SEC v. Cherif

United States Court of Appeals for the Seventh Circuit · 1991 · Corporations

933 F.2d 403 (7th Cir. 1991)

Updated August 22, 2026

CorporationsSecurities fraudInsider tradingMisappropriation theoryNominal defendantRule 10b-5Section 10(b)misappropriation

Facts

After his employment at First Chicago ended, Cherif used a reactivated identification card and confidential knowledge gained during his employment to enter the bank after hours and access the Specialized Finance Department, which held confidential information about extraordinary corporate transactions. Soon after these entries, he traded in the stocks of four companies about which the department had confidential information, making profits through accounts in his own name and in Sanchou's name. Cherif had signed the bank's integrity policy during his employment, and the SEC produced trading records, entry records, and a recorded conversation in which Cherif admitted using the card to enter the bank. About $250,000 remained in accounts in Sanchou's name, but the SEC did not allege that Sanchou himself had violated the securities laws.

Issue

Whether a former employee who uses confidential property and knowledge obtained during employment to obtain and trade on material nonpublic information can be enjoined under Section 10(b) and Rule 10b-5 under the misappropriation theory. Also, whether the district court could freeze assets held in Sanchou's accounts when the SEC had not alleged that Sanchou himself violated the securities laws, and whether the injunctions had to be modified to release more funds for attorney's fees.

Rule

A person violates Section 10(b) and Rule 10b-5 by misappropriating and trading on material nonpublic information entrusted to him by virtue of a fiduciary relationship such as employment. A former employee's common-law duty to protect confidential information entrusted during employment continues after termination, and using confidential property or knowledge gained in that relationship to obtain inside information and trade is fraud "in connection with" a securities transaction. A non-wrongdoing third party's assets may be restrained only if that person is properly treated as a nominal defendant with no legitimate ownership interest in the disputed property; Rule 19 does not itself create subject matter jurisdiction.

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

Lena Ortiz worked as a project coordinator at Harbor Crest Advisory in Chicago, where she signed confidentiality policies and regularly handled internal deal files. Six months after resigning, she used a still-functioning remote login and her knowledge of the firm's file structure to access confidential merger materials, then bought shares of a target company before the deal was announced.

If the SEC sues Lena under Section 10(b) and Rule 10b-5, what is the strongest basis for liability?

Explanation. The majority adopted the misappropriation theory: a person violates Section 10(b) and Rule 10b-5 by misappropriating and trading on material nonpublic information entrusted through a fiduciary relationship such as employment. The theory does not depend on a duty to the issuer's shareholders. A former employee's continuing duty to protect confidential information makes post-employment misuse fraudulent rather than mere theft.