagan, 521 U.S. 642 (1997), that the misappropriation theory of insider trading is not an “all-purpose breach of fiduciary duty ban,” it has become that and more – capturing relationships not typically viewed as fiduciary ones, and tippees multiple levels removed from the source of the information. The theory holds that a person violates Section 10(b) of the Securities Exchange Act and its related Rule 10b-5 when s/he misappropriates material non-public information for trading purposes in breach of a fiduciary or fiduciary-like duty owed to the source of the information. One problem, as Justice Scalia identified in United States v. Skilling, 130 S. Ct. 2896 (2010), when addressing the similarly fraught concept of honest services, is not just determining whether a fiduciary relationship exists, but what obligations that fiduciary owes in light of case-law that remains “hopelessly undefined.” The situation is amply illustrated in United States v. Corbin, 2010 WL 4236692 (S.D.N.Y. October 10, 2010), in which SDNY Judge Marrero – meticulously applying Second Circuit precedent – held that marriage can be the fiduciary relationship predicating a charge of insider trading. Moreover, a tippee defendant like Corbin may face criminal insider trading charges despite the fact that he had no relationship either with the source of the information or the individual who owed a duty to the source.
Facts
Corbin was charged with securities fraud arising out of his alleged trading on material, nonpublic information he received from a separately-charged co-conspirator, Matthew Devlin. Devlin, in turn, received the information from his wife, an employee at an international communications firm that provided services to companies engaged in mergers and acquisitions. Policies in place at her firm required Devlin's wife to maintain the confidentiality of information she learned regarding the firm's clients. Apparently unable to honor these policies at home, she had a "domestic confidentiality policy of sorts" with Devlin, requiring him not to use or share any confidential firm information she imparted to him. Despite this, Devlin passed the information on to Corbin and another, who made substantial profits trading on the tips emanating from the woman they dubbed the "golden goose." The government premised the insider trading charges against Corbin on the misappropriation theory, hypothesizing that Corbin had obtained the material, nonpublic information in violation of the duty of trust and confidence that existed between Devlin and his wife. Corbin moved to dismiss under F.R.Crim.P. 12(b)(2) and 12(b)(3), arguing that the application of misappropriation theory to him was unconstitutional because the Devlins’ relationship was not a fiduciary relationship as a matter of law.
Holding
The court rejected Corbin's constitutional challenge, finding that a duty of trust and confidence existed between the Devlins on three separate bases (all of which are set forth in the SEC's Rule 10b5-2(b)): an agreement between them that Devlin would maintain the information in confidence; a history of sharing confidences with an expectation that confidentiality would be maintained; and the spousal relationship itself. The court noted that in addition to being codified in Rule 10b5-2, the Second Circuit has expressly adopted the duty Corbin was charged with violating in United States v. Chestman, 947 F.2d 551 (2d Cir. 1991) (holding that the dynamic in certain marital relationships can constitute a fiduciary-like relationship for insider trading liability). The court also rejected the argument that Rule 10b5-2 was unconstitutional because the SEC exceeded its authority in promulgating it.
Comment
The Supreme Court approved the misappropriation theory in O’Hagan in the context of a lawyer who had traded on information he stole from his law firm’s client. Thus, O’Hagan had breached an archetypical fiduciary duty that he himself owed to the source. Corbin, by contrast, obtained the information from someone who owed an unusual duty to a conduit of the information. The expansion of misappropriation theory to encompass such attenuated tippees and novel duties makes it ripe for a void-for-vagueness constitutional challenge. While the court’s holding in Corbin is entirely consistent with Second Circuit precedent, that precedent may not survive Supreme Court scrutiny. Like § 1346 and its elusive predicate “the intangible right to honest services,” we can expect that when the Supreme Court addresses misappropriation theory again, it will - at the very least - “pare [it] down” to “paramount applications” presenting no vagueness problem (Skilling, 130 S.Ct. at 2928).
Facts
Corbin was charged with securities fraud arising out of his alleged trading on material, nonpublic information he received from a separately-charged co-conspirator, Matthew Devlin. Devlin, in turn, received the information from his wife, an employee at an international communications firm that provided services to companies engaged in mergers and acquisitions. Policies in place at her firm required Devlin's wife to maintain the confidentiality of information she learned regarding the firm's clients. Apparently unable to honor these policies at home, she had a "domestic confidentiality policy of sorts" with Devlin, requiring him not to use or share any confidential firm information she imparted to him. Despite this, Devlin passed the information on to Corbin and another, who made substantial profits trading on the tips emanating from the woman they dubbed the "golden goose." The government premised the insider trading charges against Corbin on the misappropriation theory, hypothesizing that Corbin had obtained the material, nonpublic information in violation of the duty of trust and confidence that existed between Devlin and his wife. Corbin moved to dismiss under F.R.Crim.P. 12(b)(2) and 12(b)(3), arguing that the application of misappropriation theory to him was unconstitutional because the Devlins’ relationship was not a fiduciary relationship as a matter of law.
Holding
The court rejected Corbin's constitutional challenge, finding that a duty of trust and confidence existed between the Devlins on three separate bases (all of which are set forth in the SEC's Rule 10b5-2(b)): an agreement between them that Devlin would maintain the information in confidence; a history of sharing confidences with an expectation that confidentiality would be maintained; and the spousal relationship itself. The court noted that in addition to being codified in Rule 10b5-2, the Second Circuit has expressly adopted the duty Corbin was charged with violating in United States v. Chestman, 947 F.2d 551 (2d Cir. 1991) (holding that the dynamic in certain marital relationships can constitute a fiduciary-like relationship for insider trading liability). The court also rejected the argument that Rule 10b5-2 was unconstitutional because the SEC exceeded its authority in promulgating it.
Comment
The Supreme Court approved the misappropriation theory in O’Hagan in the context of a lawyer who had traded on information he stole from his law firm’s client. Thus, O’Hagan had breached an archetypical fiduciary duty that he himself owed to the source. Corbin, by contrast, obtained the information from someone who owed an unusual duty to a conduit of the information. The expansion of misappropriation theory to encompass such attenuated tippees and novel duties makes it ripe for a void-for-vagueness constitutional challenge. While the court’s holding in Corbin is entirely consistent with Second Circuit precedent, that precedent may not survive Supreme Court scrutiny. Like § 1346 and its elusive predicate “the intangible right to honest services,” we can expect that when the Supreme Court addresses misappropriation theory again, it will - at the very least - “pare [it] down” to “paramount applications” presenting no vagueness problem (Skilling, 130 S.Ct. at 2928).
See Archives for all posts since September 2007.
