Simple English definitions for legal terms
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The misappropriation theory of insider trading is when someone trades stock in a company using secret information they got from someone else who trusted them. This is different from the classical theory of insider trading, which only applies when the trader works for the company they're trading stock in. The misappropriation theory says that it's still wrong to trade on secret information, even if you don't work for the company. The U.S. Supreme Court made this rule in a case called U.S. v. O'Hagan. The Securities and Exchange Commission (SEC) also has a rule called Rule 10b5-1 that says you can't trade on secret information.
The misappropriation theory of insider trading is a type of insider trading where an individual trades stock in a company they are not affiliated with, using material non-public information obtained through a breach of a fiduciary duty owed to the source of the information. This theory does not require that the seller owes a fiduciary duty to the company in whose stock they trade. Instead, the seller's knowledge of insider information alone is enough to create liability under Rule 10b-5.
For example, if a lawyer working on a merger between two companies shares confidential information about the deal with a friend who then trades stock in one of the companies, that friend could be liable under the misappropriation theory of insider trading. Even though the friend had no fiduciary duty to the companies involved, they used confidential information to trade securities.
The misappropriation theory of insider trading was established in the U.S. Supreme Court case U.S. v. O'Hagan in 1997. The court found a partner at a law firm liable for insider trading based on information he obtained from other partners at the firm working on a tender offer. The partner had no fiduciary duty to the companies involved, but the court found him liable because he used confidential information to trade securities.
The Securities and Exchange Commission (SEC) has since codified the misappropriation theory of insider trading in Rule 10b5-1, which prohibits trading on the basis of material non-public information.