As an academic, writing an exam that tests the law of insider trading can be enjoyable. We faculty can often come up with the most outlandish scenarios and test whether students can apply the arcane and definitely not intuitive law of insider trading.
Yet increasingly, it is becoming difficult to devise a far fetched fact pattern that hasn't actually been alleged. Your psychiatrist trades after a session with you? Alleged. Just read SEC v. Willis, 777 F. Supp. 1165 (S.D.N.Y. 1991). Your barber? See SEC v. Maxwell, 341 F. Supp. 2d 941 (S.D. Ohio 2004). Wives tell their husbands material nonpublic information, are they violating a duty of trust and confidence? The answer has to be definitely yes or no. What about when a lawyer allegedly gives confidential information to a third party? Another definite maybe yes, maybe not. Tips to high school friends? Alleged. Golfing partner, former major league baseball players, government employees? All alleged.
Already a tough area for academics, the Third Circuit (in conjunction with criminal authorities) just made it tougher. In US v. McGee, the Third Circuit had to resolve whether trades that resulted from information obtained in a relationship formed through Alcoholics Anonymous constituted insider trading.
According to the court, Member (the person in AA) “blurted out” after an AA meeting, the relevant inside information. He "expected" that the information would be kept confidential that he "believed he could trust [defendant] with the information given their long history of sharing confidences related to sobriety." So, insider trading?
Insider trading in these circumstances requires application of the misappropriation theory. This requires evidence of a violation of a duty of trust and confidence. Membership in AA arguably comes with confidentiality obligations (But see Footnote 11 of the opinion). In addition, a duty of trust and confidence can arise out of the nature of the personal relationship. Thus, the AA connection can potentially be the source of the obligation of confidentiality or can be a factor in establishing the confidentiality of the relationship. For the most part, the court (and criminal authorities) relied on the latter.
The defendant was alleged to have had a duty of trust and confidence as defined under Rule 10b5-2. 17 CFR 240.10b5-2. Specifically, that provision provides that a duty of trust and confidence arises:
- Whenever the person communicating the material nonpublic information and the person to whom it is communicated have a history, pattern, or practice of sharing confidences, such that the recipient of the information knows or reasonably should know that the person communicating the material nonpublic information expects that the recipient will maintain its confidentiality.
The decision did not, therefore, turn upon whether a duty of trust and confidence arose directly from participation in AA. US v. McGee ("Although this undermines [defendant's] argument, a finding that AA requires confidentiality is not necessary to our holding."). Instead, the obligation arose out of the longstanding personal relationship that developed during the AA process. As the court described:
- For almost a decade, [defendant] informally mentored [Member], who entrusted “extremely personal” information to [defendant] to alleviate stress associated with alcohol relapses. Confidentiality was not just [Member's] unilateral hope; it was the parties’ expectation. It was their “understanding” that information discussed would not be disclosed or used by either party. [Member] never repeated information that [defendant] revealed to him and [defendant] assured [Member] that their discussions were going to remain private. Furthermore, [defendant] encouraged [member] to use his services as an investment adviser, telling [Member], “I know everything about what you’re going through from an alcohol perspective. You can keep your trust in me.” From this evidence, a rational juror could find that a relationship of trust or confidence existed based on the parties’ history, pattern or practice of sharing confidences related to sobriety.
With the court finding that a duty of trust and confidence can arise out of this type of relationship, what's left for the faculty member trying to write a far fetched exam? Thankfully there have not been any insider trading cases (apparently) that have arisen from confidential information "blurted" out at a weight watchers meeting (one can imagine the obligations of confidentiality that apply to those sessions) or during a yoga class. Hope remains but the opportunities are definitely narrowing.