OCTOBER TERM, 1996
Syllabus
UNITED STATES
v. O'HAGAN
CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE EIGHTH
CIRCUIT
No. 96-842. Argued April 16, 1997-Decided June 25,1997
After Grand Metropolitan PLC (Grand Met) retained the law firm
of Dorsey & Whitney to represent it regarding a potential
tender offer for the Pillsbury Company's common stock, respondent
O'Hagan, a Dorsey & Whitney partner who did no work on the
representation, began purchasing call options for Pillsbury stock,
as well as shares of the stock. Following Dorsey & Whitney's
withdrawal from the representation, Grand Met publicly announced
its tender offer, the price of Pillsbury stock rose dramatically,
and O'Hagan sold his call options and stock at a profit of more
than $4.3 million. A Securities and Exchange Commission (SEC)
investigation culminated in a 57-count indictment alleging,
inter alia, that O'Hagan defrauded his law firm and its
client, Grand Met, by misappropriating for his own trading purposes
material, nonpublic information regarding the tender offer. The
indictment charged O'Hagan with securities fraud in violation of §
lO(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5,
with fraudulent trading in connection with a tender offer in
violation of § 14(e) of the Exchange Act and SEC Rule 14e-3(a), and
with violations of the federal mail fraud and money laundering
statutes. A jury convicted O'Hagan on all counts, and he was
sentenced to prison. The Eighth Circuit reversed all of the
convictions, holding that § 10(b) and Rule 10b-5liability may not
be grounded on the "misappropriation theory" of securities fraud on
which the prosecution relied; that Rule 14e-3(a) exceeds the SEC's
§ 14(e) rulemaking authority because the Rule contains no breach of
fiduciary duty requirement; and that the mail fraud and money
laundering convictions rested on violations of the securities laws,
so could not stand once the securities fraud convictions were
reversed.
Held:
1. A person who trades in securities for personal profit, using
confidential information misappropriated in breach of a fiduciary
duty to the source of the information, may be held liable for
violating § 10(b) and Rule 10b-5. Pp. 649-666.
(a) Section lO(b) proscribes (1) using any "deceptive device"
(2) "in connection with the purchase or sale of any security," in
contravention of SEC rules. The Commission adopted Rule 10b-5
pursuant to its § lO(b) rulemaking authority; liability under Rule
lOb-5 does not ex-
643
tend beyond conduct encompassed by § 10(b)'s prohibition. See,
e. g.,
Ernst &
Ernst v.
Hochfelder,
425 U. S. 185,
214. Under the "traditional" or "classical theory" of insider
trading liability, a violation of § lO(b) and Rule lOb-5 occurs
when a corporate insider trades in his corporation's securities on
the basis of material, confidential information he has obtained by
reason of his position. Such trading qualifies as a "deceptive
device" because there is a relationship of trust and confidence
between the corporation's shareholders and the insider that gives
rise to a duty to disclose or abstain from trading.
Chiarella v.
United States, 445 U. S. 222, 228-229.
Under the complementary "misappropriation theory" urged by the
Government here, a corporate "outsider" violates § lO(b) and Rule
lOb-5 when he misappropriates confidential information for
securities trading purposes, in breach of a fiduciary duty owed to
the source of the information, rather than to the persons with whom
he trades. Pp. 650-653.
(b) Misappropriation, as just defined, is the proper subject of
a § lO(b) charge because it meets the statutory requirement that
there be "deceptive" conduct "in connection with" a securities
transaction. First, misappropriators deal in deception: A fiduciary
who pretends loyalty to the principal while secretly converting the
principal's information for personal gain dupes or defrauds the
principal. A company's confidential information qualifies as
property to which the company has a right of exclusive use; the
undisclosed misappropriation of such information constitutes fraud
akin to embezzlement. Cf.
Carpenter v.
United States,
484 U. S. 19,
25-27. Deception through nondisclosure is central to liability
under the misappropriation theory. The theory is thus consistent
with
Santa Fe Industries, Inc. v.
Green, 430 U. S. 462, 473-476, a
decision underscoring that § lO(b) is not an all-purpose breach of
fiduciary duty ban, but trains on conduct that is manipulative or
deceptive. Conversely, full disclosure forecloses liability:
Because the deception essential to the theory involves feigning
fidelity to the information's source, if the fiduciary discloses to
the source that he plans to trade on the information, there is no
"deceptive device" and thus no § lO(b) violation. Second, § 10(b)'s
requirement that the misappropriator's deceptive use of information
be "in connection with the purchase or sale of [a] security" is
satisfied by the misappropriation theory because the fiduciary's
fraud is consummated not when he obtains the confidential
information, but when, without disclosure to his principal, he uses
the information in purchasing or selling securities. The
transaction and the breach of duty coincide, even though the person
or entity defrauded is not the other party to the trade, but is,
instead, the source of the nonpublic information. Because
undisclosed trading on the basis of misappropriated, nonpublic
information both deceives the source of
644
Syllabus
the information and harms members of the investing public, the
misappropriation theory is tuned to an animating purpose of the
Exchange Act: to ensure honest markets, thereby promoting investor
confidence. It would make scant sense to hold a
lawyer-turned-trader like O'Hagan a § 10(b) violator if he works
for a law firm representing the target of a tender offer, but not
if he works for a firm representing the bidder. The statute's text
requires no such result. Pp. 653-659.
(c) The Eighth Circuit erred in holding that the
misappropriation theory is inconsistent with § 10(b). First, that
court understood the theory to require neither misrepresentation
nor nondisclosure; as this Court explains, however, deceptive
nondisclosure is essential to § 10(b) liability under the theory.
Concretely, it was O'Hagan's failure to disclose his personal
trading to Grand Met and Dorsey, in breach of his duty to do so,
that made his conduct "deceptive" under § 10(b). Second, the Eighth
Circuit misread this Court's precedents when it ruled that, under
Chiarella v.
United States, 445 U. S. 222, 230, 232,
233;
Dirks v.
SEC, 463 U. S. 646, 655; and
Central Bank of Denver, N. A. v.
First Interstate Bank of
Denver, N. A., 511 U. S. 164, 191, only
a breach of a duty to parties to a securities transaction, or, at
the most, to other market participants such as investors, is
sufficient to give rise to § lO(b) liability.
Chiarella, 445
U. S., at 238, 239, 240-243, 245, expressly left open the question
of the misappropriation theory's validity, and
Dirks, 463 U.
S., at 665, 666-667, also left room for application of the
misappropriation theory in cases such as this one.
Central
Bank's discussion concerned only private civil litigation under
§ 10(b) and Rule 10b-5, not criminal liability. Pp. 660-665.
(d) Vital to this Court's decision that criminal liability may
be sustained under the misappropriation theory is the Exchange
Act's requirement that the Government prove that a person
"willfully" violated Rule lOb-5 in order to establish a criminal
violation, and the Act's provision that a defendant may not be
imprisoned for such a violation if he proves that he had no
knowledge of the Rule. The requirement of culpable intent weakens
O'Hagan's charge that the misappropriation theory is too indefinite
to permit the imposition of criminal liability. See
Boyce Motor
Lines, Inc. v.
United States, 342 U. S. 337, 342. The
Eighth Circuit may address on remand O'Hagan's other challenges to
his § lO(b) and Rule 10b-5 convictions. Pp. 665-666.
2. As relevant to this case, the SEC did not exceed its
rulemaking authority under § 14(e) by adopting Rule 14e-3(a)
without requiring a showing that the trading at issue entailed a
breach of fiduciary duty. Section 14(e) prohibits "fraudulent ...
acts ... in connection with any tender offer," and authorizes the
SEC to "define, and prescribe means reasonably designed to prevent,
such acts." Adopted under that statu-
645
tory authorization, Rule 14e-3(a) forbids any person to trade on
the basis of material, nonpublic information that concerns a tender
offer and that the person knows or should know has been acquired
from an insider of the offeror or issuer, or someone working on
their behalf, unless within a reasonable time before any purchase
or sale such information and its source are publicly disclosed.
Rule 14e-3(a) imposes a duty to disclose or abstain from trading
whether or not the trader owes a fiduciary duty to respect the
confidentiality of the information. In invalidating Rule 14e-3(a),
the Eighth Circuit reasoned,
inter alia, that § 14(e)
empowers the SEC to identify and regulate "fraudulent" acts, but
not to create its own definition of "fraud"; that, under
Schreiber v.
Burlington Northern, Inc., 472 U. S. 1,7-8, § lO(b)
interpretations guide construction of § 14(e); and that, under
Chiarella, supra, at 228, a failure to disclose information
can be "fraudulent" for § 10(b) purposes only when there is a duty
to speak arising out of a fiduciary or similar relationship of
trust and confidence. This Court need not resolve whether the SEC's
§ 14(e) fraud-defining authority is broader than its like authority
under § 10(b), for Rule 14e-3(a), as applied to cases of this
genre, qualifies under § 14(e) as a "means reasonably designed to
prevent" fraudulent trading on material, nonpublic information in
the tender offer context. A prophylactic measure properly
encompasses more than the core activity prohibited. Under § 14(e),
the SEC may prohibit acts not themselves fraudulent under the
common law or § 10(b), if the prohibition is reasonably designed to
prevent acts and practices that are fraudulent. See
Schreiber,
supra, at 11, n. 11. This Court must accord the SEC's
assessment in that regard controlling weight unless it is
arbitrary, capricious, or manifestly contrary to the statute.
Chevron U. S.
A. Inc. v.
Natural Resources Defense
Council, Inc., 467 U. S. 837, 844. In
this case, the SEC's assessment is none of these. It is a fair
assumption that trading on the basis of material, nonpublic
information will often involve a breach of a duty of
confidentiality to the bidder or target company or their
representatives. The SEC, cognizant of proof problems that could
enable sophisticated traders to escape responsibility for such
trading, placed in Rule 14e-3(a) a "disclose or abstain from
trading" command that does not require specific proof of a breach
of fiduciary duty. Insofar as it serves to prevent the type of
misappropriation charged against O'Hagan, the Rule is therefore a
proper exercise of the SEC's prophylactic power under § 14(e). This
Court declines to consider in the first instance O'Hagan's
alternate arguments that Rule 14e-3(a)'s prohibition of pre-offer
trading conflicts with § 14(e) and violates due process. The Eighth
Circuit may address on remand any such argument that O'Hagan has
preserved. Pp. 666-677.
646
3. This Court's rulings on the securities fraud issues require
reversal of the Eighth Circuit's judgment on the mail fraud counts.
O'Hagan's other arguments attacking the mail fraud convictions on
alternate grounds, which have not been addressed by the Eighth
Circuit, remain open for consideration on remand. Pp. 677-678.
92 F.3d
612, reversed and remanded.
GINSBURG, J., delivered the opinion of the Court, in which
STEVENS, O'CONNOR, KENNEDY, SOUTER, and BREYER, JJ., joined, and in
which SCALIA, J., joined as to Parts I, III, and IV. SCALIA, J.,
filed an opinion concurring in part and dissenting in part,
post, p. 679. THOMAS, J., filed an opinion concurring in the
judgment in part and dissenting in part, in which REHNQUIST, C. J.,
joined,
post, p. 680.
Deputy Solicitor General Dreeben argued the cause for the United
States. With him on the briefs were Acting Solicitor General
Dellinger, Acting Assistant Attorney General Richard, Paul R. Q.
Wolfson, Joseph C. Wyderko, Richard H. Walker, Paul Gonson, Jacob
H. Stillman, Eric Summergrad, and Randall W Quinn.
John D. French argued the cause for respondent. With him
on the brief was
Elizabeth L. Taylor. *
JUSTICE GINSBURG delivered the opinion of the Court. This case
concerns the interpretation and enforcement of § 10(b) and § 14(e)
of the Securities Exchange Act of 1934, and rules made by the
Securities and Exchange Commission pursuant to these provisions,
Rule 10b-5 and Rule 14e-3(a).
*Briefs of
amici curiae urging reversal were filed for
the American Institute of Certified Public Accountants by
Louis
A. Craco, Richard I. Miller, and
David P. Murray; for
the Association for Investment Management and Research by
Stuart
H. Singer; and for the North American Securities Administrators
Association, Inc., et al. by
Karen M. O'Brien, Meyer Eisenberg,
Louis Loss, and
Donald C.
Langevoort.
Briefs of amici curiae urging affirmance were filed for Law
Professors and Counsel by Richard W Painter and Douglas W Dunham;
and for the National Association of Criminal Defense Lawyers by
Arthur F. Mathews, David M. Becker, Andrew B. Weissman, Robert F.
Hoyt, Lisa Kemler, Milton V. Freeman, and Elkan Abramowitz.
647
Two prime questions are presented. The first relates to the
misappropriation of material, nonpublic information for securities
trading; the second concerns fraudulent practices in the tender
offer setting. In particular, we address and resolve these issues:
(1) Is a person who trades in securities for personal profit, using
confidential information misappropriated in breach of a fiduciary
duty to the source of the information, guilty of violating § 10(b)
and Rule 10b-5? (2) Did the Commission exceed its rulemaking
authority by adopting Rule 14e-3(a), which proscribes trading on
undisclosed information in the tender offer setting, even in the
absence of a duty to disclose? Our answer to the first question is
yes, and to the second question, viewed in the context of this
case, no.
I
Respondent James Herman O'Hagan was a partner in the law firm of
Dorsey & Whitney in Minneapolis, Minnesota. In July 1988, Grand
Metropolitan PLC (Grand Met), a company based in London, England,
retained Dorsey & Whitney as local counsel to represent Grand
Met regarding a potential tender offer for the common stock of the
Pillsbury Company, headquartered in Minneapolis. Both Grand Met and
Dorsey & Whitney took precautions to protect the
confidentiality of Grand Met's tender offer plans. O'Hagan did no
work on the Grand Met representation. Dorsey & Whitney withdrew
from representing Grand Met on September 9, 1988. Less than a month
later, on October 4, 1988, Grand Met publicly announced its tender
offer for Pillsbury stock.
On August 18, 1988, while Dorsey & Whitney was still
representing Grand Met, O'Hagan began purchasing call options for
Pillsbury stock. Each option gave him the right to purchase 100
shares of Pillsbury stock by a specified date in September 1988.
Later in August and in September, O'Hagan made additional purchases
of Pillsbury call options. By the end of September, he owned 2,500
unexpired Pillsbury options, apparently more than any other
individual in-
648
vestor. See App. 85, 148. O'Hagan also purchased, in September
1988, some 5,000 shares of Pillsbury common stock, at a price just
under $39 per share. When Grand Met announced its tender offer in
October, the price of Pillsbury stock rose to nearly $60 per share.
O'Hagan then sold his Pillsbury call options and common stock,
making a profit of more than $4.3 million.
The Securities and Exchange Commission (SEC or Commission)
initiated an investigation into O'Hagan's transactions, culminating
in a 57-count indictment. The indictment alleged that O'Hagan
defrauded his law firm and its client, Grand Met, by using for his
own trading purposes material, nonpublic information regarding
Grand Met's planned tender offer.
Id., at 8.1 According to
the indictment, O'Hagan used the profits he gained through this
trading to conceal his previous embezzlement and conversion of
unrelated client trust funds.
Id., at 10.2 O'Hagan was
charged with 20 counts of mail fraud, in violation of 18 U. S. C. §
1341; 17 counts of securities fraud, in violation of § 10(b) of the
Securities Exchange Act of 1934 (Exchange Act), 48 Stat. 891, 15 U.
S. C. § 78j(b), and SEC Rule 10b-5, 17 CFR § 240.10b-5
1 As evidence that O'Hagan traded on the basis of nonpublic
information misappropriated from his law firm, the Government
relied on a conversation between O'Hagan and the Dorsey &
Whitney partner heading the firm's Grand Met representation. That
conversation allegedly took place shortly before August 26, 1988.
See Brief for United States 4. O'Hagan urges that the Government's
evidence does not show he traded on the basis of nonpublic
information. O'Hagan points to news reports on August 18 and 22,
1988, that Grand Met was interested in acquiring Pillsbury, and to
an earlier, August 12, 1988, news report that Grand Met had put up
its hotel chain for auction to raise funds for an acquisition. See
Brief for Respondent 4 (citing App. 73-74, 78-80). O'Hagan's
challenge to the sufficiency of the evidence remains open for
consideration on remand.
2 O'Hagan was convicted of theft in state court, sentenced to 30
months' imprisonment, and fined. See
State v.
O'Hagan, 474 N. W. 2d 613, 615, 623 (Minn. App. 1991). The
Supreme Court of Minnesota disbarred O'Hagan from the practice of
law. See
In re O'Hagan, 450 N. W. 2d 571 (1990).
649
(1996); 17 counts of fraudulent trading in connection with a
tender offer, in violation of § 14(e) of the Exchange Act, 15 U. S.
C. § 78n(e), and SEC Rule 14e-3(a), 17 CFR § 240.14e3(a) (1996);
and 3 counts of violating federal money laundering statutes, 18 U.
S. C. §§ 1956(a)(1)(B)(i), 1957. See App. 13-24. A jury convicted
O'Hagan on all 57 counts, and he was sentenced to a 41-month term
of imprisonment.
A divided panel of the Court of Appeals for the Eighth Circuit
reversed all of O'Hagan's convictions.
92 F.3d
612 (1996). Liability under § 10(b) and Rule 10b-5, the Eighth
Circuit held, may not be grounded on the "misappropriation theory"
of securities fraud on which the prosecution relied.
Id., at
622. The Court of Appeals also held that Rule 14e3(a)-which
prohibits trading while in possession of material, nonpublic
information relating to a tender offer-exceeds the SEC's § 14(e)
rulemaking authority because the Rule contains no breach of
fiduciary duty requirement.
Id., at 627. The Eighth Circuit
further concluded that O'Hagan's mail fraud and money laundering
convictions rested on violations of the securities laws, and
therefore could not stand once the securities fraud convictions
were reversed.
Id., at 627-628. Judge Fagg, dissenting,
stated that he would recognize and enforce the misappropriation
theory, and would hold that the SEC did not exceed its rulemaking
authority when it adopted Rule 14e-3(a) without requiring proof of
a breach of fiduciary duty.
Id., at 628.
Decisions of the Courts of Appeals are in conflict on the
propriety of the misappropriation theory under § 10(b) and Rule
10b-5, see
infra this page and 650, and n. 3, and on the
legitimacy of Rule 14e-3(a) under § 14(e), see
infra, at
669670. We granted certiorari, 519 U. S. 1087 (1997), and now
reverse the Eighth Circuit's judgment.
II
We address first the Court of Appeals' reversal of O'Hagan's
convictions under § 10(b) and Rule 10b-5. Following
650
the Fourth Circuit's lead, see
United States v.
Bryan,
58 F. 3d 933, 943-959 (1995), the Eighth Circuit rejected the
misappropriation theory as a basis for § 10(b) liability. We hold,
in accord with several other Courts of Appeals,3 that criminal
liability under § 10(b) may be predicated on the misappropriation
theory.4
A
In pertinent part, § 10(b) of the Exchange Act provides:
"It shall be unlawful for any person, directly or indirectly, by
the use of any means or instrumentality of interstate commerce or
of the mails, or of any facility of any national securities
exchange-
"(b) To use or employ, in connection with the purchase or sale
of any security registered on a national securities exchange or any
security not so registered, any manipulative or deceptive device or
contrivance in contravention of such rules and regulations as the
[Securities and Exchange] Commission may prescribe as necessary or
appropriate in the public interest or for the protection of
investors." 15 U. S. C. § 78j(b).
3 See,
e. g., United States v.
Chestman, 947 F.2d
551, 566
(CA2 1991) (en bane), cert. denied, 503 U. S.
1004 (1992);
SEC v.
Cherif, 933
F.2d 403, 410
(CA7 1991), cert. denied, 502 U. S. 1071
(1992);
SEC v.
Clark, 915 F.2d
439, 453 (CA9 1990).
4 Twice before we have been presented with the question whether
criminal liability for violation of § 10(b) may be based on a
misappropriation theory. In
Chiarella v.
United
States, 445 U. S.
222, 235-237 (1980), the jury had received no misappropriation
theory instructions, so we declined to address the question. See
infra, at 661. In
Carpenter v.
United States,
484 U. S. 19, 24
(1987), the Court divided evenly on whether, under the
circumstances of that case, convictions resting on the
misappropriation theory should be affirmed. See Aldave, The
Misappropriation Theory:
Carpenter and Its Mtermath, 49 Ohio St. L. J. 373, 375
(1988) (observing that
"Carpenter was, by any reckoning, an
unusual case," for the information there misappropriated belonged
not to a company preparing to engage in securities transactions,
e. g., a bidder in a corporate acquisition, but to the Wall
Street Journal).
651
The statute thus proscribes (1) using any deceptive device (2)
in connection with the purchase or sale of securities, in
contravention of rules prescribed by the Commission. The provision,
as written, does not confine its coverage to deception of a
purchaser or seller of securities, see
United States v.
Newman, 664 F.2d
12, 17 (CA2 1981); rather, the statute reaches any deceptive
device used "in connection with the purchase or sale of any
security."
Pursuant to its § 10(b) rulemaking authority, the Commission has
adopted Rule 10b-5, which, as relevant here, provides:
"It shall be unlawful for any person, directly or indirectly, by
the use of any means or instrumentality of interstate commerce, or
of the mails or of any facility of any national securities
exchange,
"(a) To employ any device, scheme, or artifice to defraud,
[or]
"(c) 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
CFR § 240.10b-5 (1996).
Liability under Rule 10b-5, our precedent indicates, does not
extend beyond conduct encompassed by § 10(b)'s prohibition. See
Ernst &
Ernst v.
Hochfelder, 425 U. S. 185, 214 (1976)
(scope of Rule 10b-5 cannot exceed power Congress granted
Commission under § 10(b)); see also
Central Bank of Denver,
N.
A. v.
First Interstate Bank of Denver, N.
A., 511 U. S.
164, 173 (1994) ("We have refused to allow [private] 10b-5
challenges to conduct not prohibited by the text of the
statute.").
Under the "traditional" or "classical theory" of insider trading
liability, § 10(b) and Rule 10b-5 are violated when a corporate
insider trades in the securities of his corporation
652
on the basis of material, nonpublic information. Trading on such
information qualifies as a "deceptive device" under § 10(b), we
have affirmed, because "a relationship of trust and confidence
[exists] between the shareholders of a corporation and those
insiders who have obtained confidential information by reason of
their position with that corporation."
Chiarella v.
United States, 445 U. S. 222, 228
(1980). That relationship, we recognized, "gives rise to a duty to
disclose [or to abstain from trading] because of the 'necessity of
preventing a corporate insider from ... tak[ing] unfair advantage
of ... uninformed ... stockholders.'"
Id., at 228-229
(citation omitted). The classical theory applies not only to
officers, directors, and other permanent insiders of a corporation,
but also to attorneys, accountants, consultants, and others who
temporarily become fiduciaries of a corporation. See
Dirks
v.
SEC, 463 U.
S. 646, 655, n. 14 (1983).
The "misappropriation theory" holds that a person commits fraud
"in connection with" a securities transaction, and thereby violates
§ 10(b) and Rule 10b-5, when he misappropriates confidential
information for securities trading purposes, in breach of a duty
owed to the source of the information. See Brief for United States
14. Under this theory, a fiduciary's undisclosed, self-serving use
of a principal's information to purchase or sell securities, in
breach of a duty of loyalty and confidentiality, defrauds the
principal of the exclusive use of that information. In lieu of
premising liability on a fiduciary relationship between company
insider and purchaser or seller of the company's stock, the
misappropriation theory premises liability on a
fiduciary-turned-trader's deception of those who entrusted him with
access to confidential information.
The two theories are complementary, each addressing efforts to
capitalize on nonpublic information through the purchase or sale of
securities. The classical theory targets a corporate insider's
breach of duty to shareholders with whom the insider transacts; the
misappropriation theory outlaws
653
trading on the basis of nonpublic information by a corporate
"outsider" in breach of a duty owed not to a trading party, but to
the source of the information. The misappropriation theory is thus
designed to "protec[t] the integrity of the securities markets
against abuses by 'outsiders' to a corporation who have access to
confidential information that will affect thee] corporation's
security price when revealed, but who owe no fiduciary or other
duty to that corporation's shareholders."
Ibid.
In this case, the indictment alleged that O'Hagan, in breach of
a duty of trust and confidence he owed to his law firm, Dorsey
& Whitney, and to its client, Grand Met, traded on the basis of
nonpublic information regarding Grand Met's planned tender offer
for Pillsbury common stock. App. 16. This conduct, the Government
charged, constituted a fraudulent device in connection with the
purchase and sale of securities.5
B
We agree with the Government that misappropriation, as just
defined, satisfies § 10(b)'s requirement that chargeable conduct
involve a "deceptive device or contrivance" used "in connection
with" the purchase or sale of securities. We observe, first, that
misappropriators, as the Government describes them, deal in
deception. A fiduciary who "[pretends] loyalty to the principal
while secretly converting the principal's information for personal
gain," Brief for United States
5 The Government could not have prosecuted O'Hagan under the
classical theory, for O'Hagan was not an "insider" of Pillsbury,
the corporation in whose stock he traded. Although an "outsider"
with respect to Pillsbury, O'Hagan had an intimate association
with, and was found to have traded on confidential information
from, Dorsey & Whitney, counsel to tender offeror Grand Met.
Under the misappropriation theory, O'Hagan's securities trading
does not escape Exchange Act sanction, as it would under JUSTICE
THOMAS' dissenting view, simply because he was associated with, and
gained nonpublic information from, the bidder, rather than the
target.
654
17, "dupes" or defrauds the principal. See Aldave,
Misappropriation: A General Theory of Liability for Trading on
Nonpublic Information, 13 Hofstra L. Rev. 101, 119 (1984).
We addressed fraud of the same species in
Carpenter
v.
United States, 484 U. S. 19 (1987), which
involved the mail fraud statute's proscription of "any scheme or
artifice to defraud," 18 U. S. C. § 1341. Affirming convictions
under that statute, we said in
Carpenter that an employee's
undertaking not to reveal his employer's confidential information
"became a sham" when the employee provided the information to his
co-conspirators in a scheme to obtain trading profits. 484 U. S.,
at 27. A company's confidential information, we recognized in
Carpenter, qualifies as property to which the company has a
right of exclusive use.
Id., at 25-27. The undisclosed
misappropriation of such information, in violation of a fiduciary
duty, the Court said in
Carpenter, constitutes fraud akin to
embezzlement-" 'the fraudulent appropriation to one's own use of
the money or goods entrusted to one's care by another.'"
Id., at 27 (quoting
Grin v.
Shine, 187 U. S. 181,189
(1902)); see Aldave, 13 Hofstra L. Rev., at 119.
Carpenter's
discussion of the fraudulent misuse of confidential information,
the Government notes, "is a particularly apt source of guidance
here, because [the mail fraud statute] (like Section 10(b)) has
long been held to require deception, not merely the breach of a
fiduciary duty." Brief for United States 18, n. 9 (citation
omitted).
Deception through nondisclosure is central to the theory of
liability for which the Government seeks recognition. As counsel
for the Government stated in explanation of the theory at oral
argument: "To satisfy the common law rule that a trustee may not
use the property that [has] been entrusted [to] him, there would
have to be consent. To satisfy the requirement of the Securities
Act that there be no deception, there would only have to be
disclosure." Tr. of Oral Arg. 12; see generally Restatement
(Second) of Agency §§ 390, 395
655
(1958) (agent's disclosure obligation regarding use of
confidential information).6
The misappropriation theory advanced by the Government is
consistent with
Santa Fe Industries, Inc. v.
Green,
430 U. S. 462 (1977), a decision underscoring that § 10(b) is
not an all-purpose breach of fiduciary duty ban; rather, it trains
on conduct involving manipulation or deception. See id., at
473-476. In contrast to the Government's allegations in this case,
in
Santa Fe Industries, all pertinent facts were disclosed
by the persons charged with violating § 10(b) and Rule 10b-5, see
id., at 474; therefore, there was no deception through
nondisclosure to which liability under those provisions could
attach, see id., at 476. Similarly, full disclosure forecloses
liability under the misappropriation theory: Because 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-although the
fiduciary-turnedtrader may remain liable under state law for breach
of a duty of loyalty. 7
We turn next to the § 10(b) requirement that the
misappropriator's deceptive use of information be "in connection
with
6 Under the misappropriation theory urged in this case, the
disclosure obligation runs to the source of the information, here,
Dorsey & Whitney and Grand Met. Chief Justice Burger,
dissenting in
Chiarella, advanced a broader reading of §
10(b) and Rule 10b-5; the disclosure obligation, as he envisioned
it, ran to those with whom the misappropriator trades. 445 U. S.,
at 240 ("a person who has misappropriated nonpublic information has
an absolute duty to disclose that information or to refrain from
trading"); see also id., at 243, n. 4. The Government does not
propose that we adopt a misappropriation theory of that
breadth.
7Where, however, a person trading on the basis of material,
nonpublic information owes a duty of loyalty and confidentiality to
two entities or persons-for example, a law firm and its client-but
makes disclosure to only one, the trader may still be liable under
the misappropriation theory.
656
the purchase or sale of [a] security." This element is satisfied
because the fiduciary's fraud is consummated, not when the
fiduciary gains the confidential information, but when, without
disclosure to his principal, he uses the information to purchase or
sell securities. The securities transaction and the breach of duty
thus coincide. This is so even though the person or entity
defrauded is not the other party to the trade, but is, instead, the
source of the nonpublic information. See Aldave, 13 Hofstra L.
Rev., at 120 ("a fraud or deceit can be practiced on one person,
with resultant harm to another person or group of persons"). A
misappropriator who trades on the basis of material, nonpublic
information, in short, gains his advantageous market position
through deception; he deceives the source of the information and
simultaneously harms members of the investing public. See id., at
120-121, and n. 107.
The misappropriation theory targets information of a sort that
misappropriators ordinarily capitalize upon to gain norisk profits
through the purchase or sale of securities. Should a
misappropriator put such information to other use, the statute's
prohibition would not be implicated. The theory does not catch all
conceivable forms of fraud involving confidential information;
rather, it catches fraudulent means of capitalizing on such
information through securities transactions.
The Government notes another limitation on the forms of fraud §
10(b) reaches: "The misappropriation theory would not ... apply to
a case in which a person defrauded a bank into giving him a loan or
embezzled cash from another, and then used the proceeds of the
misdeed to purchase securities." Brief for United States 24, n. 13.
In such a case, the Government states, "the proceeds would have
value to the malefactor apart from their use in a securities
transaction, and the fraud would be complete as soon as the money
was obtained."
Ibid. In other words, money can buy, if not
anything, then at least many things; its misappropriation
657
may thus be viewed as sufficiently detached from a subsequent
securities transaction that § 10(b)'s "in connection with"
requirement would not be met.
Ibid.
JUSTICE THOMAS' charge that the misappropriation theory is
incoherent because information, like funds, can be put to multiple
uses, see
post, at 681-686 (opinion concurring in judgment
in part and dissenting in part), misses the point. The Exchange Act
was enacted in part "to insure the maintenance of fair and honest
markets," 15 U. S. C. § 78b, and there is no question that
fraudulent uses of confidential information fall within § 10(b)'s
prohibition if the fraud is "in connection with" a securities
transaction. It is hardly remarkable that a rule suitably applied
to the fraudulent uses of certain kinds of information would be
stretched beyond reason were it applied to the fraudulent use of
money.
JUSTICE THOMAS does catch the Government in overstatement.
Observing that money can be used for all manner of purposes and
purchases, the Government urges that confidential information of
the kind at issue derives its value only from its utility in
securities trading. See Brief for United States 10, 21;
post, at 683-684 (several times emphasizing the word
"only"). Substitute "ordinarily" for "only," and the Government is
on the mark.s
8JUSTICE THOMAS' evident struggle to invent other uses to which
O'Hagan plausibly might have put the nonpublic information, see
post, at 685, is telling. It is imaginative to suggest that
a trade journal would have paid O'Hagan dollars in the millions to
publish his information. See Tr. of Oral Arg. 36-37. Counsel for
O'Hagan hypothesized, as a nontrading use, that O'Hagan could have
"misappropriat[ed] this information of [his] law firm and its
client, deliver[ed] it to [Pillsbury], and suggest[ed] that
[Pillsbury] in the future ... might find it very desirable to use
[O'Hagan] for legal work."
Id., at 37. But Pillsbury might
well have had large doubts about engaging for its legal work a
lawyer who so stunningly displayed his readiness to betray a
client's confidence. Nor is the Commission's theory "incoherent" or
"inconsistent,"
post, at 680, 692, for failing to inhibit
use of confidential information for "personal amusement ... in a
fantasy stock trading game,"
post, at 685.
658
Our recognition that the Government's "only" is an overstatement
has provoked the dissent to cry "new theory." See
post, at
687-689. But the very case on which JUSTICE THOMAS relies,
Motor
Vehicle Mfrs. Assn. of United States, Inc. v.
State Farm
Mut. Automobile Ins. Co., 463 U. S. 29 (1983), shows
the extremity of that charge. In
State Farm, we reviewed an
agency's rescission of a rule under the same "arbitrary and
capricious" standard by which the promulgation of a rule under the
relevant statute was to be judged, see id., at 41-42; in our
decision concluding that the agency had not adequately explained
its regulatory action, see id., at 57, we cautioned that a
"reviewing court should not attempt itself to make up for such
deficiencies," id., at 43. Here, by contrast, Rule 10b-5's
promulgation has not been challenged; we consider only the
Government's charge that O'Hagan's alleged fraudulent conduct falls
within the prohibitions of the Rule and § 10(b). In this context,
we acknowledge simply that, in defending the Government's
interpretation of the Rule and statute in this Court, the
Government's lawyers have pressed a solid point too far, something
lawyers, occasionally even judges, are wont to do.
The misappropriation theory comports with § 10(b)'s language,
which requires deception "in connection with the purchase or sale
of any security," not deception of an identifiable purchaser or
seller. The theory is also well tuned to an animating purpose of
the Exchange Act: to insure honest securities markets and thereby
promote investor confidence. See 45 Fed. Reg. 60412 (1980) (trading
on misappropriated information "undermines the integrity of, and
investor confidence in, the securities markets"). Although
informational disparity is inevitable in the securities markets,
investors likely would hesitate to venture their capital in a
market where trading based on misappropriated nonpublic information
is unchecked by law. An investor's informational disadvantage
vis-a-vis a misappropriator with material, nonpublic in-
659
formation stems from contrivance, not luck; it is a disadvantage
that cannot be overcome with research or skill. See Brudney,
Insiders, Outsiders, and Informational Advantages Under the Federal
Securities Laws, 93 Harv. L. Rev. 322, 356 (1979) ("If the market
is thought to be systematically populated with ... transactors
[trading on the basis of misappropriated information] some
investors will refrain from dealing altogether, and others will
incur costs to avoid dealing with such transactors or corruptly to
overcome their unerodable informational advantages."); Aldave, 13
Hofstra L. Rev., at 122-123.
In sum, considering the inhibiting impact on market
participation of trading on misappropriated information, and the
congressional purposes underlying § 10(b), it makes scant sense to
hold a lawyer like O'Hagan a § 10(b) 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. The text of the statute
requires no such result.9 The misappropriation at issue here was
properly made the subject of a § 10(b) charge because it meets the
statutory requirement that there be "deceptive" conduct "in
connection with" securities transactions.
9 As noted earlier, however, see supra, at 654-655, the textual
requirement of deception precludes § 10(b) liability when a person
trading on the basis of nonpublic information has disclosed his
trading plans to, or obtained authorization from, the
principal-even though such conduct may affect the securities
markets in the same manner as the conduct reached by the
misappropriation theory. Contrary to JUSTICE THOMAS' suggestion,
see
post, at 689-691, the fact that § 10(b) is only a
partial antidote to the problems it was designed to alleviate does
not call into question its prohibition of conduct that falls within
its textual proscription. Moreover, once a disloyal agent discloses
his imminent breach of duty, his principal may seek appropriate
equitable relief under state law. Furthermore, in the context of a
tender offer, the principal who authorizes an agent's trading on
confidential information may, in the Commission's view, incur
liability for an Exchange Act violation under Rule 14e-3(a).
660
C
The Court of Appeals rejected the misappropriation theory
primarily on two grounds. First, as the Eighth Circuit comprehended
the theory, it requires neither misrepresentation nor
nondisclosure. See 92 F. 3d, at 618. As we just explained, however,
see
supra, at 654-655, deceptive nondisclosure is essential
to the § 10(b) liability at issue. Concretely, in this case, "it
[was O'Hagan's] failure to disclose his personal trading to Grand
Met and Dorsey, in breach of his duty to do so, that ma[de] his
conduct 'deceptive' within the meaning of [§ ]lO(b)." Reply Brief
7.
Second and "more obvious," the Court of Appeals said, the
misappropriation theory is not moored to § 10(b)'s requirement that
"the fraud be 'in connection with the purchase or sale of any
security.'" 92 F. 3d, at 618 (quoting 15 U. S. C. § 78j(b)).
According to the Eighth Circuit, three of our decisions reveal that
§ 10(b) liability cannot be predicated on a duty owed to the source
of nonpublic information:
Chiarella v.
United States,
445 U. S. 222
(1980);
Dirks v.
SEC, 463 U. S. 646 (1983); and
Central Bank of Denver, N.
A. v.
First Interstate
Bank of Denver, N.
A., 511 U. S. 164 (1994).
"[O]nly a breach of a duty to parties to the securities
transaction," the Court of Appeals concluded, "or, at the most, to
other market participants such as investors, will be sufficient to
give rise to § 10(b) liability." 92 F. 3d, at 618. We read the
statute and our precedent differently, and note again that § 10(b)
refers to "the purchase or sale of any security," not to
identifiable purchasers or sellers of securities.
Chiarella involved securities trades by a printer
employed at a shop that printed documents announcing corporate
takeover bids. See 445 U. S., at 224. Deducing the names of target
companies from documents he handled, the printer bought shares of
the targets before takeover bids were announced, expecting
(correctly) that the share prices would rise upon announcement. In
these transactions, the printer did not disclose to the sellers of
the securities (the target
661
companies' shareholders) the nonpublic information on which he
traded. See
ibid. For that trading, the printer was
convicted of violating § 10(b) and Rule 10b-5. We reversed the
Court of Appeals judgment that had affirmed the conviction. See
id., at 225.
The jury in
Chiarella had been instructed that it could
convict the defendant if he willfully failed to inform sellers of
target company securities that he knew of a takeover bid that would
increase the value of their shares. See id., at 226. Emphasizing
that the printer had no agency or other fiduciary relationship with
the sellers, we held that liability could not be imposed on so
broad a theory. See id., at 235. There is under § 10(b), we
explained, no "general duty between all participants in market
transactions to forgo actions based on material, nonpublic
information."
Id., at 233. Under established doctrine, we
said, a duty to disclose or abstain from trading "arises from a
specific relationship between two parties."
Ibid.
The Court did not hold in
Chiarella that the
only
relationship prompting liability for trading on undisclosed
information is the relationship between a corporation's insiders
and shareholders. That is evident from our response to the
Government's argument before this Court that the printer's
misappropriation of information from his employer for purposes of
securities trading-in violation of a duty of confidentiality owed
to the acquiring companies-constituted fraud in connection with the
purchase or sale of a security, and thereby satisfied the terms of
§ 10(b).
Id., at 235-236. The Court declined to reach that
potential basis for the printer's liability, because the theory had
not been submitted to the jury. See id., at 236-237. But four
Justices found merit in it. See
id., at 239 (Brennan, J.,
concurring in judgment);
id., at 240-243 (Burger, C. J.,
dissenting); id., at 245 (Blackmun, J., joined by Marshall, J.,
dissenting). And a fifth Justice stated that the Court "wisely
le[ft] the resolution of this issue for another day."
Id.,
at 238 (STEVENS, J., concurring).
662
Chiarella thus expressly left open the misappropriation
theory before us today. Certain statements in
Chiarella,
however, led the Eighth Circuit in the instant case to conclude
that § 10(b) liability hinges exclusively on a breach of duty owed
to a purchaser or seller of securities. See 92 F. 3d, at 618. The
Court said in
Chiarella that § 10(b) liability "is premised
upon a duty to disclose arising from a relationship of trust and
confidence
between parties to a transaction," 445 U. S., at
230 (emphasis added), and observed that the printshop employee
defendant in that case "was not a person in whom the sellers had
placed their trust and confidence," see id., at 232. These
statements rejected the notion that § 10(b) stretches so far as to
impose "a general duty between all participants in market
transactions to forgo actions based on material, nonpublic
information," id., at 233, and we confine them to that context. The
statements highlighted by the Eighth Circuit, in short, appear in
an opinion carefully leaving for future resolution the validity of
the misappropriation theory, and therefore cannot be read to
foreclose that theory.
Dirks, too, left room for application of the
misappropriation theory in cases like the one we confront.lO
Dirks involved an investment analyst who had received
information from a former insider of a corporation with which the
analyst had no connection. See 463 U. S., at 648-649. The
information indicated that the corporation had engaged in a massive
fraud. The analyst investigated the fraud, obtaining corroborating
information from employees of the corporation. During his
investigation, the analyst discussed his findings with clients and
investors, some of whom sold their holdings in the company the
analyst suspected of gross wrongdoing. See id., at 649.
10 The Eighth Circuit's conclusion to the contrary was based in
large part on
Dirks's reiteration of the
Chiarella
language quoted and discussed above. See
92
F.3d 612, 618-619 (1996).
663
The SEC censured the analyst for,
inter alia, aiding and
abetting § 10(b) and Rule 10b-5 violations by clients and investors
who sold their holdings based on the nonpublic information the
analyst passed on. See id., at 650-652. In the SEC's view, the
analyst, as a "tippee" of corporation insiders, had a duty under §
10(b) and Rule 10b-5 to refrain from communicating the nonpublic
information to persons likely to trade on the basis of it. See id.,
at 651, 655-656. This Court found no such obligation, see id., at
665-667, and repeated the key point made in
Chiarella: There
is no "'general duty between all participants in market
transactions to forgo actions based on material, nonpublic
information.'" 463 U. S., at 655 (quoting
Chiarella, 445 U.
S., at 233); see Aldave, 13 Hofstra L. Rev., at 122
(misappropriation theory bars only "trading on the basis of
information that the wrongdoer converted to his own use in
violation of some fiduciary, contractual, or similar obligation to
the owner or rightful possessor of the information").
No showing had been made in
Dirks that the "tippers" had
violated any duty by disclosing to the analyst nonpublic
information about their former employer. The insiders had acted not
for personal profit, but to expose a massive fraud within the
corporation. See 463 U. S., at 666-667. Absent any violation by the
tippers, there could be no derivative liability for the tippee. See
id., at 667. Most important for purposes of the instant case, the
Court observed in
Dirks:
"There was no expectation by [the analyst's] sources that he
would keep their information in confidence. Nor did [the analyst]
misappropriate or illegally obtain the information .... "
Id., at 665.
Dirks thus presents no suggestion that a
person who gains nonpublic information through misappropriation in
breach of a fiduciary duty escapes § 10(b) liability when, without
alerting the source, he trades on the information.
Last of the three cases the Eighth Circuit regarded as
warranting disapproval of the misappropriation theory,
Cen-
664
tral Bank held that "a private plaintiff may not maintain
an aiding and abetting suit under § 10(b)." 511 U. S., at 191. We
immediately cautioned in
Central Bank that secondary actors
in the securities markets may sometimes be chargeable under the
securities Acts: "Any person or entity, including a lawyer,
accountant, or bank, who employs a manipulative device or makes a
material misstatement (or omission)
on which a purchaser or
seller of securities relies may be liable as a primary violator
under 10b-5, assuming ... the requirements for primary liability
under Rule 10b-5 are met."
Ibid. (emphasis added). The
Eighth Circuit isolated the statement just quoted and drew from it
the conclusion that § 10(b) covers only deceptive statements or
omissions on which purchasers and sellers, and perhaps other market
participants, rely. See 92 F. 3d, at 619. It is evident from the
question presented in
Central Bank, however, that this
Court, in the quoted passage, sought only to clarify that secondary
actors, although not subject to aiding and abetting liability,
remain subject to primary liability under § 10(b) and Rule 10b-5
for certain conduct.
Furthermore,
Central Bank's discussion concerned only
private civil litigation under § 10(b) and Rule 10b-5, not criminal
liability.
Central Bank's reference to purchasers or sellers
of securities must be read in light of a longstanding limitation on
private § 10(b) suits. In
Blue Chip Stamps v.
Manor Drug
Stores, 421 U. S.
723 (1975), we held that only actual purchasers or sellers of
securities may maintain a private civil action under § 10(b) and
Rule 10b-5. We so confined the § 10(b) private right of action
because of "policy considerations."
Id., at 737. In
particular,
Blue Chip Stamps recognized the abuse potential
and proof problems inherent in suits by investors who neither
bought nor sold, but asserted they would have traded absent
fraudulent conduct by others. See
id., at 739-747; see also
Holmes v.
Securities Investor Protection Corporation,
503 U. S. 258,
285
665
(1992) (O'CONNOR, J., concurring in part and concurring in
judgment); id., at 289-290 (SCALIA, J., concurring in judgment).
Criminal prosecutions do not present the dangers the Court
addressed in
Blue Chip Stamps, so that decision is
"inapplicable" to indictments for violations of § 10(b) and Rule
10b-5.
United States v.
Naftalin, 441 U. S. 768, 774, n. 6
(1979); see also
Holmes, 503 U. S., at 281 (O'CONNOR, J.,
concurring in part and concurring in judgment) ("[T]he
purchaser/seller standing requirement for private civil actions
under § 10(b) and Rule 10b-5 is of no import in criminal
prosecutions for willful violations of those provisions.").
In sum, the misappropriation theory, as we have examined and
explained it in this opinion, is both consistent with the statute
and with our precedent.ll Vital to our decision that criminal
liability may be sustained under the misappropriation theory, we
emphasize, are two sturdy safeguards Congress has provided
regarding scienter. To establish a criminal violation of Rule
10b-5, the Government must prove that a person "willfully" violated
the provision. See 15 U. S. C.
11 The United States additionally argues that Congress confirmed
the validity of the misappropriation theory in the Insider Trading
and Securities Fraud Enforcement Act of 1988 (ITSFEA), §2(1), 102
Stat. 4677, note following 15 U. S. C. § 78u-1. See Brief for
United States 32-35. ITSFEA declares that "the rules and
regulations of the Securities and Exchange Commission under the
Securities Exchange Act of 1934 ... governing trading while in
possession of material, nonpublic information are, as required by
such Act, necessary and appropriate in the public interest and for
the protection of investors." Note following 15 U. S. C. § 78u-1.
ITSFEA also includes a new § 20A(a) of the Exchange Act expressly
providing a private cause of action against persons who violate the
Exchange Act "by purchasing or selling a security while in
possession of material, nonpublic information"; such an action may
be brought by "any person who, contemporaneously with the purchase
or sale of securities that is the subject of such violation, has
purchased ... or sold ... securities of the same class." 15 U. S.
C. § 78t-1(a). Because we uphold the misappropriation theory on the
basis of § 10(b) itself, we do not address ITSFEA's significance
for cases of this genre.
666
§ 78ff(a).12 Furthermore, a defendant may not be imprisoned for
violating Rule 10b-5 if he proves that he had no knowledge of the
Rule. See
ibid.13 O'Hagan's charge that the misappropriation
theory is too indefinite to permit the imposition of criminal
liability, see Brief for Respondent 3033, thus fails not only
because the theory is limited to those who breach a recognized
duty. In addition, the statute's "requirement of the presence of
culpable intent as a necessary element of the offense does much to
destroy any force in the argument that application of the
[statute]" in circumstances such as O'Hagan's is unjust.
Boyce
Motor Lines, Inc. v.
United States, 342 U. S. 337, 342
(1952).
The Eighth Circuit erred in holding that the misappropriation
theory is inconsistent with § 10(b). The Court of Appeals may
address on remand O'Hagan's other challenges to his convictions
under § 10(b) and Rule 10b-5.
III
We consider next the ground on which the Court of Appeals
reversed O'Hagan's convictions for fraudulent trading in connection
with a tender offer, in violation of § 14(e) of the Exchange Act
and SEC Rule 14e-3(a). A sole question is before us as to these
convictions: Did the Commission, as the Court of Appeals held,
exceed its rulemaking authority under § 14(e) when it adopted Rule
14e-3(a) without requiring a showing that the trading at issue
entailed a breach of
12 In relevant part, § 32 of the Exchange Act, as set forth in
15 U. S. C. § 78ff(a), provides:
"Any person who willfully violates any provision of this chapter
... or any rule or regulation thereunder the violation of which is
made unlawful or the observance of which is required under the
terms of this chapter ... shall upon conviction be fined not more
than $1,000,000, or imprisoned not more than 10 years, or both ...
; but no person shall be subject to imprisonment under this section
for the violation of any rule or regulation if he proves that he
had no knowledge of such rule or regulation."
13 The statute provides no such defense to imposition of
monetary fines.
See ibid.
667
fiduciary duty? We hold that the Commission, in this regard and
to the extent relevant to this case, did not exceed its
authority.
The governing statutory provision, § 14(e) of the Exchange Act,
reads in relevant part:
"It shall be unlawful for any person ... to engage in any
fraudulent, deceptive, or manipulative acts or practices, in
connection with any tender offer .... The [SEC] shall, for the
purposes of this subsection, by rules and regulations define, and
prescribe means reasonably designed to prevent, such acts and
practices as are fraudulent, deceptive, or manipulative." 15 U. S.
C. § 78n(e).
Section 14(e)'s first sentence prohibits fraudulent acts in
connection with a tender offer. This self-operating proscription
was one of several provisions added to the Exchange Act in 1968 by
the Williams Act, 82 Stat. 454. The section's second sentence
delegates definitional and prophylactic rulemaking authority to the
Commission. Congress added this rulemaking delegation to § 14(e) in
1970 amendments to the Williams Act. See § 5,84 Stat. 1497.
Through § 14(e) and other provisions on disclosure in the
Williams Act,14 Congress sought to ensure that shareholders
"confronted by a cash tender offer for their stock [would] not be
required to respond without adequate information."
Rondeau
v.
Mosinee Paper Corp., 422 U. S. 49,58 (1975);
see
Lewis v.
McGraw, 619 F.2d
192, 195 (CA2 1980)
(per curiam)
14 In addition to § 14(e), the Williams Act and the 1970
amendments added to the Exchange Act the following provisions
concerning disclosure: § 13(d), 15 U. S. C. § 78m(d) (disclosure
requirements for persons acquiring more than five percent of
certain classes of securities); § 13(e), 15 U. S. C. § 78m(e)
(authorizing Commission to adopt disclosure requirements for
certain repurchases of securities by issuer); § 14(d), 15 U. S. C.
§ 78n(d) (disclosure requirements when tender offer results in
offeror owning more than five percent of a class of securities); §
14(f), 15 U. S. C. § 78n(f) (disclosure requirements when tender
offer results in new corporate directors constituting a
majority).
668
("very purpose" of Williams Act was "informed decisionmaking by
shareholders"). As we recognized in
Schreiber v.
Burlington Northern, Inc., 472 U. S. 1 (1985),
Congress designed the Williams Act to make "disclosure, rather than
court-imposed principles of 'fairness' or 'artificiality,' ... the
preferred method of market regulation."
Id., at 9, n. 8.
Section 14(e), we explained, "supplements the more precise
disclosure provisions found elsewhere in the Williams Act, while
requiring disclosure more explicitly addressed to the tender offer
context than that required by § 10(b)."
Id., at 10-11.
Relying on § 14(e)'s rulemaking authorization, the Commission,
in 1980, promulgated Rule 14e-3(a). That measure provides:
"(a) If any person has taken a substantial step or steps to
commence, or has commenced, a tender offer (the 'offering person'),
it shall constitute a fraudulent, deceptive or manipulative act or
practice within the meaning of section 14(e) of the [Exchange] Act
for any other person who is in possession of material information
relating to such tender offer which information he knows or has
reason to know is nonpublic and which he knows or has reason to
know has been acquired directly or indirectly from:
"(1) The offering person,
"(2) The issuer of the securities sought or to be sought by such
tender offer, or
"(3) Any officer, director, partner or employee or any other
person acting on behalf of the offering person or such issuer, to
purchase or sell or cause to be purchased or sold any of such
securities or any securities convertible into or exchangeable for
any such securities or any option or right to obtain or to dispose
of any of the foregoing securities, unless within a reasonable time
prior to any purchase or sale such information and its source
669
are publicly disclosed by press release or otherwise." 17 CFR §
240.14e-3(a) (1996).
As characterized by the Commission, Rule 14e-3(a) is a "disclose
or abstain from trading" requirement. 45 Fed. Reg. 60410 (1980).15
The Second Circuit concisely described the Rule's thrust:
"One violates Rule 14e-3(a) if he trades on the basis of
material nonpublic information concerning a pending tender offer
that he knows or has reason to know has been acquired 'directly or
indirectly' from an insider of the offeror or issuer, or someone
working on their behalf. Rule 14e-3(a) is a disclosure provision.
It creates a duty in those traders who fall within its ambit to
abstain or disclose, without regard to whether the trader owes a
pre-existing fiduciary duty to respect the confidentiality of
the information." United States v. Chestman,
947 F.2d
551, 557 (1991) (en bane) (emphasis added), cert. denied, 503
U. S. 1004 (1992).
See also
SEC v.
Maio, 51 F.3d
623, 635 (CA7 1995) ("Rule 14e-3 creates a duty to disclose
material non-public information, or abstain from trading in stocks
implicated by an impending tender offer,
regardless of whether
such information was obtained through a breach of fiduciary
duty." (emphasis added));
SEC v.
Peters,
978 F.2d
1162, 1165 (CAlO 1992) (as written, Rule 14e-3(a) has no
fiduciary duty requirement).
In the Eighth Circuit's view, because Rule 14e-3(a) applies
whether or not the trading in question breaches a fiduciary duty,
the regulation exceeds the SEC's § 14(e) rulemaking authority. See
92 F. 3d, at 624, 627. Contra,
Maio, 51 F. 3d, at 634-635
(CA7);
Peters, 978 F. 2d, at 1165-1167 (CAlO);
15 The Rule thus adopts for the tender offer context a
requirement resembling the one Chief Justice Burger would have
adopted in
Chiarella for misappropriators under § lO(b). See
supra, at 655, n. 6.
670
Chestman, 947 F. 2d, at 556-563 (CA2) (all holding Rule
14e3(a) a proper exercise of SEC's statutory authority). In support
of its holding, the Eighth Circuit relied on the text of § 14(e)
and our decisions in
Schreiber and
Chiarella. See
92
The Eighth Circuit homed in on the essence of § 14(e)'s
rulemaking authorization: "[T]he statute empowers the SEC to
'define' and 'prescribe means reasonably designed to prevent' 'acts
and practices' which are 'fraudulent.'''
Id., at 624. All
that means, the Eighth Circuit found plain, is that the SEC may
"identify and regulate," in the tender offer context, "acts and
practices" the law already defines as "fraudulent"; but, the Eighth
Circuit maintained, the SEC may not "create its own definition of
fraud."
Ibid. (internal quotation marks omitted).
This Court, the Eighth Circuit pointed out, held in
Schreiber that the word "manipulative" in the § 14(e) phrase
"fraudulent, deceptive, or manipulative acts or practices" means
just what the word means in § 10(b): Absent misrepresentation or
nondisclosure, an act cannot be indicted as manipulative. See 92 F.
3d, at 625 (citing
Schreiber, 472 U. S., at 7-8, and n. 6).
Section 10(b) interpretations guide construction of § 14(e), the
Eighth Circuit added, see 92 F. 3d, at 625, citing this Court's
acknowledgment in
Schreiber that § 14(e)'s "'broad antifraud
prohibition' ... [is] modeled on the antifraud provisions of §
10(b) ... and Rule 10b-5," 472 U. S., at 10 (citation omitted); see
id., at 10-11, n. 10.
For the meaning of "fraudulent" under § 10(b), the Eighth
Circuit looked to
Chiarella. See 92 F. 3d, at 625. In that
case, the Eighth Circuit recounted, this Court held that a failure
to disclose information could be "fraudulent" under § 10(b) only
when there was a duty to speak arising out of" 'a fiduciary or
other similar relation of trust and confidence.'''
Chiarella, 445 U. S., at 228 (quoting Restatement (Second)
of Torts § 551(2)(a) (1976)). Just as § 10(b) demands a showing
671
of a breach of fiduciary duty, so such a breach is necessary to
make out a § 14(e) violation, the Eighth Circuit concluded.
As to the Commission's § 14(e) authority to "prescribe means
reasonably designed to prevent" fraudulent acts, the Eighth Circuit
stated: "Properly read, this provision means simply that the SEC
has broad regulatory powers in the field of tender offers, but the
statutory terms have a fixed meaning which the SEC cannot alter by
way of an administrative rule." 92 F. 3d, at 627.
The United States urges that the Eighth Circuit's reading of §
14(e) misapprehends both the Commission's authority to define
fraudulent acts and the Commission's power to prevent them. "The
'defining' power," the United States submits, "would be a virtual
nullity were the SEC not permitted to go beyond common law fraud
(which is separately prohibited in the first [self-operative]
sentence of Section 14(e))." Brief for United States 11; see id.,
at 37.
In maintaining that the Commission's power to define fraudulent
acts under § 14(e) is broader than its rulemaking power under §
10(b), the United States questions the Court of Appeals' reading of
Schreiber. See Brief for United States 38-40.
Parenthetically, the United States notes that the word before the
Schreiber Court was "manipulative"; unlike "fraudulent," the
United States observes, "'manipulative' ... is 'virtually a term of
art when used in connection with the securities markets.'" Brief
for United States 38, n. 20 (quoting
Schreiber, 472 U. S.,
at 6). Most tellingly, the United States submits,
Schreiber
involved acts alleged to violate the self-operative provision in §
14(e)'s first sentence, a sentence containing language similar to §
10(b). But § 14(e)'s second sentence, containing the rulemaking
authorization, the United States points out, does not track §
10(b), which simply authorizes the SEC to proscribe "manipulative
or deceptive device[s] or contrivance[s]." Brief for United States
38. Instead, § 14(e)'s rulemaking prescription tracks § 15(c)(2)(D)
of the Exchange Act, 15 U. S. C. § 78o(c)(2)(D),
672
which concerns the conduct of broker-dealers in over-thecounter
markets. See Brief for United States 38-39. Since 1938, see 52
Stat. 1075, § 15(c)(2) has given the Commission authority to
"define, and prescribe means reasonably designed to prevent, such
[broker-dealer] acts and practices as are fraudulent, deceptive, or
manipulative." 15 U. S. C. § 78o(c)(2)(D). When Congress added this
same rulemaking language to § 14(e) in 1970, the Government states,
the Commission had already used its § 15(c)(2) authority to reach
beyond common-law fraud. See Brief for United States 39,
n.22.16
We need not resolve in this case whether the Commission's
authority under § 14(e) to "define ... such acts and practices as
are fraudulent" is broader than the Commission's frauddefining
authority under § 10(b), for we agree with the United States that
Rule 14e-3(a), as applied to cases of this genre, qualifies under §
14(e) as a "means reasonably designed to prevent" fraudulent
trading on material, nonpublic information in the tender offer
context.17 A prophylactic
16 The Government draws our attention to the following measures:
17 CFR §240.15c2-1 (1970) (prohibiting a broker-dealer's
hypothecation of a customer's securities if hypothecated securities
would be commingled with the securities of another customer, absent
written consent); §240.15c2-3 (prohibiting transactions by
broker-dealers in unvalidated German securities); § 240.15c2-4
(prohibiting broker-dealers from accepting any part of the sale
price of a security being distributed unless the money received is
promptly transmitted to the persons entitled to it); § 240.15c2-5
(requiring broker-dealers to provide written disclosure of credit
terms and commissions in connection with securities sales in which
broker-dealers extend credit, or participate in arranging for
loans, to the purchasers). See Brief for United States 39, n.
22.
17We leave for another day, when the issue requires decision,
the legitimacy of Rule 14e-3(a) as applied to "warehousing," which
the Government describes as "the practice by which bidders leak
advance information of a tender offer to allies and encourage them
to purchase the target company's stock before the bid is
announced." Reply Brief 17. As we observed in
Chiarella, one
of the Commission's purposes in proposing Rule 14e-3(a)
673
measure, because its mission is to prevent, typically
encompasses more than the core activity prohibited. As we noted in
Schreiber, § 14(e)'s rulemaking authorization gives the
Commission "latitude," even in the context of a term of art like
"manipulative," "to regulate nondeceptive activities as a
'reasonably designed' means of preventing manipulative acts,
without suggesting any change in the meaning of the term
'manipulative' itself." 472 U. S., at 11, n. 11. We hold,
accordingly, that under § 14(e), the Commission may prohibit acts
not themselves fraudulent under the common law or § 10(b), if the
prohibition is "reasonably designed to prevent ... acts and
practices [that] are fraudulent." 15 U. S. C. § 78n(e).18
Because Congress has authorized the Commission, in § 14(e), to
prescribe legislative rules, we owe the Commission's judgment "more
than mere deference or weight."
Batterton v.
Francis,
432 U. S. 416,
424-426 (1977). Therefore, in determining whether Rule 14e-3(a)'s
"disclose or abstain from trading" requirement is reasonably
designed to prevent fraudulent acts, we must accord the
Commission's assessment "controlling weight unless [it is]
arbitrary, capricious, or manifestly contrary to the statute."
Chevron U. S.
A. Inc. v.
Natural Resources Defense
Council, Inc., 467 U. S. 837, 844 (1984). In this case, we
conclude, the Commission's assessment is none of these.19
was "to bar warehousing under its authority to regulate tender
offers." 445 U. S., at 234. The Government acknowledges that
trading authorized by a principal breaches no fiduciary duty. See
Reply Brief 17. The instant case, however, does not involve trading
authorized by a principal; therefore, we need not here decide
whether the Commission's proscription of warehousing falls within
its § 14(e) authority to define or prevent fraud.
18The Commission's power under § lO(b) is more limited. See
supra, at 651 (Rule 10b-5 may proscribe only conduct that § 10(b)
prohibits).
19 JUSTICE THOMAS' dissent urges that the Commission must be
precise about the authority it is exercising-that it must say
whether it is acting to "define" or to "prevent" fraud-and that in
this instance it has pur-
674
In adopting the "disclose or abstain" rule, the SEC
explained:
"The Commission has previously expressed and continues to have
serious concerns about trading by persons in possession of
material, nonpublic information relating to a tender offer. This
practice results in unfair disparities in market information and
market disruption. Security holders who purchase from or sell to
such persons are effectively denied the benefits of disclosure and
the substantive protections of the Williams Act. If furnished with
the information, these security holders would be able to make an
informed investment decision, which could involve deferring the
purchase or sale of the securities until the material information
had been disseminated or until the tender offer had been commenced
or terminated." 45 Fed. Reg. 60412 (1980) (footnotes omitted).
The Commission thus justified Rule 14e-3(a) as a means necessary
and proper to assure the efficacy of Williams Act protections.
The United States emphasizes that Rule 14e-3(a) reaches trading
in which "a breach of duty is likely but difficult to prove." Reply
Brief 16. "Particularly in the context of a tender offer," as the
Tenth Circuit recognized, "there is a fairly wide circle of people
with confidential information,"
Peters, 978 F. 2d, at 1167,
notably, the attorneys, investment
ported only to define, not to prevent. See
post, at 696.
JUSTICE THOMAS sees this precision in Rule 14e-3(a)'s words: "it
shall constitute a fraudulent ... act ... within the meaning of
section 14(e) .... " We do not find the Commission's Rule
vulnerable for failure to recite as a regulatory preamble: We
hereby exercise our authority to "define, and prescribe means
reasonably designed to prevent, ... [fraudulent] acts." Sensibly
read, the Rule is an exercise of the Commission's full authority.
Logically and practically, such a rule may be conceived and
defended, alternatively, as definitional or preventive.
675
bankers, and accountants involved in structuring the
transaction. The availability of that information may lead to
abuse, for "even a hint of an upcoming tender offer may send the
price of the target company's stock soaring." SEe v.
Materia, 745 F.2d
197, 199 (CA2 1984). Individuals entrusted with nonpublic
information, particularly if they have no long-term loyalty to the
issuer, may find the temptation to trade on that information hard
to resist in view of "the very large short-term profits potentially
available [to them]."
Peters, 978 F. 2d, at 1167.
"[I]t may be possible to prove circumstantially that a person
[traded on the basis of material, nonpublic information], but
almost impossible to prove that the trader obtained such
information in breach of a fiduciary duty owed either by the trader
or by the ultimate insider source of the information."
Ibid.
The example of a "tippee" who trades on information received from
an insider illustrates the problem. Under Rule 10b-5, "a tippee
assumes a fiduciary duty to the shareholders of a corporation not
to trade on material nonpublic information only when the insider
has breached his fiduciary duty to the shareholders by disclosing
the information to the tippee and the tippee knows or should know
that there has been a breach."
Dirks, 463 U. S., at 660. To
show that a tippee who traded on nonpublic information about a
tender offer had breached a fiduciary duty would require proof not
only that the insider source breached a fiduciary duty, but that
the tippee knew or should have known of that breach. "Yet, in most
cases, the only parties to the [information transfer] will be the
insider and the alleged tippee."
Peters, 978 F. 2d, at
1167.20
20 JUSTICE THOMAS opines that there is no reason to anticipate
difficulties in proving breach of duty in "misappropriation" cases.
"Once the source of the [purloined] information has been
identified," he asserts, "it should be a simple task to obtain
proof of any breach of duty."
Post, at 697. To test that
assertion, assume a misappropriating partner at Dor-
676
In sum, it is a fair assumption that trading on the basis of
material, nonpublic information will often involve a breach of a
duty of confidentiality to the bidder or target company or their
representatives. The SEC, cognizant of the proof problem that could
enable sophisticated traders to escape responsibility, placed in
Rule 14e-3(a) a "disclose or abstain from trading" command that
does not require specific proof of a breach of fiduciary duty. That
prescription, we are satisfied, applied to this case, is a "means
reasonably designed to prevent" fraudulent trading on material,
nonpublic information in the tender offer context. See
Chestman, 947 F. 2d, at 560 ("While dispensing with the
subtle problems of proof associated with demonstrating fiduciary
breach in the problematic area of tender offer insider trading,
[Rule 14e3(a)] retains a close nexus between the prohibited conduct
and the statutory aims."); accord,
Maio, 51 F. 3d, at 635,
and n. 14;
Peters, 978 F. 2d, at 1167.21 Therefore, insofar
as it serves to prevent the type of misappropriation charged
against O'Hagan, Rule 14e-3(a) is a proper exercise of the
Commission's prophylactic power under § 14(e).22
As an alternate ground for affirming the Eighth Circuit's
judgment, O'Hagan urges that Rule 14e-3(a) is invalid be-
sey & Whitney told his daughter or son and a wealthy friend
that a tender for Pillsbury was in the offing, and each tippee
promptly purchased Pillsbury stock, the child borrowing the
purchase price from the wealthy friend. JUSTICE THOMAS' confidence,
post, at 698, n. 12, that "there is no reason to suspect
that the tipper would gratuitously protect the tippee," seems
misplaced.
21 JUSTICE THOMAS insists that even if the misappropriation of
information from the bidder about a tender offer is fraud, the
Commission has not explained why such fraud is "in connection with"
a tender offer.
Post, at 697, 698. What else, one can only
wonder, might such fraud be "in connection with"?
22 Repeating the argument it made concerning the
misappropriation theory, see supra, at 665, n. 11, the United
States urges that Congress confirmed Rule 14e-3(a)'s validity in
ITSFEA, 15 U. S. C. § 78u-1. See Brief for United States 44-45. We
uphold Rule 14e-3(a) on the basis of § 14(e) itself and need not
address ITSFEA's relevance to this case.
677
cause it prohibits trading in advance of a tender offer-when "a
substantial step ... to commence" such an offer has been
taken-while § 14(e) prohibits fraudulent acts "in connection with
any tender offer." See Brief for Respondent 41-42. O'Hagan further
contends that, by covering pre-offer conduct, Rule 14e-3(a) "fails
to comport with due process on two levels": The Rule does not "give
fair notice as to when, in advance of a tender offer, a violation
of § 14(e) occurs," id., at 42; and it "disposes of any scienter
requirement," id., at 43. The Court of Appeals did not address
these arguments, and O'Hagan did not raise the due process points
in his briefs before that court. We decline to consider these
contentions in the first instance.23 The Court of Appeals may
address on remand any arguments O'Hagan has preserved.
IV
Based on its dispositions of the securities fraud convictions,
the Court of Appeals also reversed O'Hagan's convictions, under 18
U. S. C. § 1341, for mail fraud. See 92 F. 3d, at 627-628. Reversal
of the securities convictions, the Court of Appeals recognized,
"d[id] not as a matter of law require that the mail fraud
convictions likewise be reversed."
Id., at 627 (citing
Carpenter, 484 U. S., at 24, in which this Court unanimously
affirmed mail and wire fraud convictions based on the same conduct
that evenly divided the Court on the defendants' securities fraud
convictions). But in this case, the Court of Appeals said, the
indictment was so structured that the mail fraud charges could not
be disassociated from the securities fraud charges, and absent any
securities
23 As to O'Hagan's scienter argument, we reiterate that 15 U. S.
C. § 78ff(a) requires the Government to prove "willful[l]
violat[ion]" of the securities laws, and that lack of knowledge of
the relevant rule is an affirmative defense to a sentence of
imprisonment. See supra, at 665-666.
678
fraud, "there was no fraud upon which to base the mail fraud
charges." 92 F. 3d, at 627-628.24
The United States urges that the Court of Appeals' position is
irreconcilable with
Carpenter: Just as in
Carpenter,
so here, the "mail fraud charges are independent of [the]
securities fraud charges, even [though] both rest on the same set
of facts." Brief for United States 46-47. We need not linger over
this matter, for our rulings on the securities fraud issues require
that we reverse the Court of Appeals judgment on the mail fraud
counts as well.25
O'Hagan, we note, attacked the mail fraud convictions in the
Court of Appeals on alternate grounds; his other arguments, not yet
addressed by the Eighth Circuit, remain open for consideration on
remand.
***
The judgment of the Court of Appeals for the Eighth Circuit is
reversed, and the case is remanded for further proceedings
consistent with this opinion.
It is so ordered.
24 The Court of Appeals reversed respondent's money laundering
convictions on similar reasoning. See 92 F. 3d, at 628. Because the
United States did not seek review of that ruling, we leave
undisturbed that portion of the Court of Appeals' judgment.
25JUSTICE THOMAS finds O'Hagan's convictions on the mail fraud
counts, but not on the securities fraud counts, sustainable.
Post, at 700-70l. Under his view, securities traders like
O'Hagan would escape SEC civil actions and federal prosecutions
under legislation targeting securities fraud, only to be caught for
their trading activities in the broad mail fraud net. If
misappropriation theory cases could proceed only under the federal
mail and wire fraud statutes, practical consequences for individual
defendants might not be large, see Aldave, 49 Ohio St. L. J., at
381, and n. 60; however, "proportionally more persons accused of
insider trading [might] be pursued by a U. S. Attorney, and
proportionally fewer by the SEC," id., at 382. Our decision, of
course, does not rest on such enforcement policy
considerations.
679
JUSTICE SCALIA, concurring in part and dissenting in part. I
join Parts I, III, and IV of the Court's opinion. I do not agree,
however, with Part II of the Court's opinion, containing its
analysis of respondent's convictions under § 10(b) and Rule
10b-5.
I do not entirely agree with JUSTICE THOMAS'S analysis of those
convictions either, principally because it seems to me irrelevant
whether the Government's theory of why respondent's acts were
covered is "coherent and consistent,"
post, at 691. It is
true that with respect to matters over which an agency has been
accorded adjudicative authority or policymaking discretion, the
agency's action must be supported by the reasons that the agency
sets forth,
SEC v.
Chenery Corp., 318 U. S. 80, 94 (1943);
see also
SEC v.
Chenery Corp., 332 U. S. 194, 196
(1947), but I do not think an agency's unadorned application of the
law need be, at least where (as here) no
Chevron deference
is being given to the agency's interpretation, see
Chevron
U. S.
A. Inc. v.
Natural Resources Defense Council,
Inc., 467 U. S.
837 (1984). In point of fact, respondent's actions either
violated § 10(b) and Rule 10b-5, or they did not-regardless of the
reasons the Government gave. And it is for us to decide.
While the Court's explanation of the scope of § 10(b) and Rule
10b-5 would be entirely reasonable in some other context, it does
not seem to accord with the principle of lenity we apply to
criminal statutes (which cannot be mitigated here by the Rule,
which is no less ambiguous than the statute). See
Reno v.
Koray, 515 U.
S. 50, 64-65 (1995) (explaining circumstances in which rule of
lenity applies);
United States v.
Bass, 404 U. S. 336, 347-348
(1971) (discussing policies underlying rule of lenity). In light of
that principle, it seems to me that the unelaborated statutory
language: "[t]o use or employ, in connection with the purchase or
sale of any security ... any manipulative or deceptive device or
contrivance," § 10(b), must be construed to require the
manipulation or deception of a party to a securities
transaction.
680
Opinion of THOMAS, J.
JUSTICE THOMAS, with whom THE CHIEF JUSTICE joins, concurring in
the judgment in part and dissenting in part.
Today the majority upholds respondent's convictions for
violating § 10(b) of the Securities Exchange Act of 1934, and Rule
10b-5 promulgated thereunder, based upon the Securities and
Exchange Commission's "misappropriation theory." Central to the
majority's holding is the need to interpret § 10(b)'s requirement
that a deceptive device be "use[d] or employ[ed], in connection
with the purchase or sale of any security." 15 U. S. C. § 78j(b).
Because the Commission's misappropriation theory fails to provide a
coherent and consistent interpretation of this essential
requirement for liability under § 10(b), I dissent.
The majority also sustains respondent's convictions under §
14(e) of the Securities Exchange Act, and Rule 14e-3(a) promulgated
thereunder, regardless of whether respondent violated a fiduciary
duty to anybody. I dissent too from that holding because, while §
14(e) does allow regulations prohibiting nonfraudulent acts as a
prophylactic against certain fraudulent acts, neither the majority
nor the Commission identifies any relevant underlying fraud against
which Rule 14e-3(a) reasonably provides prophylaxis. With regard to
respondent's mail fraud convictions, however, I concur in the
judgment of the Court.
I
I do not take issue with the majority's determination that the
undisclosed misappropriation of confidential information by a
fiduciary can constitute a "deceptive device" within the meaning of
§ 10(b). Nondisclosure where there is a preexisting duty to
disclose satisfies our definitions of fraud and deceit for purposes
of the securities laws. See
Chiarella v.
United
States, 445 U. S.
222, 230 (1980).
Unlike the majority, however, I cannot accept the Commission's
interpretation of when a deceptive device is "use[d] ... in
connection with" a securities transaction. Although the Commission
and the majority at points seem to suggest that
681
any relation to a securities transaction satisfies the
"in connection with" requirement of § 10(b), both ultimately reject
such an overly expansive construction and require a more integral
connection between the fraud and the securities transaction. The
majority states, for example, that the misappropriation theory
applies to undisclosed misappropriation of confidential information
"for securities trading purposes,"
ante, at 652, thus
seeming to require a particular intent by the misappropriator in
order to satisfy the "in connection with" language. See also
ante, at 656 (the "misappropriation theory targets
information of a sort that misappropriators
ordinarily
capitalize upon to gain no-risk profits through the purchase or
sale of securities" (emphasis added));
ante, at 656-657
(distinguishing embezzlement of money used to buy securities as
lacking the requisite connection). The Commission goes further, and
argues that the misappropriation theory satisfies the "in
connection with" requirement because it "depends on an
inherent connection between the deceptive conduct and the
purchase or sale of a security." Brief for United States 21
(emphasis added); see also
ibid. (the "misappropriated
information had personal value to respondent
only because of
its utility in securities trading" (emphasis added)).
The Commission's construction of the relevant language in §
10(b), and the incoherence of that construction, become evident as
the majority attempts to describe why the fraudulent theft of
information falls under the Commission's misappropriation theory,
but the fraudulent theft of money does not. The majority correctly
notes that confidential information "qualifies as property to which
the company has a right of exclusive use."
Ante, at 654. It
then observes that the "undisclosed misappropriation of such
information, in violation of a fiduciary duty, ... constitutes
fraud akin to embezzlement-the fraudulent appropriation to one's
own use of the money or goods entrusted to one's care by
another."
682
Opinion of THOMAS, J.
Ibid. (citations and internal quotation marks omitted).l
So far the majority's analogy to embezzlement is well taken, and
adequately demonstrates that undisclosed misappropriation can be a
fraud on the source of the information.
What the embezzlement analogy does not do, however, is explain
how the relevant fraud is "use[d] or employ[ed], in connection
with" a securities transaction. And when the majority seeks to
distinguish the embezzlement of funds from the embezzlement of
information, it becomes clear that neither the Commission nor the
majority has a coherent theory regarding § 10(b)'s "in connection
with" requirement.
Turning first to why embezzlement of information supposedly
meets the "in connection with" requirement, the majority asserts
that the requirement
"is satisfied because the fiduciary's fraud is consummated, not
when the fiduciary gains the confidential information, but when,
without disclosure to his principal, he uses the information to
purchase or sell securities. The securities transaction and the
breach of duty thus coincide." Ante, at 656.
The majority later notes, with apparent approval, the
Government's contention that the embezzlement of funds used to
purchase securities would not fall within the misappropriation
theory.
Ante, at 656-657 (citing Brief for United States 24,
n. 13). The misappropriation of funds used for a securities
transaction is not covered by its theory, the Government explains,
because "the proceeds would have value to the malefactor apart from
their use in a securities transaction, and the fraud would be
complete as soon as the money was
1 Of course, the "use" to which one puts misappropriated
property need not be one designed to bring profit to the
misappropriator: Any "fraudulent appropriation to one's own use"
constitutes embezzlement, regardless of what the embezzler chooses
to do with the money. See,
e. g., Logan v.
State, 493
P. 2d 842, 846 (Okla. Crim. App. 1972) ("Any diversion of funds
held in trust constitutes embezzlement whether there is direct
personal benefit or not as long as the owner is deprived of his
money").
683
obtained." Brief for United States 24, n. 13; see
ante,
at 656 (quoting Government's explanation).
Accepting the Government's description of the scope of its own
theory, it becomes plain that the majority's explanation of how the
misappropriation theory supposedly satisfies the "in connection
with" requirement is incomplete. The touchstone required for an
embezzlement to be "use[d] or employ[ed], in connection with" a
securities transaction is not merely that it "coincide" with, or be
consummated by, the transaction, but that it is
necessarily
and
only consummated by the transaction. Where the property
being embezzled has value "apart from [its] use in a securities
transaction"even though it is in fact being used in a securities
transaction-the Government contends that there is no violation
under the misappropriation theory.
My understanding of the Government's proffered theory of
liability, and its construction of the "in connection with"
requirement, is confirmed by the Government's explanation during
oral argument:
"[Court]: What if I appropriate some of my client's money in
order to buy stock?
"[Court]: Have I violated the securities laws? "[Counsel]: I do
not think that you have.
"[Court]: Why not? Isn't that in connection with the purchase of
securit[ies] just as much as this one is?
"[Counsel]: It's not just as much as this one is, because in
this case it is the use of the information that enables the
profits, pure and simple. There would be no opportunity to engage
in profit-
"[Court]: Same here. I didn't have the money. The only way I
could buy this stock was to get the money.
"[Counsel]: The difference ... is that once you have the money
you can do anything you want with it. In a sense, the fraud is
complete at that point, and then you
684
Opinion of THOMAS, J.
go on and you can use the money to finance any number of other
activities, but the connection is far less close than in this case,
where the only value of this information for personal profit for
respondent was to take it and profit in the securities markets by
trading on it.
"[Court]: So what you're saying is, is in this case the
misappropriation can only be of relevance, or is of substantial
relevance, is with reference to the purchase of securities.
"[Counsel]: Exactly.
"[Court]: When you take the money out of the accounts you can go
to the racetrack, or whatever.
"[Counsel]: That's exactly right, and because of that
difference, [there] can be no doubt that this kind of
misappropriation of property is in connection with the purchase or
sale of securities.
"Other kinds of misappropriation of property mayor may not, but
this is a unique form of fraud, unique to the securities markets,
in fact, because the only way in which respondent could have
profited through this information is by either trading on it or by
tipping somebody else to enable their trades." Tr. of Oral Arg.
16-19 (emphases added).
As the above exchange demonstrates, the relevant distinction is
not that the misappropriated information
was used for a
securities transaction (the money example met that test), but
rather that it could
only be used for such a transaction.
See also id., at 6-7 (Government contention that the
misappropriation theory satisfies "the requisite connection between
the fraud and the securities trading, because it is
only in
the trading that the fraud is consummated" (emphasis added)); id.,
at 8 (same).
The Government's construction of the "in connection with"
requirement-and its claim that such requirement precludes coverage
of financial embezzlement-also demonstrates how
685
the majority's described distinction of financial embezzlement
is incomplete. Although the majority claims that the fraud in a
financial embezzlement case is complete as soon as the money is
obtained, and before the securities transaction is consummated,
that is not uniformly true, and thus cannot be the Government's
basis for claiming that such embezzlement does not violate the
securities laws. It is not difficult to imagine an embezzlement of
money that takes place via the mechanism of a securities
transaction-for example where a broker is directed to purchase
stock for a client and instead purchases such stock-using client
funds-for his own account. The unauthorized (and presumably
undisclosed) transaction is the very act that constitutes the
embezzlement and the "securities transaction and the breach of duty
thus coincide." What presumably distinguishes monetary embezzlement
for the Government is thus that it is not
necessarily
coincident with a securities transaction, not that it
never
lacks such a "connection."
Once the Government's construction of the misappropriation
theory is accurately described and accepted-along with its implied
construction of § lO(b)'s "in connection with" language-that theory
should no longer cover cases, such as this one, involving fraud on
the source of information where the source has no connection with
the other participant in a securities transaction. It seems obvious
that the undisclosed misappropriation of confidential information
is not necessarily consummated by a securities transaction. In this
case, for example, upon learning of Grand Met's confidential
takeover plans, O'Hagan could have done any number of things with
the information: He could have sold it to a newspaper for
publication, see id., at 36; he could have given or sold the
information to Pillsbury itself, see id., at 37; or he could even
have kept the information and used it solely for his personal
amusement, perhaps in a fantasy stock trading game.
Any of these activities would have deprived Grand Met of its
right to "exclusive use,"
ante, at 654, of the
information
686
Opinion of THOMAS, J.
and, if undisclosed, would constitute "embezzlement" of Grand
Met's informational property. Under
any theory of liability,
however, these activities would not violate § lO(b) and, according
to the Commission's monetary embezzlement analogy, these
possibilities are sufficient to preclude a violation under the
misappropriation theory even where the informational property
was used for securities trading. That O'Hagan actually did
use the information to purchase securities is thus no more
significant here than it is in the case of embezzling money used to
purchase securities. In both cases the embezzler
could have
done something else with the property, and hence the Commission's
necessary "connection" under the securities laws would not be met.2
If the relevant test under the "in connection with" language is
whether the fraudulent act is
necessarily tied to a
securities transaction, then the misappropriation of confidential
information used to trade no more violates § lO(b) than does the
misappropriation of funds used to trade. As the Commission concedes
that the latter is not covered under its theory, I am at a loss to
see how the same theory can coherently be applied to the
former.3
2 Indeed, even if O'Hagan or someone else thereafter used the
information to trade, the misappropriation would have been complete
before the trade and there should be no § lO(b) liability. The most
obvious realworld example of this scenario would be if O'Hagan had
simply tipped someone else to the information. The mere act of
passing the information along would have violated O'Hagan's
fiduciary duty and, if undisclosed, would be an "embezzlement" of
the confidential information, regardless of whether the tippee
later traded on the information.
3 The majority is apparently unimpressed by the example of a
misappropriator using embezzled information for personal amusement
in a fantasy stock trading game, finding no need for the Commission
to "inhibit" such recreational uses.
Ante, at 657, n. 8.
This argument, of course, misses the point of the example. It is
not that such a use does or should violate the securities laws yet
is not covered by the Commission's theory; rather, the example
shows that the misappropriation of information is not "only" or
"inherently" tied to securities trading, and hence the
misappropriation
687
The majority makes no attempt to defend the misappropriation
theory as set forth by the Commission. Indeed, the majority
implicitly concedes the indefensibility of the Commission's theory
by acknowledging that alternative uses of misappropriated
information exist that do not violate the securities laws and then
dismissing the Government's repeated explanations of its
misappropriation theory as mere "overstatement."
Ante, at
657. Having rejected the Government's description of its theory,
the majority then engages in the "imaginative" exercise of
constructing its own misappropriation theory from whole cloth.
Thus, we are told, if we merely "[s]ubstitute 'ordinarily' for
'only'" when describing the degree of connectedness between a
misappropriation and a securities transaction, the Government would
have a winner.
Ibid. Presumably, the majority would
similarly edit the Government's brief to this Court to argue for
only an "ordinary," rather than an
"inherent connection
between the deceptive conduct and the purchase or sale of a
security." Brief for United States 21 (emphasis added).
I need not address the coherence, or lack thereof, of the
majority's new theory, for it suffers from a far greater, and
dispositive, flaw: It is not the theory offered by the Commission.
Indeed, as far as we know from the majority's opinion, this new
theory has
never been proposed by the Commission, much less
adopted by rule or otherwise. It is a fundamental proposition of
law that this Court "may not supply a reasoned basis for the
agency's action that the agency itself has not given."
Motor
Vehicle Mfrs. Assn. of United States, Inc. v.
State Farm
Mut. Automobile Ins. Co., 463 U. S. 29, 43 (1983).
We do not even credit a
"post hoc rationalizatio[n]" of
counsel for the agency, id., at 50, so one is left to wonder how we
could possibly rely on a
post hoc rationaliza-
of information,
whatever its ultimate use, fails the
Commission's own test under the "in connection with" requirement of
§ 10(b) and Rule 10b-5.
688
Opinion of THOMAS, J.
tion invented by this Court and never even presented by the
Commission for our consideration.
Whether the majority's new theory has merit, we cannot possibly
tell on the record before us. There are no findings regarding the
"ordinary" use of misappropriated information, much less regarding
the "ordinary" use of other forms of embezzled property. The
Commission has not opined on the scope of the new requirement that
property must "ordinarily" be used for securities trading in order
for its misappropriation to be "in connection with" a securities
transaction. We simply do not know what would or would not be
covered by such a requirement, and hence cannot evaluate whether
the requirement embodies a consistent and coherent interpretation
of the statute.4 Moreover, persons subject to
4 Similarly, the majority's assertion that the alternative uses
of misappropriated information are not as profitable as use in
securities trading,
ante, at 657, n. 8, is speculative at
best. We have no idea what is the best or most profitable use of
misappropriated information, either in this case or generally. We
likewise have no idea what is the best use of other forms of
misappropriated property, and it is at least conceivable that the
best use of embezzled money, or securities themselves, is for
securities trading. If the use of embezzled money to purchase
securities is "sufficiently detached,"
ante, at 657, from a
securities transaction, then I see no reason why the non-
"inherent" use of information for securities trading is not also
"sufficiently detached" under the Government's theory. In any
event, I am at a loss to find in the statutory language any hint of
a "best-use" requirement for setting the requisite connection
between deception and the purchase or sale of securities.
The majority's further claim that it is unremarkable that "a
rule suitably applied to the fraudulent uses of certain kinds of
information would be stretched beyond reason were it applied to the
fraudulent use of money," ibid., is itself remarkable given that
the only existing "rule" is Rule lOb-5, which nowhere confines
itself to information and, indeed, does not even contain the word.
And given that the only "reason" offered by the Government in
support of its misappropriation theory applies (or fails to apply)
equally to money or to information, the application of the
Government's theory in this case is no less "beyond reason" than it
would be as applied to financial embezzlement.
689
this new theory, such as respondent here, surely could not and
cannot regulate their behavior to comply with the new theory
because, until today, the theory has never existed. In short, the
majority's new theory is simply not presented by this case, and
cannot form the basis for upholding respondent's convictions.
In upholding respondent's convictions under the new and improved
misappropriation theory, the majority also points to various policy
considerations underlying the securities laws, such as maintaining
fair and honest markets, promoting investor confidence, and
protecting the integrity of the securities markets.
Ante, at
657, 658-659. But the repeated reliance on such broad-sweeping
legislative purposes reaches too far and is misleading in the
context of the misappropriation theory. It reaches too far in that,
regardless of the overarching purpose of the securities laws, it is
not illegal to run afoul of the "purpose" of a statute, only its
letter. The majority's approach is misleading in this case because
it glosses over the fact that the supposed threat to fair and
honest markets, investor confidence, and market integrity comes not
from the supposed fraud in this case, but from the mere fact that
the information used by O'Hagan was nonpublic.
As the majority concedes, because "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 § lO(b) violation."
Ante, at 655 (emphasis added). Indeed, were the source
expressly to authorize its agents to trade on the confidential
information-as a perk or bonus, perhaps-there would likewise be no
§ lO(b) violation.5 Yet in either case-disclosed
5 See Tr. of Oral Arg. 9 (Government conceding that, "just as in
[Carpenter v.
United States, 484 U. S. 19 (1987)], if
[the defendant] had gone to the Wall Street Journal and said, look,
you know, you're not paying me very much. I'd like to make a little
bit more money by buying stock, the stocks
690
Opinion of THOMAS, J.
misuse or authorized use-the hypothesized "inhibiting impact on
market participation,"
ante, at 659, would be identical to
that from behavior violating the misappropriation theory:
"Outsiders" would still be trading based on nonpublic information
that the average investor has no hope of obtaining through his own
diligence.6
The majority's statement that a "misappropriator who trades on
the basis of material, nonpublic information, in short,
gains
his advantageous market position through deception; he deceives the
source of the information and simultaneously harms members of the
investing public," ante, at 656 (emphasis added), thus focuses
on the wrong point. Even if it is true that trading on nonpublic
information hurts the public, it is true whether or not there is
any deception of the source of the information.7 Moreover, as
that are going to appear in my Heard on the Street column, and
the Wall Street Journal said, that's fine, there would have been no
deception of the Wall Street Journal").
6 That the dishonesty aspect of misappropriation might be
eliminated via disclosure or authorization is wholly besides the
point. The dishonesty in misappropriation is in the relationship
between the fiduciary and the principal, not in any relationship
between the misappropriator and the market. No market transaction
is made more or less honest by disclosure to a third-party
principal, rather than to the market as a whole. As far as the
market is concerned, a trade based on confidential information is
no more "honest" because some third party may know of it so long as
those on the other side of the trade remain in the dark.
7The majority's statement, by arguing that market advantage is
gained "through" deception, unfortunately seems to embrace an error
in logic:
Conflating causation and correlation. That the misappropriator
may both deceive the source and "simultaneously" hurt the public no
more shows a causal "connection" between the two than the fact that
the sun both gives some people a tan and "simultaneously" nourishes
plants demonstrates that melanin production in humans causes plants
to grow. In this case, the only element common to the deception and
the harm is that both are the result of the same antecedent
cause-namely, using nonpublic information. But such use, even for
securities trading, is not illegal, and the consequential deception
of the source follows an entirely divergent branch of causation
than does the harm to the public. The trader thus "gains his
691
we have repeatedly held, use of nonpublic information to trade
is not itself a violation of § lO(b).
E. g.,
Chiarella, 445 U. S., at 232-233. Rather, it is the use of
fraud "in connection with" a securities transaction that is
forbidden. Where the relevant element of fraud has no impact on the
integrity of the subsequent transactions as distinct from the
nonfraudulent element of using nonpublic information, one can
reasonably question whether the fraud was used in connection with a
securities transaction. And one can likewise question whether
removing that aspect of fraud, though perhaps laudable, has
anything to do with the confidence or integrity of the market.
The absence of a coherent and consistent misappropriation theory
and, by necessary implication, a coherent and consistent
application of the statutory "use or employ, in connection with"
language, is particularly problematic in the context of this case.
The Government claims a remarkable breadth to the delegation of
authority in § lO(b), arguing that "the very aim of this section
was to pick up unforeseen, cunning, deceptive devices that people
might cleverly use in the securities markets." Tr. of Oral Arg. 7.
As the Court aptly queried, "[t]hat's rather unusual, for a
criminal statute to be that open-ended, isn't it?"
Ibid.
Unusual indeed. Putting aside the dubious validity of an open-ended
delegation to an independent agency to go forth and create
regulations criminalizing "fraud," in this case we do not even have
a formal regulation embodying the agency's misappropriation theory.
Certainly Rule lOb-5 cannot be said to embody the theoryalthough it
deviates from the statutory language by the addition of the words
"any person," it merely repeats, unchanged, § lO(b)'s "in
connection with" language. Given that the validity of the
misappropriation theory turns on the construc-
advantageous market position
through" the use of
nonpublic information, whether or not deception is involved; the
deception has no effect on the existence or extent of his
advantage.
692
Opinion of THOMAS, J.
tion of that language in § 10(b), the regulatory language is
singularly uninformative.8
Because we have no regulation squarely setting forth some
version of the misappropriation theory as the Commission's
interpretation of the statutory language, we are left with little
more than the Commission's litigating position or the majority's
completely novel theory that is not even acknowledged, much less
adopted, by the Commission. As we have noted before, such positions
are not entitled to deference and, at most, get such weight as
their persuasiveness warrants.
Metropolitan Stevedore Co. v.
Rambo, ante, at 138, n. 9, 140, n. 10. Yet I find wholly
unpersuasive a litigating position by the Commission that, at best,
embodies an inconsistent and incoherent interpretation of the
relevant statutory language and that does not provide any
predictable guidance as to what behavior contravenes the statute.
That position is no better than an ad hoc interpretation of
statutory language and in my view can provide no basis for
liability.
II
I am also of the view that O'Hagan's conviction for violating
Rule 14e-3(a) cannot stand. Section 14(e) of the Exchange Act
provides, in relevant part:
"It shall be unlawful for any person ... to engage in any
fraudulent, deceptive, or manipulative acts or practices, in
connection with any tender offer .... The Commission shall, for the
purposes of this subsection, by rules and regulations define, and
prescribe means
8That the Commission may purport to be interpreting its own
Rule, rather than the statute, cannot provide it any greater leeway
where the Rule merely repeats verbatim the statutory language on
which the entire question hinges. Furthermore, as even the majority
recognizes, Rule 10b-5 may not reach beyond the scope of § lOCb),
ante, at 651, and thus the Commission is obligated to
explain how its theory fits within its interpretation of § 10Cb)
even if it purports to be interpreting its own derivative rule.
693
reasonably designed to prevent, such acts and practices as are
fraudulent, deceptive, or manipulative." 15 U. S. C. § 78n(e).
Pursuant to the rulemaking authority conferred by this section,
the Commission has promulgated Rule 14e-3(a), which provides, in
relevant part:
"(a) If any person has taken a substantial step or steps to
commence, or has commenced, a tender offer (the 'offering person'),
it shall constitute a fraudulent, deceptive or manipulative act or
practice within the meaning of section 14(e) of the [Securities
Exchange] Act for any other person who is in possession of material
information relating to such tender offer which information he
knows or has reason to know is nonpublic and which he knows or has
reason to know has been acquired directly or indirectly from:
"(1) The offering person,
"(2) The issuer of the securities sought or to be sought by such
tender offer, or
"(3) [Any person acting on behalf of the offering person or such
issuer], to purchase or sell [any such securities or various
instruments related to such securities], unless within a reasonable
time prior to any purchase or sale such information and its source
are publicly disclosed by press release or otherwise." 17 CFR §
240. 14e-3(a) (1996).
As the majority acknowledges, Rule 14e-3(a) prohibits a broad
range of behavior regardless of whether such behavior is fraudulent
under our precedents. See
ante, at 669 (Rule applies
"'without regard to whether the trader owes a preexisting fiduciary
duty to respect the confidentiality of the information'" (emphasis
deleted)) (quoting
United States v.
Chestman,
947 F.2d
551, 557 (CA2 1991) (en banc), cert. denied, 503 U. S. 1004
(1992)).
694
Opinion of THOMAS, J.
The Commission offers two grounds in defense of Rule 14e-3(a).
First, it argues that § 14(e) delegates to the Commission the
authority to "define" fraud differently than that concept has been
defined by this Court, and that Rule 14e3(a) is a valid exercise of
that "defining" power. Second, it argues that § 14(e) authorizes
the Commission to "prescribe means reasonably designed to prevent"
fraudulent acts, and that Rule 14e-3(a) is a prophylactic rule that
may prohibit nonfraudulent acts as a means of preventing fraudulent
acts that are difficult to detect or prove.
The majority declines to reach the Commission's first justi-
fication, instead sustaining Rule 14e-3(a) on the ground
that
"under § 14(e), the Commission may prohibit acts not themselves
fraudulent under the common law or § 10(b), if the prohibition is
'reasonably designed to prevent ... acts and practices [that] are
fraudulent.'" Ante, at 673 (quoting 15 U. S. C. §
78n(e)).
According to the majority, prohibiting trading on nonpublic
information is necessary to prevent such supposedly hardto-prove
fraudulent acts and practices as trading on information obtained
from the buyer in breach of a fiduciary duty,
ante, at 675,
and possibly "warehousing," whereby the buyer tips allies prior to
announcing the tender offer and encourages them to purchase the
target company's stock,
ante, at 672-673, n. 17.9
I find neither of the Commission's justifications for Rule
14e-3(a) acceptable in misappropriation cases. With regard to the
Commission's claim of authority to redefine the concept of fraud, I
agree with the Eighth Circuit that the Commission misreads the
relevant provision of § 14(e).
9 Although the majority leaves open the possibility that Rule
14e-3(a) may be justified as a means of preventing "warehousing,"
it does not rely on that justification to support its conclusion in
this case. Suffice it to say that the Commission itself concedes
that warehousing does not involve fraud as defined by our cases,
see Reply Brief for United States 17, and thus preventing
warehousing cannot serve to justify Rule 14e-3(a).
695
"Simply put, the enabling provision of § 14(e) permits the SEC
to identify and regulate those 'acts and practices' which fall
within the § 14(e) legal definition of 'fraudulent,' but it does
not grant the SEC a license to redefine the term." 92 F.3d
612, 624 (1996).
This conclusion follows easily from our similar statement in
Schreiber v.
Burlington Northern, Inc., 472 U. S. 1, 11, n. 11
(1985), that § 14(e) gives the "Commission latitude to regulate
nondeceptive activities as a 'reasonably designed' means of
preventing manipulative acts, without suggesting any change in the
meaning of the term 'manipulative' itself."
Insofar as the Rule 14e-3(a) purports to "define" acts and
practices that "are fraudulent," it must be measured against our
precedents interpreting the scope of fraud. The majority concedes,
however, that Rule 14e-3(a) does not prohibit merely trading in
connection with fraudulent nondisclosure, but rather it prohibits
trading in connection with any nondisclosure, regardless of the
presence of a pre-existing duty to disclose.
Ante, at 669.
The Rule thus exceeds the scope of the Commission's authority to
define such acts and practices as "are fraudulent." 10
10 Even were § 14(e)'s defining authority subject to the
construction given it by the Commission, there are strong
constitutional reasons for not so construing it. A law that simply
stated "it shall be unlawful to do
'X', however
'X'
shall be defined by an independent agency," would seem to offer no
"intelligible principle" to guide the agency's discretion and would
thus raise very serious delegation concerns, even under our current
jurisprudence, J.
W Hampton, Jr., &
Co. v.
United States, 276 U. S. 394, 409
(1928). See also
Field v.
Clark, 143 U. S. 649, 693-694
(1892) (distinguishing between making the law by determining what
it shall be, and executing the law by determining facts on which
the law's operation depends). The Commission's interpretation of §
14(e) would convert it into precisely the type of law just
described. Thus, even if that were a plausible interpretation, our
usual practice is to avoid unnecessary interpretations of statutory
language that call the constitutionality of the statute into
further serious doubt.
696
Opinion of THOMAS, J.
Turning to the Commission's second justification for Rule
14e-3(a), although I can agree with the majority that § 14(e)
authorizes the Commission to prohibit nonfraudulent acts as a means
reasonably designed to prevent fraudulent ones, I cannot agree that
Rule 14e-3(a) satisfies this standard. As an initial matter, the
Rule, on its face, does not purport to be an exercise of the
Commission's prophylactic power, but rather a redefinition of what
"constitute[s] a fraudulent, deceptive, or manipulative act or
practice within the meaning of § 14(e)." That Rule 14e-3(a)
could have been "conceived and defended, alternatively, as
definitional or preventive,"
ante, at 674, n. 19, misses the
point. We evaluate regulations not based on the myriad of
explanations that could have been given by the relevant agency, but
on those explanations and justifications that were, in fact, given.
See
State Farm, 463 U. S., at 43, 50. Rule 14e-3(a) may not
be "[s]ensibly read" as an exercise of "preventive" authority,
ante, at 674, n. 19; it can only be
differently so
read, contrary to its own terms.
Having already concluded that the Commission lacks the power to
redefine fraud, the regulation cannot be sustained on its own
reasoning. This would seem a complete answer to whether the Rule is
valid because, while we might give deference to the Commission's
regulatory constructions of § 14(e), the reasoning used by the
regulation itself is in this instance contrary to law and we need
give no deference to the Commission's
post hoc litigating
justifications not reflected in the regulation.
Even on its own merits, the Commission's prophylactic
justification fails. In order to be a valid prophylactic
regulation, Rule 14e-3(a) must be reasonably designed not merely to
prevent
any fraud, but to prevent persons from engaging in
"fraudulent, deceptive, or manipulative acts or practices,
in
connection with any tender offer." 15 U. S. C. § 78n(e)
(emphasis added). Insofar as Rule 14e-3(a) is designed to prevent
the type of misappropriation at issue in this case, such acts are
not legitimate objects of prevention because
697
the Commission's misappropriation theory does not represent a
coherent interpretation of the statutory "in connection with"
requirement, as explained in Part I,
supra. Even assuming
that a person misappropriating information from the bidder commits
fraud on the bidder, the Commission has provided no coherent or
consistent explanation as to why such fraud is "in connection with"
a tender offer, and thus the Commission may not seek to prevent
indirectly conduct which it could not, under its current theory,
prohibit directly. 11
Finally, even further assuming that the Commission's
misappropriation theory is a valid basis for direct liability, I
fail to see how Rule 14e-3(a)'s elimination of the requirement of a
breach of fiduciary duty is "reasonably designed" to prevent the
underlying "fraudulent" acts. The majority's primary argument on
this score is that in many cases" 'a breach of duty is likely but
difficult to prove.'"
Ante, at 674 (quoting Reply Brief for
United States 16). Although the majority's hypothetical
difficulties involved in a tipper-tippee situation might have some
merit in the context of "classical" insider trading, there is no
reason to suspect similar difficulties in "misappropriation" cases.
In such cases, Rule 14e3(a) requires the Commission to prove that
the defendant "knows or has reason to know" that the nonpublic
information upon which trading occurred came from the bidder or an
agent of the bidder. Once the source of the information has been
identified, it should be a simple task to obtain proof of any
breach of duty. After all, it is the bidder itself that was
defrauded in misappropriation cases, and there is no rea-
11 I note that Rule 14e-3(a) also applies to persons trading
upon information obtained from an insider of the target company.
Insofar as the Rule seeks to prevent behavior that would be
fraudulent under the "classical theory" of insider trading, this
aspect of my analysis would not apply. As the majority notes,
however, the Government "could not have prosecuted O'Hagan under
the classical theory,"
ante, at 653, n. 5, hence this
proviso has no application to the present case.
698
Opinion of THOMAS, J.
son to suspect that the victim of the fraud would be reluctant
to provide evidence against the perpetrator of the fraud.12 There
being no particular difficulties in proving a breach of duty in
such circumstances, a rule removing the requirement of such a
breach cannot be said to be "reasonably designed" to prevent
underlying violations of the misappropriation theory.
What Rule 14e-3(a) was in fact "designed" to do can be seen from
the remainder of the majority's discussion of the Rule. Quoting at
length from the Commission's explanation of the Rule in the Federal
Register, the majority notes the Commission's concern with "'unfair
disparities in market information and market disruption.'"
Ante, at 674 (quoting 45 Fed. Reg. 60412 (1980)). In the
Commission's further explanation of Rule 14e-3(a)'s
purpose-continuing the paragraph partially quoted by the
majority-an example of the problem to be addressed is the so-called
"stampede effect"
12 Even where the information is obtained from an agent of the
bidder, and the tippee claims not to have known that the tipper
violated a duty, there is still no justification for Rule 14e-3(a).
First, in such circumstances the tipper himself would have violated
his fiduciary duty and would be liable under the misappropriation
theory, assuming that theory were valid. Facing such liability,
there is no reason to suspect that the tipper would gratuitously
protect the tippee. And if the tipper accurately testifies that the
tippee was (falsely) told that the information was passed on
without violating the tipper's own duties, one can question whether
the tippee has in fact done anything illegal, even under the
Commission's misappropriation theory. Given that the fraudulent
breach of fiduciary duty would have been complete at the moment of
the tip, the subsequent trading on that information by the tippee
might well fail even the Commission's own construction of the "in
connection with" requirement. See supra, at 683-687. Thus, even if
the tipper might, in some circumstances, be inclined to protect the
tippee, see
ante, at 675-676, n. 20, it is doubtful that the
tippee would have violated the misappropriation theory in any
event, and thus preventing such nonviolations cannot justify Rule
14e3(a). Second, even were this scenario a legitimate concern, it
would at most justify eliminating the requirement that the tippee
"know" about the breach of duty. It would not explain Rule
14e-3(a)'s elimination of the requirement that there
be such
a breach.
699
based on leaks and rumors that may result from trading on
material, nonpublic information.
Id., at 60413. The majority
also notes (but does not rely on) the Government's contention that
it would not be able to prohibit the supposedly problematic
practice of "warehousing" -a bidder intentionally tipping allies to
buy stock in advance of a bid announcement-if a breach of fiduciary
duty were required.
Ante, at 672-673, n. 17 (citing Reply
Brief for United States 17). Given these policy concerns, the
majority notes with seeming approval the Commission's justification
of Rule 14e-3(a) "as a means necessary and proper to assure the
efficacy of Williams Act protections."
Ante, at 674.
Although this reasoning no doubt accurately reflects the
Commission's purposes in adopting Rule 14e-3(a), it does little to
support the validity of that Rule as a means designed to prevent
such behavior: None of the above-described acts involve breaches of
fiduciary duties, hence a Rule designed to prevent them does not
satisfy § 14(e)'s requirement that the Commission's Rules
promulgated under that section be "reasonably designed to prevent"
acts and practices that "are fraudulent, deceptive, or
manipulative." As the majority itself recognizes, there is no "
'general duty between all participants in market transactions to
forgo actions based on material, nonpublic information,'" and such
duty only "'arises from a specific relationship between two
parties.'"
Ante, at 661 (quoting
Chiarella, 445 U.
S., at 233). Unfair disparities in market information, and the
potential "stampede effect" of leaks, do not necessarily involve a
breach of any duty to anyone, and thus are not proper objects for
regulation in the name of "fraud" under § 14(e). Likewise (as the
Government concedes, Reply Brief for United States 17),
"warehousing" is not fraudulent given that the tippees are using
the information with the express knowledge and approval of the
source of the information. There simply would be no deception in
violation of a duty to disclose under such circumstances. Cf.
ante, at 654-655 (noting Government's conces-
700
Opinion of THOMAS, J.
sion that use of bidder's information with bidder's knowledge is
not fraudulent under misappropriation theory).
While enhancing the overall efficacy of the Williams Act may be
a reasonable goal, it is not one that may be pursued through §
14(e), which limits its grant of rulemaking authority to the
prevention of fraud, deceit, and manipulation. As we have held in
the context of § 10(b), "not every instance of financial unfairness
constitutes fraudulent activity."
Chiarella, supra, at 232.
Because, in the context of misappropriation cases, Rule 14e-3(a) is
not a means "reasonably designed" to prevent persons from engaging
in fraud "in connection with" a tender offer, it exceeds the
Commission's authority under § 14(e), and respondent's conviction
for violation of that Rule cannot be sustained.
III
With regard to respondent's convictions on the mail fraud
counts, my view is that they may be sustained regardless of whether
respondent may be convicted of the securities fraud counts.
Although the issue is highly fact bound, and not independently
worthy of plenary consideration by this Court, we have nonetheless
accepted the issue for review and therefore I will endeavor to
resolve it.
As I read the indictment, it does not materially differ from the
indictment in
Carpenter v.
United States, 484 U. S. 19 (1987).
There, the Court was unanimous in upholding the mail fraud
conviction, id., at 28, despite being evenly divided on the
securities fraud counts, id., at 24. I do not think the wording of
the indictment in the current case requires a finding of securities
fraud in order to find mail fraud. Certainly the jury instructions
do not make the mail fraud count dependent on the securities fraud
counts. Rather, the counts were simply predicated on the same
factual basis, and just because those facts are legally
insufficient to constitute securities fraud does not make them
legally insufficient
701
to constitute mail fraud.13 I therefore concur in the judgment
of the Court as it relates to respondent's mail fraud
convictions.
13 While the majority may find it strange that the "mail fraud
net" is broader reaching than the securities fraud net,
ante, at 678, n. 25, any such supposed strangeness-and the
resulting allocation of prosecutorial responsibility between the
Commission and the various United States Attorneys-is no business
of this Court, and can be adequately addressed by Congress if it
too perceives a problem regarding jurisdictional boundaries among
the Nation's prosecutors. That the majority believes that, upon
shifting from securities fraud to mail fraud prosecutions, the
"practical consequences for individual defendants might not be
large," ibid., both undermines the supposed policy justifications
for today's decision and makes more baffling the majority's
willingness to go to such great lengths to save the Commission from
itself.
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