US v. Newman and the Rewriting of the Law of Insider Trading (Part 5)
First was the problem of coverage. To the extent limiting the analysis to fiduciaries, the Court promised to leave the prohibitions on insider trading inapplicable to most insiders or their advisors.
To address the problem of accountants and lawyers, the Court invented what has become known as the “temporary insider” doctrine. Persons hired by the company could assume a fiduciary duty. See Id. (“Under certain circumstances, such as where corporate information is revealed legitimately to an underwriter, accountant, lawyer, or consultant working for the corporation, these outsiders may become fiduciaries of the shareholders. The basis for recognizing this fiduciary duty is not simply that such persons acquired nonpublic corporate information, but rather that they have entered into a special confidential relationship in the conduct of the business of the enterprise and are given access to information solely for corporate purposes. “).
While fiduciary duty concepts were probably fluid enough under state law to allow its extension to untraditional classes of persons (beyond officers, directors and key employees), the Court adopted an interpretation that more or less always imposed temporary fiduciary obligations on these advisers. The Court cited no state law cases for this interpretation. The idea that investment banks or lawyers could be sued for breach of fiduciary duty to shareholders as a general course (as opposed to aiding and abetting a breach) was inconsistent with state law. Nonetheless, the Court needed to plug a gap created by its own analysis, otherwise Dirks would not be able to legally tip information but lawyers and accountants could.
With respect to ordinary employees or officers selling rather than buying shares, the opinion remained silent. Lower courts (and the SEC) for the most part ignored the discontinuity between the need for a fiduciary duty and its application to these groups of individuals. Insider trading applied to ordinary employees and to officers who sold even though under state law, it almost certainly did not.
With respect to the latter group, the SEC could rely on In re Cady Roberts, an administrative decision that did extend the prohibition on insider trading to non-shareholders. See In re Cady Roberts, 40 SEC 907 (admin proc. Nov. 8, 1961). Indeed, in Dirks, the Court often referred to the “Cady Roberts duty.” Cady Roberts, however, found that insiders had a duty to purchasers not because of a fiduciary relationship but because of the obvious unfairness to the investing public. See Id. (“We cannot accept respondents’ contention that an insider’s responsibility is limited to existing stockholders and that he has no special duties when sales of securities are made to non-stockholders. This approach is too narrow. It ignores the plight of the buying public-- wholly unprotected from the misuse of special information.”).
Officers and directors of corporations, however, do not have fiduciary obligations to the investing public. The case does not, therefore, provide any meaningful support for applying fiduciary principles to purchasers of shares from insiders (at least purchasers who are not already shareholders).
With respect to Newman, the decision and the request for rehearing en banc is posted, along with the SEC’s amicus brief, at the DU Corporate Governance web site. The amicus filed by a small group of law professors that supports the decision is here.