Under the misappropriation theory, corporate outsiders are prohibited from trading based on material, non-public information (MNPI) in breach of a duty owed to the source of the information, not to the counterparty. The misappropriation theory premises liability on a trader’s deception of those who entrusted him with access to confidential information, thereby defrauding the principal of the exclusive use of that information. The relevant question is whether the source disclosed the information with an expectation of confidentiality, that is, with the expectation that such information would not be shared with other parties. It is sufficient to prove that the tipper knew or had reason to know that the information was disclosed in a confidential manner.1
The DOJ and SEC have pursued insider trading charges against external service providers, lawyers, accountants, and family members of corporate insiders under this theory.
Recently, the Second Circuit in United States v. Chow held that, under the misappropriation theory, the managing director of an investment firm, by virtue of entering into NDAs, retained a legal duty of confidentiality not to share information about an impending acquisition of a semi-conductor manufacturer.2 Chow drew upon the Second Circuit’s earlier decision in United States v. Kosinski, which found that individuals who enter into confidentiality agreements, and thereby obtain company information that they agree not to disclose, become “temporary insiders” with fiduciary-like duties.3
In Chow, the Second Circuit found the evidence was sufficient to support inferences that Chow knowingly and intentionally breached his duty of confidentiality under the NDAs when he disclosed MNPI regarding the progress of negotiations surrounding the acquisition to Michael Yin, a social acquaintance and former work colleague. During a four-month period, Yin traded on the target company’s stock, purportedly based on the information obtained from Chow, and amassed $5 million.4
The Second Circuit further held that there was sufficient evidence establishing that Chow received a personal benefit from Yin in exchange for disclosing the MNPI, even though Chow did not expect to receive any of Yin’s $5 million trading profits. Rather, the Second Circuit noted that Yin provided Chow with information on other manufacturers of semi-conductors and linked his investment bank contacts with Chow’s fund for profitable undertakings. Chow also received gifts of wine and cigars from Yin.5
Overall, while Chow did not necessarily create new law, the case iterates that, at least within the Second Circuit, a standard NDA is sufficient to establish a duty of confidence and that violating such an obligation by trading on MNPI or sharing it with another could expose one to insider trading liability.
1 See United States v. O’Hagan, 521 U.S. 642, 652 (1997).
2 See United States v. Chow, 993 F.3d 125, 138–139 (2d Cir. 2021).
3 United States v. Kosinski, 976 F.3d 135, 144-45 (2d Cir. 2020), petition for cert. denied, 141 S.Ct. 2755 (2021).
4 See Chow, 993 F.3d at 131-33, 139-42.
5 See id. at 142.