Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc.

United States Court of Appeals for the Second Circuit · 1974 · Corporations

495 F.2d 228 (2d Cir. 1974)

Updated August 22, 2026

CorporationsSecurities fraudInsider tradingTipper-tippee liabilityRule 10b-5Section 10(b)inside informationtipper

Facts

Merrill Lynch, acting as prospective managing underwriter for a Douglas debenture offering, received confidential adverse inside information from Douglas management about sharply reduced earnings projections. Merrill Lynch and certain officers, directors, and employees passed that nonpublic information to selected Merrill Lynch customers, who knew or should have known the information was undisclosed and then sold or short-sold more than 165,000 shares of Douglas stock on the NYSE before public disclosure. Merrill Lynch and the individual defendants received commissions and other compensation from these trades. Plaintiffs bought Douglas stock on the NYSE during the same period without knowledge of the inside information and alleged they would not have purchased had the information been disclosed.

Issue

Whether Section 10(b) and Rule 10b-5 are violated when a prospective underwriter and its personnel tip material adverse inside information to customers who then trade on a national securities exchange without public disclosure, and whether those tippers and tippees are liable in damages to contemporaneous open-market purchasers who did not buy the specific shares sold by defendants. Also at issue was whether causation and reliance were sufficiently alleged despite the absence of privity and the anonymity of exchange trading.

Rule

Anyone in possession of material inside information must either disclose it to the investing public or abstain from trading in or recommending the securities while the information remains undisclosed. That duty applies not only to insiders but also to nontrading tippers who divulge the information and to tippees who know or should know of its confidential, nonpublic character. In a Rule 10b-5 nondisclosure case, privity is not required, and causation in fact is established where defendants were under a duty to disclose material facts that reasonable investors might consider important and traded or recommended trading without disclosure.

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

Pine Harbor Securities in New York was helping arrange a bond offering for Solara Devices, a public company based in Ohio. During due diligence, Solara privately told Pine Harbor's syndicate desk that its quarterly losses were far worse than expected; before any public release, a vice president at Pine Harbor quietly passed that information to two favored clients so they could protect their holdings, but the vice president did not personally trade.

If uninformed investors bought Solara shares on the NASDAQ during the same period, which is the strongest argument that the vice president violated Rule 10b-5?

Explanation. The majority held that nontrading tippers can violate Section 10(b) and Rule 10b-5 by divulging confidential material inside information to others who trade on it. The rule is not limited to personal trading, matched counterparties, or SEC injunction actions. The wrong is the tipping of material inside information for trading while the investing public remains uninformed.