Analysis of United States v. James Herman OHagan - Case Study Example

CASE HEADING: United s v. James Herman O'Hagan, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997) CONCISE RULE OF LAW: 10(b) of the Exchange Act provides: "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange- . . . . . "(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors." 15 U.S.C. 78j(b).

Rule 10b-5, provides: "It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange, "(a) To employ any device, scheme, or artifice to defraud, [or] .. . . . . "(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, "in connection with the purchase or sale of any security." 17 CFR 240.

10b-5 (1996). Rule 14e-3(a), provides: "(a) If any person has taken a substantial step or steps to commence, or has commenced, a tender offer (the offering person'), it shall constitute a fraudulent, deceptive or manipulative act or practice within the meaning of section 14(e) of the [Exchange] Act for any other person who is in possession of material information relating to such tender offer which information he knows or has reason to know is nonpublic and which he knows or has reason to know has been acquired directly or indirectly from: "(1) The offering person, "(2) The issuer of the securities sought or to be sought by such tender offer, or "(3) Any officer, director, partner or employee or any other person acting on behalf of the offering person or such issuer, to purchase or sell or cause to be purchased or sold any of such securities or any securities convertible into or exchangeable for any such securities or any option or right to obtain or to dispose of any of the foregoing securities, unless within a reasonable time prior to any purchase or sale such information and its source are publicly disclosed by press release or otherwise.

" 17 CFR 240.14e-3(a) (1996). ISSUE(S): 1) Whether or not a person who trades in securities for personal profit, using confidential information misappropriated in breach of a fiduciary duty to the source of the information, guilty of violating 10(b) and Rule 10b-5 2) Whether or not the Commission exceeded its rulemaking authority by applying Rule 14e-3(a), even when it relates to trading on undisclosed information in a tender offer setting, even in the absence of a duty to disclose FACTS: In July 1988, Grand Metropolitan PLC (Grand Met) retained Dorsey & Whitney to represent it in a potential tender offer for the common stock of the Pillsbury Company.

Both parties took precautions to protect the confidentiality of Grand Met's tender offer plans. Respondent James Herman O'Hagan was a partner in the said law firm but did not work on the Grand Met representation. He began purchasing call options for Pillsbury stock. By September he had 2,500 Pillsbury option; and 5,000 shares of Pillsbury common stock which he bought at under $39 a share. On September 9, 1988, Dorsey & Whitney withdrew from representing Grand Met. Grand Met, then, publicly announced its tender offer resulting in the sudden rise of the of the Pillsbury stock to nearly $60 per share.

O'Hagan sold his call options and stocks, making a profit of more than $4.3 million. The Securities and Exchange Commission (Commission) conducted its investigation which resulted in a 57 count indictment alleging that O'Hagan defrauded his law firm and its client by using for his own trading purposes material, nonpublic information regarding Grand Met's planned tender offer in violation of 10(b) and Rule 10b-5 of the Exchange Act. He was convicted by the jury and sentenced to a 41 month term of imprisonment.

On appeal, the Court reversed the decision on account that there was no breach of fiduciary duty since he was not a part of the group that represented Grand Met. HOLDING(S) AND DECISION: 1) Yes. A person who trades in securities for personal profit, using confidential information misappropriated in breach of a fiduciary duty to the source of the information is guilty of violating 10(b) and Rule 10b-5. 2) No. The Commission did not exceeded its rulemaking authority by applying Rule 14e-3(a), even when it relates to trading on undisclosed information in a tender offer setting, even in the absence of a duty to disclose because the underlying reason for the law is to protect the integrity of the securities market.

REASONING: 1) The "misappropriation theory" applies since a person commits fraud in a securities transaction under 10(b) and Rule 10b-5, when he misappropriates confidential information for securities trading purposes, in breach of a duty owed to the source of the information. This fraud is form of deception directly prohibited under said law. So even if O'hagan was not a direct party to representation agreement between his law firm and Grand Met he is bound not to use or disclose said information. 2) The misappropriation theory having been proved to apply to this case is also designed to "protec[t] the integrity of the securities markets against abuses by outsiders' to a corporation who have access to confidential information that will affect th[e] corporation's security price when revealed, but who owe no fiduciary or other duty to that corporation's shareholders.

" Thus, the Commission did rightfully apply the same to this case.