A decision this month by a federal appeals court in St. Louis
reversing the securities fraud conviction of a Minneapolis attorney
has dealt a potentially crippling setback to enforcement of the
laws against insider trading.
In July 1988, the British conglomerate Grand Met retained
Dorsey & Whitney, one of the largest and most prestigious law firms
in the Midwest, to represent its interest in acquiring the
Minneapolis-based Pillsbury Co. James O'Hagan, a Dorsey partner
specializing in securities law, soon became very interested in
acquiring Pillsbury securities. Within the next two months, O'Hagan
became the world's largest investor in Pillsbury options,
mortgaging his house in the process.
Ordinarily this would have been an extremely high-risk
investment strategy. Unlike corporate stock, which has intrinsic
value, "call" options are a wasting asset that eventually become
worthless unless the underlying stock appreciates in value before
the expiration date of the option. Of course, O'Hagan was in a
position to know not only that the value of Pillsbury stock was
going to rise but also when and by how much. When Grand Met
announced its takeover plans in October, the price of Pillsbury
stock rose immediately to almost $60 a share from $39. O'Hagan
realized a profit of $4.3 million.
The magnitude and timing of O'Hagan's trades attracted the
attention of the Securities and Exchange Commission. Its
investigation culminated in a 57-count indictment. A Minneapolis
jury convicted him on all counts, and he was sentenced to 41 months
in prison. The 8th U.S. Circuit Court of Appeals saw it
differently, vacating O'Hagan's conviction in a 2-1 decision.
Insider trading is a violation of Section 10(b) of the
Securities and Exchange Act of 1934, and the SEC's Rule 10(b)-5.
Both require proof of deceptive conduct "in connection with" the
purchase or sale of securities. The Supreme Court has held that the
insider trading prohibition is a function of the duty of loyalty
owed by a corporation's directors, officers and employees to its
shareholders. It is unlawful to corporate insiders with secret
information to purchase securities from, or sell securities to,
their own shareholders.
Though he clearly had access to material nonpublic information
about the future of Pillsbury, O'Hagan owed no loyalty to Pillsbury
securities holders who sold him their options in August and
September 1980. However, by appropriating for personal profit
client information required to be held in the strictest
confidentiality, O'Hagan betrayed the trust and confidence of his
own employer, Dorsey & Whitney.
The 2nd, 3rd, 7th and 9th federal court circuits in recent
years have all adopted the "misappropriation" theory, of which
O'Hagan was surely aware at the time of his Pillsbury trading and
under which he was indicted. …