Brief Fact Summary.
Dirks (Defendant), based on some nonpublic information he received and a following investigation, assisted the SEC (Plaintiff) in convicting Equity Funding of America (EFA) for corporate fraud and was then sued by the SEC (Plaintiff) for violating Â§ 10(b) due to his open disclosure of nonpublic information to investors.
Synopsis of Rule of Law.
Before a tippee will be held liable for an open disclosure of nonpublic information received from an insider, the tippee must derivatively assume and breach the insider’s fiduciary duty and the tippee will be deemed to have derivatively assumed and breached this duty only when he knows or should know that the insider will benefit in some way for the disclosure of the information to the tippee.
An insider will be liable under Rule 10b-5 for inside trading only where he fails to disclose material nonpublic information before trading in it and thus makes secret profits.View Full Point of Law
Dirks (Defendant), the tippee and officer of a brokerage firm, was told by the insider, Secrist, that Equity Funding of America (EFA) was committing corporate fraud.Â The Defendant then investigated EFA to verify Secrist’s information.Â Neither Defendant nor his firm owned or traded EFA stock.Â However, during Defendant’s investigation, he openly disclosed the information to investors and many of them sold their EFA stock as a result.Â The price of EFA stock then dropped from $26 to $15.Â However, mainly because of Defendant’s investigation, the SEC (Plaintiff) was able to convict the officers of EFA for corporate fraud.Â Still, the Plaintiff sued the Defendant and reprimanded him for revealing the nonpublic information to the investors.Â The court of appeals affirmed.Â Defendant applied for and was granted certiorari by the U.S. Supreme Court.
Will a tippee automatically be liable for openly revealing nonpublic information received from an insider?
(Powell, J.) No.Â Before a tippee will be held liable for an open disclosure of nonpublic information received from an insider, the tippee must derivatively assume and breach the insider’s fiduciary duty to the shareholders of not trading on nonpublic information. The tippee will be deemed to have derivatively assumed and breached this duty only when he knows or should know that the insider will benefit in some way for disclosing the information to the tippee.Â Simply receiving the nonpublic information by a tippee from an insider does not automatically include an insider’s fiduciary duty.Â Here, the insider, Secrist, did not benefit as a result of his disclosure.Â He revealed the information to Dirks (Defendant), the tippee, only to help expose the fraud that EFA officers were committing.Â Therefore, because the insider, Secrist, did not benefit from his disclosure of nonpublic information to Defendant, the tippee, Secrist, did not breach his fiduciary duty to the shareholders.Â And so, since the insider, Secrist, did not breach his duty to the shareholders, there was no derivative breach by Dirks (Defendant) when he revealed the nonpublic information to investors.Â Reversed.
This case is consistent with the Court’s decision in Chiarella v. U.S., 445 U.S. 222 (1980), where the Court found that there is no general duty to disclose before trading on material nonpublic information and held that a duty to disclose under Â§ 10(b) does not arise from simply possessing the market information.Â Instead, the Court found, this duty arises when a fiduciary relationship exists.