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Can Disclosure Set You Free?
The misappropriation theory of insider trading, which was first recognized by the Supreme Court in United States v. O'Hagan, 521 U.S. 642 (1997), establishes liability for individuals who are not typical 'insiders' of companies and also appears to offer such defendants a specific defense to insider trading charges. The O'Hagan Court based the misappropriation theory on a duty owed by the defendant to the source of non-public material information, rather than to the shareholders of the company whose stock was being traded. Because a defendant prosecuted under the misappropriation theory had a duty only to his source, the Court explained that a defendant's disclosure to the source of information prior to trading or tipping could neutralize the acts of deception necessary for a securities fraud claim. O'Hagan, 521 U.S. at 655.
This 'disclosure to the source' defense remained untested until a recent SEC action against Patricia Rocklage, the wife of a pharmaceutical executive. Mrs. Rocklage defended against the SEC's allegations of insider trading by arguing, in part, that she disclosed to the source of her information ' her husband ' her intent to use the material non-public information she had obtained in confidence. SEC v. Rocklage, 470 F.3d 1 (1st Cir. 2006).
The First Circuit, expressing uncertainty and reservations about the scope and application of the 'disclosure to the source' defense, distinguished O'Hagan and found that Mrs. Rocklage could be held liable for insider trading despite her disclosure. The Rocklage decision raises doubts about the defense and exposes a structural weakness in the misappropriation theory that should be of great significance to criminal-defense attorneys and prosecutors alike.
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