Legal Definitions - misappropriation theory of insider trading

The misappropriation theory of insider trading describes a specific type of illegal stock trading where an individual trades securities based on confidential, non-public information that they obtained by breaching a duty of trust or loyalty owed to the source of that information. Unlike the "classical" theory of insider trading, this theory applies even when the person trading does not owe any direct duty to the company whose stock they are buying or selling.

Instead, the wrongdoing lies in the deceptive act of taking secret information that was entrusted to them (or obtained through a relationship of trust) and using it for personal financial gain. This is considered fraudulent because it involves "stealing" or "embezzling" confidential information from its rightful owner or the party who provided it, without their knowledge or permission.

Here are a few examples illustrating the misappropriation theory:

• Financial Consultant's Breach: A financial consultant is hired by a private equity firm to conduct due diligence on a potential acquisition target, "InnovateTech Inc." During their work, the consultant gains access to highly confidential financial projections for InnovateTech that indicate a significant undervaluation. Before the private equity firm's takeover bid is publicly announced, the consultant secretly buys a large number of shares in InnovateTech for their personal portfolio.

  Explanation: The consultant owed a duty of confidentiality and loyalty to the private equity firm (the source of the information). By using the firm's confidential information to trade InnovateTech stock for personal profit, they breached this duty. They did not owe a direct duty to InnovateTech's shareholders, but they misappropriated information entrusted to them by their client.

• Printing Press Employee's Discovery: An employee at a specialized printing press is responsible for printing the quarterly earnings reports for various publicly traded companies before their official release. While preparing Company X's report, they notice a surprisingly strong earnings forecast that is far better than market expectations. Knowing this information is not yet public, the employee immediately purchases shares of Company X stock.

  Explanation: The printing press employee owed a duty of confidentiality to their employer and, by extension, to Company X (as the information's owner). By trading on this non-public information, they misappropriated confidential data entrusted to them through their employment, breaching their duty to the printing press and the information's owner.

• IT Contractor's Access: A freelance IT contractor is hired by a major pharmaceutical company to upgrade their internal server systems. During the upgrade process, the contractor inadvertently gains access to highly sensitive internal documents detailing an imminent, successful Phase 3 clinical trial result for a new drug, which is expected to significantly boost the company's stock price. Before the official announcement, the contractor uses this information to buy shares in the pharmaceutical company.

  Explanation: The IT contractor, by virtue of their professional engagement, had a duty of confidentiality to the pharmaceutical company (the source of the information). Even if the discovery was accidental, using this confidential information for personal trading constitutes a breach of that duty and a misappropriation of the company's private data.