Chiarella v. United States

Brief Fact Summary.

Chiarella (Defendant) was employed as a printer, and while there, saw information that one corporation was planning to attempt to secure control of another, and he used this information by going out and trading stock.

Synopsis of Rule of Law.

An individual who purchases stock and who has no duty to a prospective seller because he is neither an insider nor a fiduciary has no obligation to disclose material information he has acquired, and his failure to disclose such information does not, therefore, constitute a violation of § 10(b) of the Securities Exchange Act of 1934.

Facts.

While employed as a printer at Pandick Press, Chiarella (Defendant) was exposed to documents of one corporation revealing its plan to attempt to secure control of a second corporation.  Although the identities of the corporations were hidden by blank spaces or false names until the true names were sent over the night of the final printing, Defendant had deduced the names of the target companies beforehand from other information contained in the documents.  He did not reveal any of this information to the prospective sellers and then purchased charges in the target corporations.  After the takeover attempts were made public, he sold them and realized a gain more than $30,000 over 14 months.  An investigation was initiated by the SEC, which concluded with Defendant’s entering into a consent decree agreeing to return his profits to the sellers of the shares.  That same day, Pandick Press fired him.  He was then indicted eight months later on 17 counts of violating § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 19b-5.  Defendant argued that his silence regarding the information he discovered did not constitute a violation of § 10(b) as he was under no duty to disclose the information to the prospective sellers, because as he was neither an insider nor a fiduciary.  The district court instructed the jury that Defendant should be convicted if it found he had willfully failed to notify sellers of target companies securities that he knew of an impending takeover bid that would make their shares more valuable.  In affirming the resulting conviction, the court of appeals held that “(a)nyone—corporate insider or not—who regularly receives material non-public information may not use that information to trade in securities without incurring an affirmative duty to disclose.â€Â  The Supreme Court granted certiorari.

Issue.

If a stockholder owed no duty of disclosure to the party he purchased securities from, does his failure to disclose material information he has acquired constitute a violation of § 10(b) of the Securities Exchange Act of 1934?

Held.

(Powell, J.)  No.  If an individual who purchases stock is not an insider or a fiduciary, and therefore has no duty to a prospective seller, his failure to disclose inside material information he acquired does not establish a fraud in violation of § 10(b) of the Securities Exchange Act of 1934.  Administrative and judicial interpretations have established that silence in connection with the purchase or sale of securities may operate as a fraud actionable under § 10(b) despite the absence of statutory language or legislative history specifically addressing the legality of nondisclosures.  However, such liability is premised upon a duty to disclose which arises from a relationship of trust and confidence between parties to a transaction.  Here, the charges of the lower courts did not sufficiently reflect his duty requirement.  Plus, both courts failed to identify a relationship between Chiarella (Defendant) and the sellers that could give rise to a duty and therefore provide a basis for his conviction under § 10(b) for failure to disclose the information he had.  It may well be that he breached a duty to the acquiring corporation when he acted upon information he obtained by virtue of his position as an employee of the printer employed by the corporation.  It is not necessary to decide whether this breach of duty would support a conviction under § 10(b), for this theory was not presented to the jury.  Reversed.

Dissent.

(Burger, C.J.) I would read § 10(b) and Rule 10b-5 to mean that a person who has misappropriated nonpublic information has an absolute duty to disclose that information or to refrain from trading.  The broad language of the statute and the intent of Congress to use it as an elastic “catchall†provision to protect the uninitiated investor from misbehavior indicates the propriety of such an interpretation.

(Blackmun, J.) Chiarella (Defendant) was guilty of fraud because he knowingly “stole†the information regarding the pending tender offers.  His conduct was also fraudulent within the meaning of § 10(b) and Rule 10b-5, as this type of manipulative trading lies at the heart of what the security laws are intended to prohibit, regardless of whether his employer’s principals had approved his conduct.  The majority’s requirement of a “special relationship†similar to a fiduciary duty undermines the flexible, purposefully catchall nature of § 10(b).  Such a requirement, on which the duty to disclose or to abstain from trading on material nonpublic information is now conditioned, finds no support in the language of the statute or its legislative history.  It is also not consistent with the principle that the securities laws should be interpreted flexibly rather than with narrow technicality.  Defendant’s misuse of confidential information was “inherently unfair,†and therefore, his conviction should be upheld.

Discussion.

The SEC has not made a practice of challenging trading by non-insiders on the basis of undisclosed market information.  In fact, it has generally pointed to some fiduciary duty or special relationship between the purchase or seller and the outsider trader as a basis for such challenges.  For example, in SEC v. Campbell, [1972-1973 Transfer Binder] Fed. Sec. L. Rep. (CCH) P93, 580 (C.D. Cal. July 24, 1972), the writer of a financial column engaged in “scalping,†i.e., purchasing stocks just before recommending them in his column and then selling them when the price rose after the recommendation was published.  The SEC went to great lengths to compare his relationship with his readers to that of an adviser’s relationship with his clients.