U.S. v. O'Hagan and the misappropriation theory of insider trading

U.S. v. O'Hagan case

Facts

In the U.S. v. O'Hagan case, the defendant, James Herman O'Hagan, was a partner in a major Minneapolis firm, and was involved in a corporate acquisition as a representative of the acquiring corporation (Corley, et al., 2002). D allegedly used insider information to purchase stock before the details of the acquisition were made public.

History discovered in 1988 that Grand Met PLC, one of his clients, planned to acquire Pillsbury Company (Corley, et al.). D purchased Pillsbury stock and options to acquire Pillsbury stock. D made four million dollars when the acquisition was announced.

D's actions caught the attention of the plaintiff, the Securities Exchange Commission (SEC) and the local U.S. attorney. D was convicted of 57 counts of securities fraud, mail fraud and money laundering, and received a 41-month prison term.

This decision was based mainly on the "misappropriation theory," which prohibits using any information to defraud in the sale of securities as stated in Rule 10b-5.

Issue

However, the U.S. Court of Appeals overturned the decision, stating that Rule 10b-5 did not reach the use of inside information by a non-insider, as long as the non-insider did not deceive a participant in the trade (Corley, et al.).

In addition, it ruled that, because there was no breach of fiduciary duty by the defendant to the company that owned the stock or the trade participants, there was inadequate association between the misappropriation and the sale to allow the use of the proposed Rule 10b-5.

The Court of Appeals ruled that the SEC could not define fraud to include the misuse of inside information where there was no breach of fiduciary duty. The case was sent to the Supreme Court, which overruled the Court of Appeals' decision

Result

The U.S. v. O'Hagan case is considered one of the most important cases dealing with insider trading which the Supreme Court has decided in the last decade (Corley, et al.). The classic theory of insider trading did not apply to this case, as the trader did not have any legal or ethical ties to the company. However, the Supreme Court ruled that the Misappropriation Theory held D. liable for violating the securities laws.