United States v. O'Hagan, 521 U.S. 642 (1997) (U.S. Supreme Court)
United States v. O'Hagan is the Supreme Court's landmark decision endorsing the misappropriation theory of insider trading under Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5.
Does a person who misappropriates confidential information in breach of a duty owed to the source of the information and uses it for securities trading violate §10(b) and Rule 10b-5? And is SEC Rule 14e-3—which prohibits trading on material nonpublic information in the tender offer context without requiring a breach of fiduciary duty—a valid exercise of the SEC's authority under §14(e)?
Under the misappropriation theory, a person commits fraud "in connection with" a securities transaction, in violation of §10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty of trust and confidence owed to the source of the information. The deception consists of nondisclosure of his intended use of the information to the source to whom he owes the duty, coupled with scienter. The "in connection with" element is satisfied when the deceptive use of confidential information is integral to the securities transaction. Separately, §14(e) authorizes the SEC to adopt prophylactic rules reasonably designed to prevent fraudulent, deceptive, or manipulative acts in connection with tender offers; Rule 14e-3 validly prohibits trading on material nonpublic tender-offer information regardless of whether a fiduciary breach is shown.
Yes. The Supreme Court held that §10(b) and Rule 10b-5 encompass the misappropriation theory: O'Hagan's undisclosed, self-serving use of confidential information, in breach of a duty owed to the source (his firm and its client), was deceptive and "in connection with" the purchase or sale of securities. The Court also held that Rule 14e-3 is a valid exercise of the SEC's authority under §14(e) to regulate tender offers by adopting prophylactic measures that do not require proof of a fiduciary breach.
O'Hagan definitively established the misappropriation theory as a basis for insider trading liability, expanding the reach of §10(b) beyond the classical insider–shareholder relationship to cover deception of the source of information. It also confirmed the SEC's robust authority to craft prophylactic rules for tender offers, validating Rule 14e-3's possession-based prohibition. For law students, O'Hagan is essential to understanding modern insider trading doctrine: it clarifies the duty structure (duty to source versus duty to shareholders), the role of deception and scienter, the "in connection with" requirement, and the special regulatory treatment of tender offers.