Dirks v. Securities and Exchange Commission

Supreme Court of the United States · 1983 · Corporations

CorporationsInsider tradingTippee liabilityRule 10b-5SECRule 10b-5Section 10(b)tippee

Facts

Dirks, an officer of a broker-dealer firm, received allegations from former Equity Funding officer Ronald Secrist that Equity Funding's assets were vastly overstated because of fraud. Dirks investigated by interviewing company officers and employees, and while doing so he openly discussed the information with clients and investors, some of whom sold substantial Equity Funding holdings. Dirks and his firm did not own or trade Equity Funding stock, and Dirks also urged the Wall Street Journal to write about the allegations. After trading was halted and regulators uncovered the fraud, the SEC censured Dirks for passing the information to investors who traded on it.

Issue

Whether a person who receives material nonpublic information from corporate insiders and passes it to investors who trade violates the antifraud provisions of the federal securities laws. More specifically, whether a tippee has a duty to disclose or abstain merely because he knowingly received confidential information from an insider, or only when the insider breached a fiduciary duty in disclosing it.

Rule

A tippee's duty to disclose or abstain is derivative from the insider's duty to the corporation's shareholders. A tippee assumes a fiduciary duty not to trade on material nonpublic information only when the insider breached his fiduciary duty by disclosing the information and the tippee knows or should know of that breach; the insider breaches that duty only when he discloses the information for a direct or indirect personal benefit, such as pecuniary gain, reputational benefit that will translate into future earnings, a quid pro quo, an intention to benefit a particular recipient, or a gift of confidential information to a trading relative or friend.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

In Seattle, Nora Kim, the chief financial officer of RainHarbor Biologics, secretly tells her college roommate Ava Lin that the company will miss earnings badly. Nora says she is sharing the news so Ava can avoid losses, and Ava immediately sells her shares before any public announcement.

Is Ava most likely liable under Rule 10b-5 as a tippee?

Explanation. A tippee's duty is derivative of the insider's breach. The insider breaches by disclosing material nonpublic information for a direct or indirect personal benefit. A gift of confidential information to a trading relative or friend qualifies as such a benefit. Because Ava knew the information came from an insider and traded, she is liable. The majority rejected any general equal-information rule, and lack of a preexisting fiduciary duty does not defeat derivative tippee liability when the insider breached.