1. State the SEC’s theory of tippee liability. Would such a theory have an inhibiting influence on the role of market analysts?

2. When is a tippee subject to a fiduciary duty to the shareholders not to trade on material nonpublic information?

3. Does the Court establish a “constructive insider” rule in its footnote?

On March 6, 1973, Raymond Dirks, an investment analyst, received information from Ronald Secrist, a former officer of Equity Funding of America, alleging that the assets of Equity Funding were vastly overstated as the result of fraudulent corporate practices. Upon investigation, Dirks received only denials from senior management, but certain corporation employees corroborated the charges of fraud. Neither Dirks nor his firm owned or traded any Equity Funding stock, but throughout his investigation, he openly discussed the information he had obtained with a number of clients and investors, causing liquidation of Equity Funding stock in excess of $16 million. Dirks urged the Wall Street Journal to publish a story on the fraud allegations. However, it declined because it feared that publishing damaging hearsay might be libelous. Dirks continued his investigation and spread word of Secrist’s charges over the next two weeks. During this time, Equity Funding stock fell from $26 per share to less than $15 per share. On March 27, the NYSE halted trading of Equity Funding stock, and a subsequent investigation revealed the vast fraud that had taken place. The SEC, investigating Dirks’s role in the exposure of the fraud, found that Dirks had aided and abetted violations of the Securities Act of 1933, the Securities Exchange Act of 1934, and SEC Rule 10b-5 by publicly repeating the allegations of fraud. Upon appeal by Dirks, the decision of the lower court was upheld by the Court of Appeals. An appeal was taken to the Supreme Court.

JUDICIAL OPINION

POWELL, J.… In the seminal case of In re Cady, Roberts & Co., 40 S.E.C. 907 (1961), the SEC recognized that the common law in some jurisdictions imposes on “corporate ‘insiders’, particularly officers, directors, or controlling stockholders” an “affirmative duty of disclosure…when dealing in securities.” The SEC found that not only did breach of this common-law duty also establish the elements of a Rule 10b-5 violation, but that individuals other than corporate insiders could be obligated either to disclose material nonpublic information before trading or to abstain from trading altogether. In Chiarella [445 U.S. 222 (1980)], we accepted the two elements set out in Cady, Roberts for establishing a Rule 10b-5 violation: “(i) the existence of a relationship affording access to inside information intended to be available only for a corporate purpose, and (ii) the unfairness of allowing a corporate insider to take advantage of that information by trading without disclosure.” In examining whether Chiarella had an obligation to disclose or abstain, the Court found that there is no general duty to disclose before trading on material nonpublic information, and held that “a duty to disclose under § 10(b) does not arise from the mere possession of nonpublic market information.” Such a duty arises rather from the existence of a fiduciary relationship. Not “all breaches of fiduciary duty in connection with a securities transaction,” however, come within the ambit of Rule 10b-5. There must also be “manipulation or deception.” In an inside-trading case this fraud derives from the “inherent unfairness involved where one takes ………..