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Court allows broader meaning of insider trading




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This article is from the Investing Articles: Stocks and Options series.

Court allows broader meaning of insider trading

USA Today Article

WASHINGTON - People can be prosecuted for using inside information to buy or sell a company's stock even if they don't work for the company or owe it any legal duty, the Supreme Court ruled Wednesday.

The divided ruling upheld a legal tool for prosecuting cases where someone who is not a company insider uses confidential information - often another firm's secret takeover plans - to reap profits by buying the company's stock.

The justices reinstated the insider-trading convictions of former Minneapolis lawyer James O'Hagan. O'Hagan was convicted in 1994 of illegally earning more than $4.3 million by trading in Pillsbury stock after learning that a client of his law firm would attempt a takeover of Pillsbury.

Wednesday's decision reversed a lower court ruling that the Clinton administration said "opened a large loophole" in the ban on insider trading.

Insider trading ordinarily applies to transactions by people who have confidential information because they work for the company whose stock they are trading. Also, people who are tipped off by an insider can be prosecuted for insider trading.

But during the 1980s the Securities and Exchange Commission broadened its definition of insider trading to bar trading in a company's stock by someone who has confidential information but does not work for the company or owe it any legal duty.

O'Hagan's lawyer argued to the Supreme Court that because his client did not work for Pillsbury, he owed no legal duty to the company or its stockholders and therefore could not be prosecuted for insider trading.

"It makes scant sense to hold a lawyer like O'Hagan a ... violator if he works for a law firm representing the target of a tender offer, but not if he works for a law firm representing the bidder," Justice Ruth Bader Ginsburg wrote for the court.

"It is a fair assumption that trading on the basis of material, nonpublic information will often involve a breach of duty of confidentiality to the bidder or target company or their representatives," Ginsburg wrote.

Her opinion was joined by Justices John Paul Stevens, Sandra Day O'Connor, Anthony M. Kennedy, David H. Souter and Stephen G. Breyer.

Justice Antonin Scalia agreed with the majority that one of the two prosecution theories at issue in today's case should be upheld. But he contended the other, involving "misappropriation" of inside information, should not be applied to O'Hagan.

Chief Justice William H. Rehnquist and Justice Clarence Thomas dissented.

O'Hagan's law firm had been hired by a British company, Grand Metropolitan PLC, which was planning the takeover bid.

O'Hagan was convicted of 57 counts including securities fraud, mail fraud and fraudulent trading in connection with a takeover offer. He was sentenced to 18 months in prison.

The 8th U.S. Circuit Court of Appeals reversed the convictions. It said federal law does not allow a securities fraud conviction such as O'Hagan's to be based on "misappropriation" of inside information because it did not require deception or a breach of duty to the targeted company's shareholders.

The appeals court also threw out a separate SEC rule used to prosecute people for insider trading related to takeover offers. The court said a federal securities law does not let the SEC outlaw such transactions by people who do not owe a duty of trust to the targeted company.

The appeals court also reversed O'Hagan's mail fraud convictions, saying they were based on the securities fraud counts.

The case is U.S. vs. O'Hagan, 96-842.

By The Associated Press

 

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