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Full Opinion
United States Court of Appeals
For the First Circuit
No. 06-1571
SECURITIES AND EXCHANGE COMMISSION,
Plaintiff, Appellee,
v.
PATRICIA B. ROCKLAGE; WILLIAM M. BEAVER; DAVID G. JONES,
Defendants, Appellants.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Morris E. Lasker,* Senior U.S. District Judge]
Before
Torruella, Lynch, and Lipez,
Circuit Judges.
David H. Erichsen, with whom Peter Spaeth, Pratik A. Shah,
and Wilmer Cutler Pickering Hale and Dorr LLP were on brief, for
appellant Patricia B. Rocklage.
David E. Marder, with whom Benjamin D. Stevenson and Robins,
Kaplan, Miller & Ciresi LLP were on brief, for appellant William
M. Beaver.
Brian E. Whiteley and Scibelli, Whiteley and Stanganelli,
LLP on brief for appellant David G. Jones.
Randall W. Quinn, Assistant General Counsel, with whom Brian
G. Cartwright, General Counsel, Jacob H. Stillman, Solicitor, and
Jeffrey Tao, Senior Counsel, were on brief, for appellee.
*
Of the Southern District of New York, sitting by designation.
November 14, 2006
LYNCH, Circuit Judge. This is an interlocutory appeal
from the denial of defendants' motion to dismiss a civil complaint
based on an issue of law.
The complaint was brought by the SEC on a
misappropriation theory of insider trading. It alleged that
defendant Patricia B. Rocklage intentionally used deceptive means
to obtain from her husband highly negative and non-public
information about his publicly-traded company, in order to tip her
brother who owned company stock, which then led to trading of the
stock by her brother and another. Specifically, Mrs. Rocklage
initially concealed from her husband her prior agreement with her
brother to tip him if she learned significant negative information
about the company. She also concealed that she did not intend to
maintain the confidentiality that her husband had reasonably
understood to bind her. After Mrs. Rocklage acquired the
information on the basis of this deception, and shortly before she
actually tipped her brother, however, she told her husband that she
was going to give her brother the information. Her husband asked
her not to do so, but she did so anyway, pursuant to the agreement.
Under the circumstances and timing of the events, there was little
her husband could do to prevent her from tipping her brother or to
prevent her brother from trading on the information. Her brother
sold his stock in the company on the next day the market opened and
he passed the information on to a friend who did the same. The
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brother, William M. Beaver, and friend, David G. Jones, are also
defendants.
The three defendants moved under Federal Rule of Civil
Procedure 12(b)(6) to dismiss the SEC's complaint for failure to
state a claim; they argued that under language in United States v.
O'Hagan, 521 U.S. 642 (1997), Mrs. Rocklage's pre-tip disclosure to
her husband, telling him that she intended to tip-off her brother,
completely negated any liability under the misappropriation theory.
We conclude that O'Hagan does not require dismissal of this suit
for failure to state a claim.
I.
On January 12, 2005, the SEC filed a civil complaint
against the defendants. The complaint alleged the following key
facts, which we must take as true under Rule 12(b)(6). See Conley
v. Gibson, 355 U.S. 41, 45-46 (1957). We draw all reasonable
inferences in the SEC's favor. See Ramirez v. Arlequin, 447 F.3d
19, 20 (1st Cir. 2006).
Mrs. Rocklage was the wife of Scott M. Rocklage. Mr.
Rocklage was the Chairman and CEO of Cubist Pharmaceuticals, Inc.,
a publicly-traded biotechnology company. Mrs. Rocklage was not an
employee of Cubist.
On December 31, 2001, Mr. Rocklage learned that one of
the company's key drugs had failed its clinical trial. That
afternoon, he phoned Mrs. Rocklage to discuss the trial results and
-4-
he reached her while she was in a limousine. Before discussing the
results with her, Mr. Rocklage made clear his intention that the
results be kept confidential. He told her that she was not to
react to what he was about to say, and he instructed her not to
discuss the results in front of the limousine driver. She agreed.
From the time that Mr. Rocklage joined Cubist in 1994, he had
routinely communicated material, nonpublic information to his wife,
and she had always kept the information confidential. Based on
Mrs. Rocklage's agreement, and based on their prior history of
sharing nonpublic information about the company and her keeping
that information confidential, Mr. Rocklage had a reasonable
expectation that she would not disclose the trial results to
anyone. Based on his understanding that she would keep the
information confidential, Mr. Rocklage informed his wife that the
clinical trial had failed. Before the results were disclosed to
her, Mrs. Rocklage understood her husband's expectation of
confidentiality.
Unbeknownst to her husband, Mrs. Rocklage had a
preexisting understanding with her brother, defendant Beaver, that
she would inform him with "a wink and a nod" if she learned
significant negative news about Cubist. At the time that Mrs.
Rocklage learned the negative trial results, she knew or had
reason to believe that Beaver owned Cubist stock. She also knew or
-5-
had reason to know her brother would trade in Cubist securities if
she disclosed the nonpublic information to him.
On the evening of December 31, 2001, Mr. Rocklage
discussed the failure of the drug trial in more depth with Mrs.
Rocklage. He informed her that Cubist would be making a public
announcement about the results, and that until that happened the
results were nonpublic. Mrs. Rocklage asked how the news would
affect Cubist's stock, and Mr. Rocklage informed her that the stock
price would drop significantly. As before, at the time that Mr.
Rocklage originally conveyed this information to Mrs. Rocklage, he
had a reasonable expectation that she would keep it confidential
and would not otherwise have disclosed the information. In effect,
by her deception Mrs. Rocklage induced her husband to disclose
material non-public information he would not otherwise have
disclosed, and she did so with the intention of sharing this
information with her brother to allow him to trade securities.
After that conversation, and on or about the evening of
December 31, 2001, Mrs. Rocklage informed her husband that she
planned to signal her brother to sell his stock. Mr. Rocklage
urged her not to do so, and he expressed his displeasure at the
idea. Nevertheless, sometime before the morning of January 2,
2002, Mrs. Rocklage called Beaver and gave him "a wink and a nod"
regarding Cubist. Beaver interpreted this to mean that he should
sell his Cubist stock, and so on the morning of January 2, 2002 --
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the first possible trading day after he was tipped off -- Beaver
sold all of his 5,583 shares of Cubist stock. By tipping her
brother, Mrs. Rocklage was providing a gift of confidential
information to a relative, and so she personally benefitted.
Beaver also tipped off his close friend and neighbor,
defendant Jones. Jones knew that Beaver's brother-in-law, Mr.
Rocklage, was Chairman and CEO of Cubist. Jones sold all of his
7,500 shares of Cubist stock on the morning of January 3, 2002.
Cubist publicly announced the negative drug trial results
on January 16, 2002, after the market had closed for the day. By
selling when they did, Beaver and Jones avoided losses of $99,527
and $133,222, respectively.
The SEC alleged that on the basis of these facts all
three defendants were guilty of insider trading under § 10(b) of
the Securities Exchange Act of 1934, see 15 U.S.C. § 78j(b), and
Rule 10b-5 thereunder, see 17 C.F.R. § 240.10b-5.1 It sought both
injunctive relief and monetary penalties from the defendants.
All three defendants filed a Rule 12(b)(6) motion to
dismiss for failure to state a claim. On August 23, 2005, the
district court issued an opinion denying their motion. In its
opinion, the court explained that the Supreme Court has recognized
1
The SEC also alleged that the defendants had violated
§ 17(a) of the Securities Act of 1933. See 15 U.S.C. § 77q(a).
All parties agree that the analysis under § 17(a) is identical to
the analysis under § 10(b) and Rule 10b-5. Accordingly, we analyze
the issues solely under the latter two provisions.
-7-
two theories of insider trading liability: the "classical theory"
and the "misappropriation theory." The classical theory generally
only imposes liability when a trader or tipper is an insider of the
traded-in corporation. The classical insider-trader thus breaches
a fiduciary duty owed to the corporation's shareholders. The
misappropriation theory, however, creates liability when a tipper
or trader misappropriates confidential information from his source
of the information. The misappropriator thus breaches a fiduciary
duty owed to the source.
The district court agreed with defendants that Mrs.
Rocklage could not be held liable under the classical theory. She
was not a traditional insider at Cubist. And the court determined
that the relationship between Mrs. Rocklage and Cubist's
shareholders was not of the kind that could lead to "temporary
insider" status: no alleged facts demonstrated that Mr. Rocklage's
disclosure to her was "solely for corporate purposes." See Dirks
v. SEC, 463 U.S. 646, 655 n.14 (1983).
The district court disagreed, however, with the
defendants' argument that there was no liability under the
misappropriation theory. Although O'Hagan had said that disclosure
to the source would negate liability under the misappropriation
theory, the district court found O'Hagan distinguishable. However,
the court's grounds for distinguishing O'Hagan were based on a
misreading of O'Hagan's facts. The court reasoned that because
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O'Hagan's law firm had obligations to the traded-in company (as the
district court read the case), any hypothetical disclosure by
O'Hagan would have quickly made its way to the shareholders. In
Mrs. Rocklage's case, by contrast, the special nature of the
marital relationship meant that her disclosure would never make its
way to the shareholders; Mr. Rocklage's loyalties lay first and
foremost with his wife. Thus the district court found that the
complaint stated facts sufficient to support a misappropriation
theory of liability.
The district court also refused to dismiss the case
against the downstream tippees, Beaver and Jones. If a claim was
stated against Mrs. Rocklage, it held, then the tippees' liability
turned on whether they knew or should have known of Mrs. Rocklage's
breach of duty. The district court determined this last question
to be one of fact, and thus inappropriate for resolution on a
12(b)(6) motion.2
All three defendants moved the district court for
reconsideration, correctly arguing that the district court had
misread O'Hagan. Contrary to the court's reading, O'Hagan's firm
had represented the bidding company in a tender offer, not the
target company whose shares O'Hagan traded. See O'Hagan, 521 U.S.
at 647. Thus, the defendants argued that O'Hagan's firm had no
2
The district court also rejected Jones' argument that the
complaint did not allege fraud with sufficient particularity. See
Fed. R. Civ. P. 9(b).
-9-
obligation to inform the target's shareholders, and any
hypothetical disclosure by him would not have had real effect. In
the alternative, the defendants asked the court to certify the
issue for interlocutory appeal pursuant to 28 U.S.C. § 1292(b).
On December 14, 2005, the district court denied the
motion for reconsideration. The court conceded that it had misread
O'Hagan but reasoned that O'Hagan was distinguishable because a
hypothetical disclosure by O'Hagan would have given either his firm
or the bidding company the opportunity and motivation to take
remedial action. By contrast, the nature of the marital
relationship meant that Mrs. Rocklage's disclosure did not give her
husband adequate opportunity to take similar remedial action. The
court certified the issue for an interlocutory appeal, see 28
U.S.C. § 1292(b), which this court accepted.
II.
This case turns on an understanding of the underpinnings
of the misappropriation theory, an understanding of the acts that
are the deceptive or manipulative device or devices alleged, and
a careful reading of the O'Hagan opinion. We first discuss the
misappropriation theory, examining why the Supreme Court concluded
that this theory came within the ambit of § 10(b). Then we explain
our resolution of the remaining disputed issues, and how our
resolution of those issues flows from O'Hagan.
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A. The Misappropriation Theory of Insider Trading Liability
The text of § 10(b) makes it unlawful to "use or employ,
in connection with the purchase or sale of any security . . . any
manipulative or deceptive device or contrivance in contravention
of" rules promulgated by the SEC. 15 U.S.C. § 78j(b). Rule 10b-5
furnishes further explication of this statute, providing inter alia
that it is unlawful to "engage in any act, practice, or course of
business which operates or would operate as a fraud or deceit upon
any person, in connection with the purchase or sale of any
security." 17 C.F.R. § 240.10b-5(c). From these two sources of
law on insider trading, the Supreme Court has fashioned two
theories of liability: the "classical" theory, and the
"misappropriation" theory. See O'Hagan, 521 U.S. at 651-52.
Under the classical theory, § 10(b) and Rule 10b-5 are
violated when an insider trades (without disclosure) in a
corporation's securities based on material, nonpublic information
that he has acquired. So long as that insider owes a fiduciary
duty to the corporation's stockholders, the Supreme Court has
deemed such trades to be deceptive because they constitute a breach
of that fiduciary duty. Id. However, when the trading individual
owes no fiduciary duty to the stockholders of the traded-in
corporation, and he has not obtained the information from one who
has breached such a duty, there can be no insider trading liability
-11-
under the classical theory. See Chiarella v. United States, 445
U.S. 222, 231-35 (1980).
In such cases, however, liability may still be premised
on a misappropriation theory. Liability under that theory is based
on deception of the source of the information, rather than on
deception of the shareholders; it is that deception which brings
this trading within the statutory language. See O'Hagan, 521 U.S.
at 652 ("[T]he misappropriation theory premises liability on a
fiduciary-turned-trader's deception of those who entrusted him with
access to confidential information."). Such deceptive trading
exploits unfair informational disparities in the securities market;
making such trading illegal also comports with the congressional
purposes underlying § 10(b). See id. at 658-59.
O'Hagan, the case in which the Supreme Court first
recognized the misappropriation theory, illustrates the theory's
underpinnings. The defendant, James O'Hagan, worked at a law firm
representing the bidding company in a contemplated tender offer.
Id. at 647. O'Hagan learned about the proposed deal and purchased
shares in the target company before the deal was made public. Id.
at 647-48. Because O'Hagan's firm represented the bidder, he owed
no fiduciary duty to the target's stockholders and could not be
prosecuted under the classical theory. Id. at 653 n.5.
Nevertheless, the Court held he was liable under a misappropriation
theory because he had deceived both his law firm and its client: he
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had pretended to be loyal to them while secretly converting
information obtained from them into personal gain. See id. at 653-
55. The Court remarked that it would make "scant sense to hold a
lawyer like O'Hagan a § 10(b) violator if he work[ed] for a law
firm representing the target of a tender offer, but not if he
work[ed] for a law firm representing the bidder. The text of the
statute requires no such result." Id. at 659.
The Court did say, however, that "[b]ecause the deception
essential to the misappropriation theory involves feigning fidelity
to the source of information, if the fiduciary discloses to the
source that he plans to trade on the nonpublic information, there
is no 'deceptive device' and thus no § 10(b) violation." Id. at
655. It is this language in O'Hagan, arguably dicta,3 on which
defendants pin their argument: they contend that Mrs. Rocklage's
disclosure to her husband eliminated any deception involved with
her tipping, which would mean that her actions did not come within
the text of § 10(b).
B. Liability Under the Misappropriation Theory After
O'Hagan
To establish liability under the misappropriation theory,
the SEC must show that Mrs. Rocklage communicated material
nonpublic information, with scienter, in violation of a fiduciary
3
Since O'Hagan presented no issue of actual disclosure by
O'Hagan, the statement could be viewed as dicta. Even dicta in
Supreme Court opinions is looked on with great deference. See
United States v. Santana, 6 F.3d 1, 9 (1st Cir. 1993).
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duty she owed to her husband. See Ernst & Ernst v. Hochfelder, 425
U.S. 185, 193 (1976); SEC v. Sargent, 229 F.3d 68, 74-76 (1st Cir.
2000). Additionally, to satisfy the language of § 10(b), the SEC
must demonstrate that Mrs. Rocklage engaged in a "manipulative or
deceptive device," and that she did so "in connection with the
purchase or sale of any security." 15 U.S.C. § 78j(b); see also
O'Hagan, 521 U.S. at 653-56.4
The defendants do not dispute that the complaint meets
the scienter requirement, and that the disclosed information was
material and nonpublic. They also do not seriously challenge the
SEC's allegation that Mrs. Rocklage breached a duty she owed to her
spouse under 17 C.F.R. § 240.10b5-2(b)(3).5
4
In Sargent this court left open whether the SEC must also
show that a tipper received sufficient personal benefit. See 229
F.3d at 77. As in Sargent, we need not decide this issue here.
Even if there is a requirement that the tipper receive a personal
benefit, the mere giving of a gift to a relative or friend is a
sufficient personal benefit. See id. The gift of information Mrs.
Rocklage gave her brother meets that standard.
5
This regulation, which the defendants do not challenge for
purposes of the Rule 12(b)(6) motion, provides that there is a
"duty of trust or confidence" for purposes of the misappropriation
theory when
a person receives or obtains material
nonpublic information from his or her spouse,
parent, child, or sibling; provided, however,
that the person receiving or obtaining the
information may demonstrate that no duty of
trust or confidence existed with respect to
the information, by establishing that he or
she neither knew nor reasonably should have
known that the person who was the source of
the information expected that the person would
keep the information confidential, because of
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The heart of this case is thus whether the SEC's
complaint has stated a claim that Mrs. Rocklage engaged in any
"manipulative or deceptive device" that was "in connection with the
purchase or sale of any security." In answering that question, we
find it helpful to examine the issue in two parts. First, we
identify exactly what "manipulative or deceptive devices" Mrs.
Rocklage was alleged to have engaged in and we assess whether they
were sufficiently "in connection with" a securities transaction.
Second, we examine Mrs. Rocklage's pre-tip disclosure to her
husband to determine whether that disclosure eliminated the
deception from her actions.
1. The Deceptive Devices
The SEC contends that Mrs. Rocklage engaged in deceptive
devices, in connection with a securities transaction, when she
tricked her husband into revealing confidential information to her
so that she could, and did, assist her brother with the sale of his
Cubist stock. We agree and think it helpful to view the devices in
terms of deceptive acquisition of information and then deceptive
tipping of her brother, both of which were steps in a broader
scheme to enable her brother to trade in Cubist securities. The
the parties' history, pattern, or practice of
sharing and maintaining confidences, and
because there was no agreement or
understanding to maintain the confidentiality
of the information.
17 C.F.R. 240.10b5-2(b)(3) (emphasis added).
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question of whether Mrs. Rocklage's disclosure makes these acts
nondeceptive is a different question, which we address later.
We start with the second of these actions. Had Mrs.
Rocklage never made any disclosure of her intent to tip her
brother, there would have been deception in connection with a
securities transaction when she did tip her brother, without her
husband's consent, to enable her brother to trade in securities.
Under O'Hagan, this would have been the case irrespective of the
means by which Mrs. Rocklage acquired the information.6
Still putting aside for the moment any consideration of
the effects of disclosure, we turn to the other alleged deceptive
action -- Mrs. Rocklage's acquisition of information. Here more
analysis is required. We agree that this acquisition of
information was deceptive. The complaint alleges, and we must take
as true, that before her husband's initial disclosure about the
clinical trial, Mrs. Rocklage did absolutely nothing to correct his
mistaken understanding that she would keep the trial results
confidential. This was so even though Mrs. Rocklage knew that her
husband had this (mis)understanding, and even though she had a
preexisting arrangement to disclose certain confidential
information to her brother.
6
Indeed, had Mrs. Rocklage legitimately acquired the
information, and then tipped her brother without disclosure, she
would have been in essentially the same position as the defendant
in O'Hagan. The defendants do not argue that her act of tipping
was not "in connection with" a securities transaction.
-16-
The defendants argue that this acquisition of
information, even if deceptive, was not "in connection with" a
securities transaction. They point to language from O'Hagan
discussing the "in connection with" requirement and explaining that
"the fiduciary's fraud is consummated, not when the fiduciary gains
the confidential information, but when . . . he uses the
information to purchase or sell securities." O'Hagan, 521 U.S. at
656. In defendants' view, Mrs. Rocklage's deceptive acquisition of
information was simply too far removed from her brother's sale of
securities to satisfy § 10(b)'s "in connection with" requirement.
We disagree with defendants' reading of O'Hagan and of
the "in connection with" requirement. We read the quoted sentence
in O'Hagan as explaining when a misappropriator's deceptive scheme
ends, and not as indicating when it begins. See Webster's 3d New
International Dictionary of the English Language Unabridged 490
(Philip Babcock Gove ed., 1993) (defining the verb "to consummate"
as meaning "to bring to completion"). Next, O'Hagan had no
occasion to interpret the "in connection with" requirement in a
case alleging deceptive acquisition of information intended to be
used in a securities transaction. The opinion does not discuss
whether O'Hagan tricked or deceived his law firm into telling him
about the tender offer, and whether while doing so he knew he would
use the information for trading. The government's brief to the
Supreme Court stated that "[t]he record does not indicate how
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[O'Hagan] first learned" about the potential tender offer. See
Brief for the United States at 4 n.1, O'Hagan, 521 U.S. 642 (No.
96-842). There was no claim that O'Hagan had used deception to
obtain the information. On those facts, it is no surprise that the
Supreme Court based liability only on O'Hagan's act of undisclosed
trading itself. See United States v. Falcone, 257 F.3d 226, 233
(2d Cir. 2001) (noting that the defendant in O'Hagan "legitimately
possessed the information" and that any misappropriation only
occurred "when he used that information to trade securities").
Since the act of trading was itself deceptive in O'Hagan,
the "securities transaction and the breach of duty thus
coincide[d]." O'Hagan, 521 U.S. at 656. In this case it is true
there was no such exact coincidence. But that disjunction does not
mean the deception in obtaining the information was not in
connection with the sale of securities.
This case differs from O'Hagan in that the SEC squarely
alleges that Mrs. Rocklage deceptively obtained information, and
that she did so as part of a preexisting scheme to assist her
brother in the sale of securities. The question is how that
difference is relevant to the "in connection with" requirement.
Indeed, in a case raising somewhat similar concerns the Second
Circuit recognized that "the Supreme Court in O'Hagan did not
purport to set forth the sole combination of factors necessary to
-18-
establish the requisite connection in all contexts." Falcone, 257
F.3d at 233.
The Second Circuit's opinion in Falcone held that O'Hagan
did not alter that circuit's long standing rule, stated in United
States v. Carpenter, 791 F.2d 1024, 1027 (2d Cir. 1986), aff'd by
an equally divided court and aff'd by the full court on other
grounds, 484 U.S. 19 (1987), that the government can satisfy the
"in connection with" requirement when a tipper misappropriates
information that his tippees later trade on. The court reasoned
that
the defendants' use of the misappropriated
information for the[ir] financial benefit
. . . and to the financial detriment of those
investors with whom [the defendants] traded
supports the conclusion that [the defendants']
fraud was "in connection with" the purchase or
sale of securities under section 10(b) and
Rule 10b-5. We can deduce reasonably that
those who purchased or sold securities without
the misappropriated information would not have
purchased or sold, at least at the transaction
prices [they obtained], had they had the
benefit of that information. Certainly the
protection of investors is the major purpose
of section 10(b) and Rule 10b[-]5.
Falcone, 257 F.3d at 230 (quoting Carpenter, 947 F.2d at 566).
Although neither Carpenter nor Falcone was a case in which the
court relied on the tipper specifically engaging in deception in
order to acquire information, both stand for the proposition that
the "in connection with" requirement may be satisfied even when the
act of misappropriation in breach of a duty (in those cases,
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tipping), and the act of trading, do not coincide. In our view
O'Hagan not only left this untouched, see id. at 233-34, but
reinforced it.
Indeed, O'Hagan's discussion of the "in connection with"
requirement actually bolsters the SEC's position in this case.
O'Hagan discussed a hypothetical in which a person defrauds a bank
into giving him a loan and then uses the proceeds to purchase
securities. See 521 U.S. at 656-57. That hypothetical thus dealt
with a case of deceptive acquisition, albeit the deceptive
acquisition of money. Importantly, the Supreme Court indicated
that such deception was not "in connection with" a securities
transaction because the acquired item was money and not
information. See id. The wide variety of uses for money made this
deceptive acquisition "sufficiently detached from a subsequent
securities transaction." Id. at 657. But the information Mrs.
Rocklage deceptively obtained and gave her brother did not have
that same variety of uses; it was instead the sort of information
"that misappropriators ordinarily capitalize upon to gain no-risk
profits through the purchase or sale of securities." Id. at 656.
Thus her deceptive acquisition of the information is fairly
regarded as an act that was part of a broader scheme of deception
in connection with the sale of securities.
Moreover, we think that Mrs. Rocklage's actions fit
within a natural reading of the "in connection with" requirement.
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Mrs. Rocklage's preexisting arrangement with her brother can easily
be understood as a "scheme" or "practice" or "course of business,"
17 C.F.R. § 240.10b-5(a),(c), whose goal was to enable her brother
to trade in Cubist securities at a substantially reduced level of
risk. Her deception of her husband was a natural and integral part
of this scheme; she induced her husband to reveal material negative
information to her about Cubist, knowing full well that in
obtaining that information she would enable her brother to execute
a securities transaction. She then actively facilitated a
securities transaction by tipping her brother, and securities were
in fact sold based on her information. These events show that her
deceptive acquisition of material inside information was "in
connection with" a securities transaction.
Finally, our interpretation finds further support in the
investor protection purposes of § 10(b). See SEC v. Zandford, 535
U.S. 813, 819-20 (2002) (interpreting § 10(b)'s "in connection
with" requirement "flexibly" so as to further the statute's broad
investor protection purposes); O'Hagan, 521 U.S. at 658-59 (same).
One of the animating purposes of the statute was to "insure honest
securities markets and thereby promote investor confidence."
O'Hagan, 521 U.S. at 658. It furthers that purpose if the "in
connection with" requirement reaches schemes in which one party
deceptively and intentionally obtains material nonpublic
information to enable another to trade with an unfair informational
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advantage. See id. at 658-59 (discussing how informational
disparities can negatively impact securities markets).
2. The Effect of Mrs. Rocklage's Pre-Tip Disclosure of her
Intent to Tip her Brother
We have determined that the complaint alleges that Mrs.
Rocklage engaged in a scheme involving devices that would have been
deceptive in the absence of disclosure, and we have concluded that
these devices were employed "in connection with" a securities
transaction. We now turn to the heart of defendants' argument:
whether Mrs. Rocklage's pre-tip disclosure to her husband,
indicating her intent to pass the information to her brother,
nonetheless means no claim of deception is stated by virtue of
O'Hagan's language about disclosure.
The defendants' view is that a pre-tip disclosure to the
source of an intention to trade or tip completely eliminates any
deception involved in the transaction. They rely on O'Hagan's
language that "if the fiduciary discloses to the source that he
plans to trade on the nonpublic information, there is no 'deceptive
device' and thus no § 10(b) violation." Id. at 655. The
defendants argue that O'Hagan put no qualifiers on what is meant by
"disclos[ure] to the source" of a plan to trade on nonpublic
information, and so the SEC is not free to qualify the concept.
The SEC disagrees, arguing that the disclosure referenced
in O'Hagan must mean disclosure that is "useful" to the fiduciary's
principal. The SEC draws support from a footnote in O'Hagan which
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may be read as implying that disclosure enables a source to take
remedial action. See id. at 659 n.9 (explaining that "once a
disloyal agent discloses his imminent breach of duty, his principal
may seek appropriate equitable relief under state law"). As the
SEC sees it, disclosure to the source serves a useful purpose when
"the source of material non-public information reasonably could be
expected to, and reasonably could, prevent the unauthorized use of
the information for securities trading."
Under that standard, the SEC argues, Mrs. Rocklage's
disclosure was not a useful one for her source -- and in this
regard was unlike O'Hagan's hypothetical disclosure. The SEC
argues this is so due to both the timing of the events and the
marital relationship of the people involved. The timing of Mrs.
Rocklage's disclosure that she intended to tip her brother --
coming during or right before the New Year's holiday -- meant that
Mr. Rocklage would have had a great deal of difficulty pursuing
remedial action to stop the sale of the securities. In fact, the
sale was effectuated immediately at the next opening of the market.
Also, the SEC argues it would be unreasonable to expect Mr.
Rocklage to have risked marital discord by taking action against
his wife; once she made clear she would tell her brother despite
her husband's wishes, his interest may have shifted to protecting
her against liability. The SEC makes the point that under
Massachusetts law Mr. Rocklage was probably unable to pursue legal
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action against his wife in reaction to her disclosed intention to
tip (such as by seeking to enjoin her from tipping). See Mass.
Gen. L. ch. 233 § 20 (preventing husbands and wives from testifying
about their private conversations).7
In our view this case presents a narrower question. We
start by asking about the nature of the various acts in the
deceptive scheme before considering the role of and the nature of
the disclosure. Unlike this case, O'Hagan was not a case which
involved the deceptive acquisition of information. Arguably, the
language in O'Hagan can be read to create a "safe harbor" if there
is disclosure to the fiduciary principal of an intention to trade
on or tip legitimately acquired information. This is because under
O'Hagan's logic such a "safe harbor" applies, if at all, when the
alleged deception is in the undisclosed trading or tipping of
information. In those cases, disclosure of the intent to trade
arguably will eliminate the sole source of deception. But a case
of deceptive acquisition of information followed by deceptive
tipping and trading is different. It makes little sense to assume
7
There are difficulties with both sides' proposed tests on
the effect of disclosure. The SEC's general "usefulness" test does
not provide clear lines, and to the extent that the test depends on
state law it has the potential for creating a lack of uniformity in
the application of federal securities law. On the other hand,
defendants' position would lead to the conclusion that even a
useless and pro forma disclosure could preclude insider trading
liability; their theory would protect from liability a disclosure
made only a few seconds before a trade was executed. Such a result
clearly would not advance § 10(b)'s investor protection purposes.
Cf. O'Hagan, 521 U.S. at 658-59.
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that disclosure of an intention to tip using deceptively acquired
information would necessarily negate the original deception.
Indeed, by framing the issues this way, we see a second
important distinction between O'Hagan and the case at bar. O'Hagan
was a case in which only one deceptive device was alleged:
undisclosed trading on confidential information. In this case the
SEC's complaint is fairly read as alleging sequential acts that
could each constitute deceptive devices: (1) the acquisition of
material non-public information through the deception of Mrs.
Rocklage's husband, and (2) Mrs. Rocklage's use of this information
to tip off her brother without her husband's consent, followed by
the tippees' use of the information to trade. Perhaps, under
O'Hagan, Mrs. Rocklage's disclosure made the second of these
devices non-deceptive. But then the proper question becomes
whether disclosure that negates deception as to one set of actions
in a scheme necessarily renders all prior deceptive acts non-
deceptive.
While that question was not directly addressed in
O'Hagan, the opinion does offer helpful clues. In a passage that
leads to a third distinction between O'Hagan and the fact pattern
here, the Court in O'Hagan seemed to contemplate that any
liability-avoiding disclosure would come before the defendant
engaged in the deceptive activity. See O'Hagan, 521 U.S. at 655
(explaining that there would be no liability "if the fiduciary
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discloses to the source that he plans to trade on the nonpublic
information") (emphasis added). There is no indication that
O'Hagan meant to change the earlier understood view of § 10(b),
albeit one articulated outside the insider trading context, that a
disclosure "is not effective if it comes after the positions of the
parties have changed" in reliance on an earlier deceptive
statement. 5C Jacobs, Disclosure and Remedies Under the Securities
Laws, § 12:110, at 12-502.7 (2006) (citing In re Commonwealth
Oil/Tesoro Petroleum Corp. Sec. Litig., 467 F. Supp. 227, 246-47
(W.D. Tex. 1979)). Indeed, in a non-insider trading § 10(b) case,
this court has sustained liability in the face of post-transaction
disclosures; the after-the-fact disclosures did not cure the fact
that the key information was originally withheld. See Holmes v.
Bateson, 583 F.2d 542, 559 (1st Cir. 1978). On the facts of this
case, we are unwilling to say that O'Hagan requires us to conclude
that Mrs. Rocklage's post-acquisition disclosure of her intention
to tip somehow rendered her acquisition of information non-
deceptive.
Our analysis is bolstered by the Supreme Court's
explanation that the misappropriator "defrauds the principal of the
exclusive use of [his] information." O'Hagan, 521 U.S. at 652
(emphasis added). Mr. Rocklage was deprived of the exclusive use
of the information, before his wife stated her intention to tip,
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through Mrs. Rocklage's deceptive acquisition. Her later
disclosure did nothing to change this.
Once the various distinctions between this case and
O'Hagan are understood, defendants' position is really that because
some of Mrs. Rocklage's actions may have been non-deceptive, her
scheme as a whole had no deceptive elements. We do not believe
that O'Hagan requires such an understanding of § 10(b), and we in
fact conclude that O'Hagan rejects such an understanding.
In related areas of the law, it is well accepted that a
scheme can be deceptive or fraudulent even if not all parts of the
scheme are deceptive or fraudulent. The Supreme Court's decision
in Carpenter, discussing the mail and wire fraud statutes, is
especially instructive. O'Hagan cited with apparent approval the
government's argument that Carpenter's discussion of fraud was "a
particularly apt source of guidance . . . because [the mail fraud
statute] (like section 10(b)) has long been held to require
deception." 521 U.S. at 654 (alteration in original) (quoting
Brief for the United States, supra, at 18 n.9) (internal quotation
marks omitted); see also id. (describing Carpenter as addressing a
"fraud of the same species" as the fraud that the misappropriation
theory targets); 2 Welling et al., Federal Criminal Law and Related
Actions § 17.5, at 8 (1998) (recognizing the "central role of
deception" in the mail and wire fraud statutes at issue in
Carpenter).
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The scheme in Carpenter was fraudulent insofar as the
defendants were misappropriating articles from the Wall Street
Journal in advance of publication. See 484 U.S. at 25-28. They
did so in order to trade in stocks the articles covered, with the
understanding that the Journal's future coverage would affect stock
prices. In sustaining the defendants' convictions for mail and
wire fraud, the unanimous Court noted that it was sufficient that
the Journal itself, in its final published form, was ultimately
distributed to customers via the wires and the mail. Id. at 28.
Importantly, the Court deemed distribution of the articles to
Journal customers to be "an essential part of the scheme." Id.
There was no suggestion in that case, nor could there be, that the
distribution of the Journal to its regular customers was somehow
fraudulent. Yet the defendants' actions as a whole still comprised
a "scheme or artifice to defraud," see 18 U.S.C. §§ 1341,1343, and
so the Court sustained their convictions under the mail and wire
fraud statutes. See id. at 25; see also Schmuck v. United States,
489 U.S. 705, 714-15 (1989) (holding that innocent and non-
fraudulent mailings can support a conviction under the mail fraud
statute if they are part of a scheme that has a fraudulent
element); cf. Carpenter, 791 F.2d at 1027-34 (finding, under a
misappropriation theory, that the Carpenter events constituted a
deceptive scheme for § 10(b) purposes), aff'd by an equally divided
court, 484 U.S. at 24.
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In light of her disclosure to her husband, Mrs.
Rocklage's mechanism for "distributing" the information to her
brother may or may not have been rendered non-deceptive by her
stated intention to tip. But because of the way in which Mrs.
Rocklage first acquired this information, her overall scheme was
still deceptive: it had as part of it at least one deceptive
device. Thus as a matter of the facts alleged in the complaint,
and taking all facts and inferences in favor of the plaintiff, a
§ 10(b) claim is stated.
Contrary to the parties' arguments, we decline to
articulate a broad, generalized test for exactly when disclosure
will negate deception under a § 10(b) misappropriation theory.
That is deliberate. The import and reach of the Supreme Court's
language in O'Hagan about disclosure as a cure for deception has
created uncertainty in the courts and has provoked a great deal of
academic commentary.8 Until the Supreme Court has clarified its
language about disclosure, this uncertainty is an important factor
8
See, e.g., Karmel, Outsider Trading on Confidential
Information -- A Breach in Search of a Duty, 20 Cardozo L. Rev. 83,
95 (1998); Langevoort & Gulati, The Muddled Duty To Disclose Under
Rule 10b-5, 57 Vand. L. Rev. 1639, 1675-77 (2004); Nagy, Reframing
the Misappropriation Theory of Insider Trading Liability: A Post-
O'Hagan Suggestion, 59 Ohio St. L.J. 1223, 1256-59 (1998); Painter
et al., Don't Ask, Just Tell: Insider Trading After United States
v. O'Hagan, 84 Va. L. Rev. 153, 180-81 (1998); Prakash, Our
Dysfunctional Insider Trading Regime, 99 Colum. L. Rev. 1491, 1506-
32 (1999); Quinn, The Misappropriation Theory of Insider Trading in
the Supreme Court: A (Brief) Response to the (Many) Critics of
United States v. O'Hagan, 8 Fordham J. Corp. & Fin. L. 865, 893-95
(2003).
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in why we are unwilling to state generalized rules. Our task is to
decide cases on an individual basis, and it suffices for us to say
that on the facts asserted in the complaint, the SEC has stated a
claim. Given the variety of types of deception and types of
disclosure, caution is warranted until the complexity and variety
of problems are understood. Furthermore, the SEC may wish to
address this issue through the regulatory process.
We acknowledge that defendants' argument is both strong
and very well presented. In the end, only the Supreme Court,
Congress, or the SEC can bring the needed clarity to these
questions.
III.
The defendants' brief does not challenge the district
court's finding that if Mrs. Rocklage is liable under the
misappropriation theory, the complaint also states a claim against
the downstream tippees, Beaver and Jones. Also, because we find
that the complaint states a claim under the misappropriation
theory, we decline to reach the issue of whether it also states a
claim under the classical theory because Mrs. Rocklage was a
temporary insider. Finally, we have no occasion to reach the
contingent issue of whether Beaver and Jones can be liable for
insider trading even if the complaint states no valid claim against
Mrs. Rocklage.
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The district court's decision is affirmed, and the case
is remanded for further proceedings consistent with this opinion.
Costs are awarded to the SEC.
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